Plenty of services have been disrupted by technology. When was the last time you used a travel agent? How many of us use tax software instead of an accountant? Is financial advice about to be taken over by technological innovation? Or will it simply improve the quality and efficiency of in-person advice, as it has in numerous skilled professions from medicine to graphic design?
Many of the first robo-advising services arguably suffered from a general ignorance of the financial advising profession. I can imagine that entrepreneurs called in famous finance professors and asked them how to automate investment advising. To a finance professor who doesn’t really understand the profession, it’s all about making investment portfolios more efficient. So that’s what the robos did.
Building a well-diversified, tax-efficient passive portfolio that automatically rebalances isn’t rocket science. Many advisors have been using technology to help with these tasks for years. This type of mechanical portfolio management is also remarkably scalable and cheap. It is a commodity, and those who provide the service at the lowest cost will attract the most investment dollars. Financial services companies (for example Charles Schwab & Co.) recognize this and now offer the service for free in order to attract investor dollars to its financial products.
Not surprisingly, this competition has caused a flood of inflows into the lowest cost providers as growth in some of the most famous first-mover robos has stalled. Recently, Wealthfront CEO Adam Nash touted the potential of artificial intelligence as a possible way to resurrect some excitement about the company. But the reality is that investors attracted to the original concept of an automated portfolio manager have largely been captured.
The first rule of robo-advising is that the robo part (rebalancing, tax efficiency) may not be worth the cost of admission. According to David Blanchett, head of retirement research at Morningstar, “many of the robos are significantly over-representing the benefits of tax loss harvesting.” And rebalancing isn’t that difficult.
The reality is that an investment portfolio that automatically rebalances and changes allocation to match age and risk tolerance is already available at a lower cost in target date ETFs. At 15–30 basis points plus ETF fees, this means that it may be hard to attract sophisticated do-it-yourself investors. When your product is an easily replicated technology, there is no moat protecting your business model.
In a recent article comparing returns on mutual funds sold directly to investors versus those sold through brokers, Boston College finance professor Jonathan Reuter identifies two distinct types of investor — one who is sophisticated and self-directed, and the other who relies on a broker to guide investment choice. Sophisticated, self-directed investors care about fund expense ratios and net performance. Those who rely on a broker don’t.
According to Reuter, “robo-advisers may appeal most strongly to investors who already have a preference for low cost mutual funds and are therefore conditioned to focus on fees. The long-run result may be robo-advising services that all offer similar portfolio management services and charge similar prices.”
It is these self-directed investors who have made Vanguard the second largest asset management firm in the world. They’re also the ones most likely to recognize the value of services that increase the net, risk-adjusted return on their (mostly) passive portfolio. They’ll be the first adopters of technology that improves performance.
They’ll also be the first to leave if they can get a better deal. They’re the investors that robos seemed to be attracting through marketing that bashes the expense of traditional advisors. And self-directed investors aren’t sticky.
It shouldn’t be surprising then that Vanguard’s Personal Advisor Services project, which mixes the ability to talk with a remote human advisor along with passive, efficient investing strategies at a cost of 30 basis points, has more than doubled over the last year to over $36 billion in assets — a figure that is five times the combined assets of Betterment and Wealthfront, the two largest robo advisors. Investors also get access to lower cost (10 basis points less) admiral shares as well as access to an actual human advisor who can tailor an investment plan to an individual’s needs.
Who is going to be a client of Vanguard’s remote in-person advising service? According to Frank Kolimago, head of Vanguard Personal Advisor Services, “the vast majority of clients who’ve adopted the service are existing Vanguard clients.” And when do they decide to pay a little extra for advice? “About two-thirds of our clients are within 10 years of age 65,” notes Kolimago. In other words, they pay for advising when they have questions they can’t answer themselves.
About 40% of client interactions are through virtual video conversations. Kolimago points out that “clients are embracing the video consultations. Technology is allowing us to do things that we never would have imagined 20 years ago.”