I have fond memories of 1999.  My year ended at the top of Nob Hill in San Francisco, celebrating with a group of my business school classmates. I have a vague memory from that night of singing along to that famous song by the artist formerly known as Prince.  

The dot-com world was one big party in 1999, fueled by seemingly endless cash from investors, creative new business models, and often-outlandish claims from company founders.  I remember talking to an analyst colleague after a conference call with a high profile dot-com company: when asked about the rationale behind the company’s stock split, the company executive responded “because that’s what growth companies do.” No, we didn’t buy that that stock. 

Many companies and sell-side analysts came up with creative new approaches to valuing businesses, sometimes based on sound thinking about the future but more frequently based on dubious theories that ignored basic economic realities. We know how the party ended, with riches for some and expensive lessons for many others.

On a smaller scale, I think that we’re seeing some parallels to 1999 in the robo-advisor arena. Money is flowing into robo initiatives from venture capital providers and from incumbent financial services firms that don’t want to miss the party.  The latest incumbents entering the fray include TD Ameritrade and Pershing, following the launch of Schwab’s retail offering earlier this year and the June launch of Schwab’s robo solution for advisors.  A couple of the leading robo firms have more than $100 million of venture capital funding, and incumbent firms are spending their own money to keep pace. 

With so much attention paid to this arena, we’re seeing some head-scratching claims. Cue the music for the latest:    

  • “We’re profitable on a per customer basis”
    Betterment claims to be profitable on a per-customer basis, a statement hard to align with generally accepted accounting standards given assets under management that imply revenues of less than $10 million a year, and a cost structure that includes staff (reportedly nearing 100 employees), office space and advertising. Even with the most generous estimates of revenue, annual costs appear to be a multiple of the firm’s current revenue.   
  • “Betterment customers can expect 4.3% higher returns than the typical DIY investor”
    This is an eyebrow-raising kind of claim, one seemingly based on simulations conducted under the most favorable of conditions.  I’d like to see the actual results from the inception of their program receive the same prominence on the website as simulated results. 
  •  “Schwab Intelligent Portfolios charges no advisory fees, no commissions and no account service fees”
    Very few services are truly free, and when a financial services provider claims to offer a free service, I look for hidden costs or subsidies.  Although Schwab isn’t charging an explicit fee for the service, they will profit through indirect mechanisms such as spreads on cash balances maintained at Schwab Bank, ETF platform fees, management fees for Schwab ETFs included in the program and payments for order routing. 

This is the classic example of the codependent relationship between consumers and financial institutions, in which consumers embrace a service with low explicit costs while paying potentially high implicit costs. 

  • “It is worse than payday lending, and it needs to stop” Wealthfront CEO Adam Nash comparing the $3 per month fee that Betterment charges to investors that deposit less than $100 per month to the charges imposed by payday lenders.  I suspect that Senator Elizabeth Warren and her former colleagues at the Consumer Financial Protection Bureau might disagree with this assessment.

Now that I’ve poked some good-natured fun at excessive exuberance among robo-advisors, I’d like to explain how advisors who ignore the robo threat do so at their peril.

3 Signs You’re Vulnerable to Robos

  1. You’re an active manager that picks U.S. stocks or relies exclusively on actively managed mutual funds.
    Picking stocks is hard, really hard and few advisors do it well. Some of the smartest and hardest workers in the investment business spend every waking hour trying to beat the market, and most fail. Picking stocks on a part-time basis, which is the reality for most advisors, is not a recipe for success. 
    If this is you, know that robo-advisors are going to attack you every day – pointing to cost, performance and taxes as advantages of their model over yours. If you pick portfolios of actively managed mutual funds, you’ll still be vulnerable to criticism about cost and taxes, even if you deliver good performance. Picking outperforming managers isn’t easy, either, so the robo offer of a low-cost, well diversified, tax efficient portfolio may be appealing to many of your clients.
  2. You create low-cost, tax sensitive portfolios of ETFs/mutual funds 
    Good for you! Unless you’re charging 1% or more for your services and your “value proposition” is simply assembling the portfolio.
  3. Your client service model is built around paper reports and lunch and dinner meetings.
    The leading robo-advisors have a client experience featuring easy-to-use websites, wide-ranging educational content and a great deal of ongoing transparency. The robo-advisors have done a fantastic job of challenging the service model of most financial institutions. The client experience offered by robo-advisors appeals to the next generation of investors and an increasing percentage of aging boomers like me.  
    Also, the robo-advisors are constantly innovating, so if you’re hoping to catch up with them be aware that they won’t be standing still waiting for you to catch up.  It’s important to anticipate where your competitors are going, not where they’ve been. 

3 Competitive Advantages You Have Over Robos

While you shouldn’t fear the robo, you should respond, focusing on your unique competitive advantages that the robos can’t match. Those advantages are: 

Insight and Trust
You know your clients and have earned their trust. Outstanding advisors guide their clients through financial and personal journeys that have many twists and turns along the way. The advisor-client relationship is often more about behavioral counseling than providing a numerical answer to each question. 

Use technology to automate the tasks that computers are great at solving, use technology and easy-to-understand graphics to illustrate different possible solutions and, above all, use technology as a tool to facilitate more effective communication with your client.  For the best advisors, technology will enhance rather than replace human interaction. If you can’t or don’t want to build the capabilities in-house, buy or partner with a firm that offers the technology you need. 

2. Embrace Complexity
Complexity is your friend! Most people’s financial lives aren’t boiled down to a single financial goal “solved” by a single mathematical function. Most people over the age of 30 have multiple goals which often conflict with one another and may have overlapping rather than sequential time horizons. At times, achieving one goal means that you can’t achieve another.
An algorithm often won’t solve the problem of modifying goals or time horizons, and negotiating complex and emotional topics. 
Many baby boomers are facing fundamental generational conflicts – saving for retirement for themselves while facing elder care considerations for their parents and college expenses for their children. Technology can help with the math of that generational conflict, but probably not be as helpful with the emotional and lifestyle tradeoffs that enter into the decision-making process.

3. Customization
I spent part of my career managing target-date funds, and am proud of my tenure managing funds designed to help people to retire comfortably. Target date funds provide a systematic mechanism for clients to save money for retirement, doing so in a manner that adjusts risk exposure as clients grow older. But target date funds have a critical flaw, which is that they are a “one size fits most” vehicle.
Although robo advisors offer some degree of customization based on a client’s risk profile, I think robo tools are blunt instruments that fall short of the best custom work I’ve seen from advisors creating goal-based portfolios.

Above all, I think that advisors looking to compete with the robo threat should embrace change – take the best that robo-advisors have to offer, and combine it with the best that you have to offer, in order to meet the needs of your current and future clients.