I’ve been telling you for most of 2016 that financial technology, or Fintech, is changing the investing and trading landscape.
One of the most profound Fintech disruptors is the creation of automated investment services, more commonly known as “robo-advisors.”
The idea of automating investment services was the brainchild of a handful of millennial-focused Fintech entrepreneurs, most of whom are millennials themselves.
With their general aversion to traditional fee-based advisory services, their experience of living through the tech-wreck of 2000 and the 2008 market shellacking, their comfort and trust in computers and technology, millennials (the generation born or coming of age between 1982 and 2000) were presumed to be the perfect audience for robo-advisory services.
Sure enough, assets under management by robots (and their human helpers) exploded into the billions this year.
But millennials aren’t the only group who are enamored with these low cost, automated investment services. They’re catching on with lots of investors.
If you’re not one of those investors, today, I’m going show you how robo-advisors work and what they cost, as well as the pitfalls associated with this newfangled investing horizon.
Low Fees Are a Huge Incentive
Automated investment services aren’t hard to understand, on the surface at least.
Basically, you fill out online “paperwork” including questions about your age, maybe your education level and knowledge or investing experience, your financial situation, your goals, and other pertinent questions that traditional financial advisors or registered investment advisors should be asking you.
Then your data is run through algorithms that determine how much you should invest, what you should invest in, and when to reallocate or rebalance your portfolio.
If everyone was comfortable with robo-advisors there wouldn’t be any need for additional human help. But a lot of investors endeavoring into the robo-advisor world want some additional human contact.
So there are different product offerings available.
In fact, there are five so-called automated investment service account types:
- Direct-to-consumer accounts with no human interaction;
- Direct-to-consumer accounts with limited advisor assistance;
- Direct-to-consumer accounts with heavier advisor assistance;
- Traditional services with in-house digital wealth management offerings; and
- Retirement-specific providers, including both direct-to-consumer and business-to-business providers.
As far as fees, they range from low to super low.
Different providers offer different fee structures and several offer multiple structures.
The lowest fee I’ve seen is 25 basis points, that’s 25 one-hundredths of one percent. While that fee looks like a come-on fee because it’s offered on accounts with less than $10,000 invested, annual fees vary. The basic fee model is an “assets under management” annual management fee, where you pay a fee based on how much money you have parked in your account.
A few services offer fixed annual fees. Some offer sliding scale fees, where the more money you put into your account the smaller the fee becomes. And most providers offer additional fee-based services if you want some hand-holding that doesn’t involve a computer.
What Happens in a Crash?
While low fees are a huge plus when it comes to actual returns, they aren’t everything.
Robo-advisory services don’t cut the mustard for me when it comes to things like:
- Really determining individual client profiles and preferences that don’t fit into the “buckets” used to channel your money into algorithms flooded with other supposedly like-minded investors.
- Determining financial goals, expectations of investment return, diversification, and rebalancing plans based on rapidly changing markets and changing personal circumstances.
- Determining the correct investment mix for you based on your expectations for markets, including equities, bonds, commodities, global exposure & other asset classes
Besides the mechanical approach to dumping investors into buckets, I see potential problems on the robo-advisor horizon because they presently don’t require any fiduciary duty standards or other securities laws safeguards that apply to human advisors.
When it comes to robo-advisory services it’s unclear if fiduciary duty laws even apply.
The truth is robo-advisors are not free from conflicts of interest, they may not meet “a high standard of care,” may not provide “completely” personalized investment advice, and may not fulfill other fiduciary standards that a traditional advisor would have to meet.
That scares me.
But that’s only the beginning of what scares me.
No one has any idea how robo-advisors will perform in a market downturn or crash because the huge growth of automated services occurred after the 2008 market crash.
Well, not no one. I have a very good idea about what will happen.
And of course there’s the question of Internet security and cyber hacking as well as potential algorithmic issues where automatic trading algos could go rogue within robo-advisor portfolios.
There are serious pitfalls to robo-advisory services that providers never tell you about.
I’m going to tell you about the worst of them next week.