When it comes to investment advice, would you trust a financial professional or a robot?
A growing number of people are choosing the latter, on the belief that algorithms can provide rational and dispassionate advice at a cost well below that of traditional advisers.
A handful of automated investment startups created in the past few years now have more than US$4 billion in assets under management, according to Forrester Research.
It is a small segment of a trillion-dollar wealth management industry but growing at a red-hot pace, Forrester analyst Bill Doyle said.
“This is a more meaningful crop of disruptors than we’ve seen for many years, really since the Internet brokerages emerged,” the analyst told reporters.
Doyle said the digital investment services appeal to young adults who lack the minimum — often US$100,000 to US$1 million — for traditional wealth managers, but who want advice or management of their investments.
Robo-adviser firms often allow customers to set their preferences and let the algorithm do the rest — trading, rebalancing and minimizing taxes.
Costs are often far less than a traditional advisory firm, which might charge 1 percent or more of a customer’s assets.
Wealthfront, the largest of the new breed, announced this month it had reached US$2 billion in assets under management in just over three years.
The California startup has an investment team led by Princeton University emeritus professor of economics Burton Malkiel, the author of a 1973 book that championed “passive” investing in low-cost indices for stocks, bonds and other assets.
The strategy is based on the idea that “active” managers rarely outperform over the long term on a broad index such as the Standard & Poor’s 500, especially when manager fees are included. These firms mainly recommend exchange-traded funds that offer these blends of assets.
Other startups including Betterment and FutureAdvisor use a similar formula — turning over daily portfolio management to an automated algorithm that selects investments based on a customer’s risk profile, age and other factors, in an effort replicate broad market returns.
“More people are searching for a technology-first automated solution,” Betterment’s Joe Ziemer said.
The New York startup launched in 2010 now has 73,000 customers and US$1.6 billion under management.
Betterment’s average customer is 36 years old but its fastest growing segment is people over 50.
The mainstream financial industry has taken notice.
The large investment firm Charles Schwab this month launched its “Intelligent Portfolios,” using a similar method, without any fees beyond the underlying investment fund costs.
Schwab is likely to quickly overtake the “pure play” automated firms but will not put them out of business, according to Doyle.
“Schwab’s entry will raise this whole market. It brings credibility to this model,” Doyle said.
However, Doyle said the large investment firms have done little to appeal to young adults with relatively small amounts to invest.
Some financial advisers argue that an algorithm can never replace the personal recommendations and hand-holding a live person can provide.
“Our conversations are deeper. We talk with people about their goals, about saving for retirement, for that home they want to buy.” National Association of Insurance and Financial Advisors president Juli McNeely said. “Sometimes my biggest job is to talk people off the bridge. When there is a market panic, they want to jump. We need to talk it through so they understand what’s happening. It’s a comfort to have someone to talk to.”
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