Financial technology or "fintech" is all the rage today, incorporating new technologies and mobile accessibility in the service of investors. One interesting innovation is the automation of investment decisions through the use of computer algorithms. Those so-called "robo advisers" are gaining acceptance, especially among younger investors already comfortable with online and virtual business relationships.
Early entrants in 2008 included Betterment and Wealthfront, but the segment is now dominated by discount brokerage firms like Vanguard and Schwab. While they still represent just a tiny fraction of assets under management, growth has been explosive. Today, robo advisers manage over $150 billion and are expected to exceed $400 billion in 2018 and $2 trillion by 2020.
Those products are still relatively new and untested, particularly during a sustained period of market turbulence. Furthermore, each provider utilizes its own proprietary methodology, which can be difficult for average investors to evaluate. Accurate assessment of important goals and risk tolerance can be challenging to fully explore in a virtual setting. And as with any potential investment, fees and expenses are important determinants of long-term results and should be compared carefully. So what's the verdict?
For many Americans, especially the one third of the population with no retirement savings at all, a robo adviser may be one tool to overcome the inertia of inaction and get started on a sustainable investment program.
Obviously, traditional investment advisers would argue in favor of the value of a personal relationship encompassing professional, customized financial management. This gains in importance as an individual's net worth appreciates and his or her financial picture becomes more complex. Issues like tax efficiency, estate and financial planning take on greater significance and the value of advice increases. In fact, few successful advisers attempt to compete based upon investment performance alone, but on the holistic benefits of a comprehensive relationship.
Still, many people choose to manage their own portfolios. There has never been a better time for self-directed individuals in terms of information and available investment products to assemble and effectively manage financial assets at very low cost. The proliferation of inexpensive index ETFs and the dramatic reduction in trading costs has changed the game for do-it-yourselfers.
But what about those who lack the time or expertise to manage their own accounts but don't want to hire an adviser, or those who just can't seem to get started? For many of these folks, the robo adviser might be just the ticket, if carefully selected and monitored.
The process begins with a risk assessment and determination of financial goals through an online questionnaire. The investor walks through a series of questions to set parameters for selecting the appropriate model. Most firms offer three to five different models ranging from conservative to more aggressive, depending upon your stated objectives.
Once the assessment is complete, the account is funded and the computers take over, allocating funds according to the model and periodically rebalancing to account for varying performance of the underlying asset classes.
For beginners, this may be an attractive option since most robos have a very low or no minimum investment. And for many, the most important decision is not the specific funds but the commitment to get started.
With so many new entrants, selecting the right one is a challenge. You might start with the majors like Schwab, Fidelity, TD and Vanguard. Also consult NerdWallet for an excellent comparison of different service models offered by Betterment, Wealthfront, and other independents.
Personal advice and consultation remains the gold standard. But robo advisers can fill an important niche, especially if the alternative is no action at all.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Investment Co. in Chattanooga.