Robo-advisors are touted as the next big thing in digital banking and investments. For the May Digital Banking Tracker™, PYMNTS spoke with Dan Egan, director of Behavioral Finance and Investments at Betterment, who told us how robo-advisor services are shaking up the investment banking industry — and investors are lining up. That, plus, how financial newcomers are shaking up the digital banking landscape and a directory of over 170 providers, including 10 new additions, await.
In the world of transportation and mobility, one of the most-awaited innovations is the autonomous vehicle capable of automatically navigating streets and routes based on user preference. Meanwhile, in the world of digital banking, an innovation that can help clients automatically navigate investments based on their preferences is already available: robo-advisors.
Over the past decade, several institutions have begun experimenting with robo-advisors (also known as robo-investors). Robo-advisors are online portfolio management solutions relying on computer algorithms to manage client investments with little human involvement. They gather information about client investment goals and use that input to automatically divert funds toward the most appropriate areas of the client’s portfolio (such as stocks or bonds), helping them meet their financial objectives.
One of the biggest appeals of robo-advisors for financial advisory firms is the cost-savings. Because robo-advisors’ decision-making is carried out by computer algorithms, they cost considerably less than a human-managed service. For example, robo-advisor firm WiseBanyan charges a 0 percent management fee and requires no investment minimum, whereas Wealthfront charges an annual 0.25 percent management fee and requires a $500 account minimum.
The assets managed by robo-investment services have risen significantly over the years to an estimated $50 billion. By some accounts, robo-advisors are expected to oversee $2 trillion in assets by 2020.
But while innovations like the robo-advisor and autonomous vehicles might generate buzz and promise exciting benefits to users, the question remains: Will investors be willing to trust them with their assets?
Some firms are betting that investors are ready to take a chance on digital investment. Online investment firm Betterment is one of the first companies to bring robo-advisor services to market. The company currently has over $8.5 billion in assets under management and employs a blend of financial goal-based solutions, automated wealth management tools and tax-loss harvesting. For a discussion about how robo-advisors have the potential to alter the investment banking landscape, PYMNTS recently caught up with Dan Egan, Betterment’s director of Behavioral Finance and Investments. Egan shared why investors are willing to trust automatic investment tools over traditional, human financial advisors to help them reach their financial goals.
New World of Investments
Last year, the Department of Labor implemented the fiduciary rule, which is aimed at ensuring retirement brokers put their clients’ interests first and disclose any potential conflicts of interest. While the rule is meant to assure investors that their brokers are putting their clients’ best interests first, Egan said the necessity for a law requiring client interests be taken into consideration first raised some eyebrows. Suddenly, investors realized that brokers had previously not been required to disclose potential conflicts.
“I think that blew people away,” Egan said.
A survey conducted last year of 1,018 U.S. adults found almost half (46 percent) were under the false impression that all financial advisors were legally required to act as fiduciaries and put the best interests of their clients’ first when making retirement savings advice. With the Department of Labor currently reviewing the legality of the fiduciary rule, consumers are becoming more cautious about the advice they get from a financial advisor or a broker.
“Everybody wants a financial advisor they can trust and do well by them,” Egan said.
In other words, the fiduciary rule revealed to consumers that human brokers could be more motivated in selling services or products to their clients that work in the broker’s self-interest, instead of the services that best meet their clients’ needs. A recent survey found 93 percent of Americans want financial advisors to be legally required to put their clients’ interests first when doling out retirement investment advice.
As these revelations and potential rule changes seep into public consciousness, Egan sees an opportunity for robo-advisor firms like Betterment to step in to ease investors’ anxieties by offering conflict-free services. The firm is set up as a fiduciary advisor and follows a fiduciary standard.
“That’s something the public is becoming more aware of now and is starting to value fiduciary non-conflicted advice,” Egan said.
Breaking Down Robo-Investment Misconceptions
When it gets down to the nuts and bolts of it, Egan said, there’s a fairly general misperception about what a “robo-advisor” or “robo-investment” firm actually is. There are, as it turns out, no robots involved in the company’s solutions. Or, as Egan puts it, “No robots were harmed in the making of this investment portfolio.” Cue robo-rim-shot.
But, he pointed out, Betterment does use a series of computer algorithms designed to help customers meet their financial goals by taking stock of their financial profiles. The algorithm asks consumers what they are saving for, details about their financial circumstances and their financial goals. Based on the consumer’s input, the algorithm produces a financial plan to help them meet their objectives.
The company’s solutions automatically rebalance portfolios by directing dividends or deposits to the portions of a portfolio that need it. It also offers a tax loss harvesting feature that Egan referred to as “making lemonades out of lemons,” by looking for ways to reduce consumers’ taxes by using investment losses to offset taxable income.
But just because Betterment relies on algorithms doesn’t mean there aren’t human beings working behind the scenes, said Egan. He pointed out that Betterment has a team of in-house certified financial planners who play a key role in developing the computer algorithms and who are available to speak with consumers about their specific circumstances.
“We take [the financial experts] questions, their answers, their thought processes, and we codify them into algorithms and make them available to everybody,” he said.
Betterment also offers its clients access to the company’s financial planners with relatively low annual fees (between 0.4 and 0.5 percent). These services, however, are reserved for customers who are subscribed to one of the firm’s top-tiered plans.
Planning for Financial Futures … and Space Travel
According to Egan, Betterment currently has about 230,000 customers using its platform and is managing over $8.5 billion in assets.
As Egan described it, Betterment’s customers have a wide variety of goals for their investments. These ambitions include planning for upcoming expenses, such as purchasing a vehicle, making a down payment on a house or planning a wedding. In a few cases, customers are even planning trips to space in the next 10 to 15 years.
Trips to space may be a long way off, but it’s typically never too soon to start saving for a big investment. But as customers consider robo-advisors to manage their assets, Egan is confident that Betterment has found a “sweet spot” that offers both digital-first investment and lower costs than conventional investment firms.
“My hope is that people start realizing that they can get good, un-conflicted financial advice and investment management for a low cost that is going to help them lead better financial lives,” Egan said.
And it appears that some more established institutions are ready to get on board with robo-advisor services. Several major financial service firms, including E-Trade, Fidelity, Charles Schwab and TD Ameritrade, have expressed interest in or have launched their own robo-advisor services to automate portfolio management.
But the robo-advisor tools have a long way to go before they can become mainstream. According to a poll from Gallup and Wells Fargo taken last year, less than half of surveyed investors were familiar with robo-investments. The same survey found only 5 percent of respondents said they have heard “a lot” about robo-investing.
The same survey found more investors still have more confidence in humans than robo-advisors to simplify the investment process, help customers understand their risks and make good client recommendations, among other services.
Still, the Gallop/Wells Fargo survey called attention to one of the key selling points that make robo-advisors appealing to investors. Two-thirds of those surveyed believe robo-advisors will charge lower fees than a human.
Robo-advisors might not be mainstream yet, but once they become more widely available, the solutions have the potential to be as disruptive to investments as the self-driving car promises to be for mobility and driving. And no matter how you look at it, change is coming down the road.
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About the Tracker
The PYMNTS Digital Banking Tracker™ brings you the latest news, research and expert commentary from the FinTech and consumer banking space, along with the rankings of over 170 companies serving or powering the digital banking sector.
We’re always on the lookout for opportunities to partner with innovators and disruptors.
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