It has been predicted that by 2020, the robo-adviser market is going to expand to $7 trillion. The low management fees are extremely attractive, and robo advisers are making investment accessible to customers with only a small portfolio balance — as little as $5,000. There are currently around 100 robo advisers in America, but as this industry expands, the market is set to become more competitive. Does this mean we’ll be waving goodbye to traditional financial advisers?
What Exactly Are Robo Advisers?
Robo-advisers are financial advisory firms that are using computer technology and algorithms in order to simplify the investment process. The robo adviser first uses tech to create a handful of investment portfolios. It will then pick the best one based on the instructions that that the investor has provided with regard their tolerance for risk and their investment goals.
What Are the Advantages?
Robo advisers reduce costs, by using technology to build portfolios up, which is an advantage to investors. It means that the world of financial investment is opened up to more people. The application process is easy, you just pick your investor and complete their questionnaire. Most robo-advisers offer IRAs — both traditional and Roth. There are new niche players entering the robo-advisory market all the time.
For instance Bloom specializes in 401(K) management, and Emperor Investments deal solely with stock portfolios. For new graduates and investors under the age of 35, Twine — a branch of John Hancock — have recently launched their own robo-advisory service for young investors. Many companies also offer access to live advisers alongside their computer counterparts, so you get the best of both.
So What’s the Downside?
Independent robo advisers not only have to gain new customers, but outperform other players. For underfunded platforms, this makes it difficult to compete. A client acquisition might cost between $600-$1,000. If the client maintains an account of say $30,000, and he pays a management fee of 0.25 percent, that equates to a pay-out that will take six to eight years.
For a small firm, this is a long time to wait and could be detrimental to the business. The low management fees mean that it can be difficult for robo-advisory firms to succeed. A niche robo adviser needs a profitable fee structure and a unique value proposition in order to be sustainable. They need to be able to differentiate themselves in this competitive market and offer something interesting to investors.
How Will the Market Move Forward?
At the moment, it is the industry leaders that are thriving in the robo-advisory market, such as Betterment, Wealthfront and Personal Capital. These are the experienced firms and are already well-established.
Startups are failing at a high rate because with management fees averaging between 0.25 and 0.89 percent, there is little room for error. The fact is high acquisition costs are making it difficult for startups to hit the ground running.
However, as computer technology becomes more sophisticated and the investments become less risky, it is likely we will see more and more robo-advisory services. Will they take over from 35,000 SEC-registered investment firms in America? This remains to be seen. However, it is certain that the robo adviser is here to stay. It is opening up the world to new investors that want to save for the future.
Don’t panic, the robos aren’t taking over the world just yet. But we will however undoubtedly see them become more mainstream.