Rise of Robo-Advisors Brings Challenges, Opportunities for Consumers

— -- First we had Robocop, the multi-sequel movie. Then we had robo-calls from political candidates (and unfortunately still do). Now, we have robo-advisors.

No, these aren’t C-3PO-style robots out of "Star Wars" that sit at a desk and manage assets. Robo-advisors are investment management platforms that rely on sophisticated computer programs. These programs design portfolios composed of stocks and bonds, based on clients’ risk tolerance, goals and time horizon, as gleaned from questionnaires that clients fill out. The programs automatically rebalance portfolios, restoring them to their original asset allocations when they get out of whack because some assets have moved more in value than others. It’s a digital way to set a portfolio and forget it.

This new platform is being offered by several new firms founded on it, though some established advisory firms –- ones that have long been offering traditional services -- are now beginning to offer robo-advice as an alternative or combined with traditional services. Some estimates hold that robo-advisors now have about .5 percent of U.S. assets after just a few years in existence, and these assets are growing apace. By one estimate, this figure will probably grow to more than 5 percent by 2020.

Before robo, about the only option for people seeking low-cost advice was to consult an advisor by the hour. But this option is for people who want to manage their own investments, and many advisors don’t work this way. With robo, the computer actually does the work.

Not surprisingly, robo-advice is attracting young investors, with Gen-Xers comprising more than two-thirds of all robo-clients. However, there are statistical indications that the platform holds allure for much older investors. One study found that baby boomers are as likely to be engaged with robo-advice as millennials, though millennials usually have a low participation rate in any type of advisory service because they lack disposable income to invest.

Robo-advice holds some distinct advantages, including:

• Substantially lower fees. Annual robo-advisor fees based on assets under management ranging from .25 to .35 percent, and in some cases .15 percent for assets above $100,000 -- aren’t uncommon. By contrast, many traditional advisors charge around 1 percent or more, and often knock this down when managing assets totaling above a set level, perhaps $500,000 or $1 million, depending on how high their minimums run.
• Lower required minimum asset levels. Because of increased economies of scale, robo-advisors can accept clients with far lower total assets, and some have no required minimum. Many human advisors have a $250,000 minimum, and the minimums of many advisors of the well-heeled draw the line at $500,000 or even several times that.
• Reliable rebalancing. Regular advisors rebalance periodically, at set intervals or when a portfolio gets out of whack by a certain margin, but exactly when this will actually happen isn’t always clear. Rebalancing like clockwork isn’t a problem with robo-accounts, as the computers never sleep. However, clients might want to ensure that rebalancing doesn’t occur so often that it runs up trading charges to an extent beyond the advantage actually gained.

Disadvantages include:

• Limited choices, in many cases. The pioneer templates for this service tend to include equity-vehicle offers usually not more varied than exchange-traded funds (ETFs), which are typically passively managed. Eventually, more likely will offer individual stocks, though, unlike passively managed ETFs, this doesn’t tend to be a good asset class for set-it-and-forget-it investing).
• A limited scope of services. If you’re seeking detailed financial planning, which requires an individualized approach, robo-advice may not be for you. Though some vendors are starting to provide human advice for an additional fee, the level of detail involved may not be enough for some people facing major decisions such as when to claim Social Security benefits (a deceptively complex decision) or how to determine the best rates for drawing down their total assets during their imminent retirement.
• Unsuitability for preferences. For investors of all ages, situations and goals, the cookie-cutter nature of robo-advice may not conform to your preferences. Your robo-advisor’s software may put you in a fund that clashes with your goals for socially responsible investing. For example, you may not want to invest in oil companies, preferring instead to invest in clean energy.

Doubtless, robo-advice will become increasingly sophisticated, offering more choices and detail as better computer programs are created for the industry. But some investors will probably still want traditional advice tailored to their unique situations or regarding goals that defy quantification.

Regardless, the current surge of robo-advice is already changing the advisory industry landscape. The low fees are prompting many who might not otherwise have a balanced portfolio –- or, in some cases, any portfolio -– to invest. There’s no question that the impact of robo-advice will be far more profound in the coming years, as more investors sign on and as traditional advisors start to offer it as another arrow in their quiver to be used along with the human touch.

Any opinions expressed in this column are solely those of the authors.

Jamie Cornehlsen and Ted Schwartz are advisors with Capstone Investment Financial Group in Colorado Springs, Colo. Cornehlsen is also president of Dunn Warren Investment Advisors in Greenwood Village, Colo. A Certified Financial Planner®, Schwartz advises individuals and endowments. He holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com. Cornehlsen, a Chartered Financial Analyst®, advises business owners and employees on retirement plans. He holds a B.A. from the University of Colorado and an M.B.A. from the William E. Simon School of Business at the University of Rochester. He can be reached at jcornehlsen@capstoneinvest.com.