Even though robo-advising is still in its infancy, we’re already seeing signs that consumers are embracing the idea of getting financial advice from an algorithm rather than from a person.
Read more: Clark’s investment guide
The rise of robo-advising
First, a definition is in order: What exactly is robo-advising and what does a robo-advisor do?
A robo-advisor is basically an online financial advisor. It is a computer system that uses algorithms and model portfolios based on certain information from a client to develop an investment plan.
Seven out of 10 people in a survey conducted by consulting group Accenture said they would use robo-advisers. Yet at the same time, 68% said they wanted to talk to someone if they had a complaint and 61% said they would want the human touch for confusing financial choices like those involving mortgages.
The reality is that robo-advising doesn’t put a premium on human interaction.
‘No one is there to hold your hand while you’re making life’s big financial decisions like how to pay off college loans, having questions about buying that next house or deciding on the best savings plan to reach retirement goals,’ says financial advisor Wes Moss.
So these kinds of systems are great for helping you with investment allocation, but not really for financial planning in the traditional sense.
Next among the big financial players to join the party was Vanguard. They launched Personal Advisor Services a few months after Schwab. To its credit, Vanguard’s offering combines technology with a bit of the human touch. (Account minimum required: $50,000)
These startups blazed the trail
Before the Schwab, Vanguard and Fidelity got into the game, there were a bunch of scrappy startups blazing the trail.
WiseBanyan.com was the first free online-based financial advisor. The portfolios they recommend are made up of the ultra low-cost exchange traded-funds that Clark loves. The free portfolio building is offered hoping you’ll buy other services from them — no obligation of course.
WiseBanyan is just one of a number of organizations that launched a couple of years ago trying this kind of thing. WealthFront.com is another. It’s specifically set up to offer free guidance to those with portfolios of less than $10,000. Once you’re beyond that, they charge a quarter of a percent per year.
Betterment.com charges fees on a scale, but they’re generally about one-eighth of a percent per year of the money you have on hand. Other similar sites to check out include Blooom.com and GetWela.com.
If you’re just starting out or are younger in life, Internet-based artificial intelligence advice is a reasonable way for you to get financial guidance and direction.
But note this well: Later in life, there’s no substitute for a well-trained and educated human being like a fee-only financial planner. Such a person can be invaluable for guiding you when you’ve built up a pile of money and it’s getting closer to when you’re going to spend it.
Where does the industry stand today and where is it going?
Betterment, which is one of the leading independent robo-advisory firms, pays a pretty penny to acquire customers. Morningstar senior equity analyst Michael Wong told CNBC that he estimates it costs robo-advisors about $1,000 to acquire a new client.
The company has north of 160,000 customers with an average account size of $27,000. Yet Betterment reportedly makes less than $100 in fees per customer each year. So it will take more than a decade to make back the money they spend to get clients. That’s a hard business model to sustain.
Wong figures that any robo-advisor would need about $16 billion to $40 billion in assets under management just to break even. Betterment has about $4.4 billion on the books.
While he’s quick to note their trailblazing nature, Wong doesn’t mince words about the industry’s future.
‘The robo-advisors will leave a lasting legacy in the wealth management industry, [and] they’ve prompted a lot of changes at advisory firms. But there will probably be just a couple of stand-alone firms that survive, another handful will be acquired, and we’ll see a lot of failures.’
Read more: 6 ways to buy stocks for free or very cheap