How Robo Advisors Are Impacting Investing

April 28, 2014

ETF.com: Fees vary in these algo-based providers. Some are even free. Does the quality of advice vary as well? Do you get what you pay for?

Easterbrook: I think they proved that it's relatively easy to automate the process—aggregating your holdings, identifying where you have high-cost/poor-performing funds, where your asset allocation is off.

The algorithms can't factor in what age you are; they can't do complex financial planning yet. But it's not that hard to identify a fund you hold is performing poorly, or is very expensive and there’s a better passive option.

But you're right in the sense that you're getting what you paid for. You're only getting portfolio advice, and you're not getting the holistic advice a financial advisor can give you.

ETF.com: In what way are these firms going to impact the traditional financial advice industry? Do you expect them to eventually replace traditional advisors?

Easterbrook: No. I think, generally, traditional management firms that refuse to innovate over the long term will be in trouble regardless of what the startups are doing. Think of a typical full-service firm. They've got a big branch network; they emphasize quarterly face-to-face meetings.

That's very expensive. They have poor websites that don’t really fit the next generation of investors as you shift to Gen X and  Y. That's a challenge in and of itself, regardless of what the startup world is doing.

But I also think these firms are reinforcing a much lower price point for the cost of advice than what traditional wealth management firms offer. Even if they're not competing with those traditional firms today, they're competing over the long term by reinforcing a different set of expectations for the cost of advice.

ETF.com: If you're an investor, how do you go about deciding whether algo-based or online managed accounts from companies like Wealthfront, or a trade-mimicking platform, is right for you? Where do you start the process of figuring out which one of these outfits is best for you?

Easterbrook: That's a great question. Algorithm-based advice is really helpful if you have a complex portfolio with lots of holdings at different places. Say you have a 401(k), an IRA, taxable brokerage account, your spouse has a 401(k), and/or you want to review what your financial advisor's doing—you want a third-party review on the funds your advisor’s put you in.

For low-cost managed accounts, it’s great if you want to invest a lump sum. You’re going all in, and starting over.

Now, if you want to work with a human financial advisor, but don't really want to meet them every quarter face to face because you’re more concerned about costs, you use an online-only financial advisor. And if you want to try to beat the market and try to save some money doing it, you should try “trade mimicking.”

Finally, if a lot of your money is locked up in a 401(k), you're not trying to allocate it, there are firms focused just on that.

It’s a big space and there's something for everyone if they can only find it. It’s hard.

ETF.com: As a final thought, you’ve spent a couple of years researching this space. What really stands out to you in the evolution of this so-called next-generation financial advice?

Easterbrook: The reason we called it “next-generation investing” is because we think there's a big shift taking place as we go from boomers to Gen X, then Gen Y investors. People have been predicting that traditional advisors will have to get more transparent, have to lower costs, have to offer better digital services for years. And they still haven't in a lot of cases.

As this generational shift happens, you've got different preferences that will make it harder for traditional wealth management firms to connect with Gen-X and Gen-Y. At the same time, you've got this next generation of startups that, broadly speaking, have lower costs, lower minimums, better transparency, better websites, less conflict of interest.

These divergent forces are bad news for traditional wealth management firms.

It could be a very potent disruption in the industry. It will be interesting to see what happens to the industry. I'm not naive; inevitably some of these startups will fail, but many will succeed.

 

 

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