How Robo Advisors Are Impacting Investing

April 28, 2014 As you look at these firms, however diverse, are there any benefits they all share? What makes them a good option for investors?

Easterbrook: To speak broadly, relative to their established competitors, they generally have relatively lower costs, relatively lower minimums, better transparency—or at least online transparency—good pricing for fees and performance.

It's very easy to figure out just how much you're paying. And for the most part, you can track performance online, compared to an index.

They have modern and user-friendly websites, which many of the traditional wealth management firms lack. And for the most part, they don't have as many potential conflicts of interest. On the flip side, what are the pitfalls in this industry?

Easterbrook: For the algorithm-based advice group and the low-cost managed accounts [like Wealthfront and Betterment], for those firms, there's some concern over what's going to happen during a market crash.

Let's say the doomsayers are right and there's a major market downturn. For those firms that don't have any kind of human touch or account manager, how are they going to perform?

In the last crash, we saw a lot of people flock to the sidelines and average Joes tend to get caught in the sell-low-buy-high trap. That's a problem with human emotions, and that's something that's hard to address when you don't have a human relationship, and you're just doing email updates, blog posts. That will be a challenge for these two types of firms. I'm not saying they won't do fine, but we don’t know.

Another pitfall is that in many of these firms, you're replacing the human element and relying on a questionnaire instead. In some cases, those questionnaires either aren't detailed enough, or aren't suited for investors of all knowledge levels.

If you're asking someone, “Here's three hypothetical market scenarios; which one bests matches your risk tolerance?” most people have no idea how to answer that question. That's another big problem people seem to miss.

Finally, these firms don't do complex financial planning or services, like estate planning. There are some things they're not trying to do, and that only a human financial advisor can help you with. Are these firms regulated differently than traditional advisory and wealth managers?

Easterbrook: It depends on what kind of group you're talking about, but for the most part, they're RIAs. Where you get into the tuition-financing firms or the real estate crowd funding, they've got a different set of regulations, but for the most part, the kind of B-to-C investment advice, investment or planning services, they're RIAs. Your research shows that algo-based investing firms are leading the charge in terms of asset gathering and growth. They tell the investor what to buy, what to sell, all at a fund level, based on online surveys; which is to say, the way you answer your survey is hugely important. What’s the main benefit to going the algo-based route?

Easterbrook: The thing about algo-based advice is that people have complicated financial portfolios. In a lot of cases, you've got your 401(k) here; your IRA there; the taxable brokerage account at E*Trade; your spouse's 401(k) here; and you kind of lose sight of your total portfolio.

If you can afford a financial advisor that can act as your CFO, great. But if you can't, they’re very good at aggregating all your holdings and giving you specific buy/sell/hold advice, like, “Did you realize you actually don't have any exposure to real estate? Buy a REIT. You have too much exposure to international stock; buy this instead.” There's certainly value in algo-based advice.



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