This week, we have a follow-up question from blog reader Jasmin:
How good are automated online investing services?
This is one of the most common questions I hear from millennials. Many automated investing services (also called “roboadvisors” or simply “robos”) have launched in the past several years. Robos have made investing very easy and convenient for some people, because robo clients do not have to research investments on their own or consult with an advisor. Instead of opening an account and deciding what to buy, the robo will automatically allocate and invest based on an online risk-tolerance questionnaire.
Although robos are not doing anything novel, I believe they bring a lot of value to the marketplace. Most roboadvisors offer a solid service, at a low cost, with very low account minimums. Perhaps most importantly, they provide these things to a segment of investors that did not have many good options previously.
While some investors prefer to invest themselves and others use the services of an advisor, many investors cannot meet the account minimums of a traditional advisor nor have the inclination to manage investments themselves. Robos are great for these investors.
However, there are a few important factors to consider when deciding whether or not to use a robo:
- Most of the robos only offer asset allocation advice. They cannot advise on individual investments, stock options, tax planning, real estate, and so on. It is fine to separate investment management from financial, tax, and estate planning (many investors don’t even need, much less pay for, these services). However, investors should know that roboadvisors typically provide a narrower set of services than human advisors.
- Portfolios are not customized. Clients are not able to customize their portfolio, hold positions with low cost basis that would be cost-prohibitive to sell, make tactical adjustments, or effect other personalized customizations. I tend to agree with the argument that roboadvisors should be regulated as mutual funds rather than as investment advisors, based on how the current regulations are written.
- As discussed previously, there is no best or even standard asset allocation. Designing an asset allocation is very subjective and allocations across robos vary quite a bit.
- Most of the robos only use passively-managed index funds. Sometimes passive management is better, sometimes active management is better. Passive-only is probably a better bet than active-only due to the generally lower costs, but a service that blended active and passive would be much better IMO.
- I have seen some roboadvisors market impossible and misleading claims. I won’t get into the weeds in this post, but as always: caveat emptor.
This is only tangential to the original question, but I think the outlook for robos is worth mentioning. The first wave of start-up B2C roboadvisors, priced their services very aggressively. Perhaps they priced too low. Some shifted to a B2B model of offering white-labeled versions of their services to third-parties. Others shut down or sold themselves to fund sponsors.
Fund sponsors quickly figured out that robos were a great tool for fund distribution and many sponsors bought or started their own robos. I have always thought that the fund sponsor-owned robos would be tough to beat because their product fees (from the underlying funds) can subsidize the distribution (the robo service). So far, this seems to the case, as the Vanguard and Schwab robos easily outgrew the early incumbents Wealthfront and Betterment.
This trend of sponsor-backed robos dominating should continue as many robos find it difficult to generate any net income. I doubt Wealthfront has turned a profit yet, despite being a market leader with tons of VC investment. The competition will likely get tougher too, as the sponsor-owned robos can offer their services for free (Schwab does). How can anyone compete with free? How can anyone compete with free in a commoditized industry? I don’t think it is possible.
So I think the future will be dominated by free or close-to-free robos that are mostly owned by fund sponsors. This should drive costs down, although it also brings some conflicts of interest (but those issues are common to many advisory business models, not just robos; so that’ll be another post someday). Overall, I think robos are and will continue to be a choice for a certain segment of the investor population.
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