Investing Trends: Here Come the Robo-Advisors!
With everything else moving online at an ever increasing clip, it seems only natural that investment advice should move in that direction also. You will hear more about “robo-advisors” (detailed description in this Barron’s article) in the months and years ahead. While the term may be offputting to some, we may come to realize that investment decisions made by a robot (with no emotions) might actually provide us with better outcomes..
This concept of the “robo-advisor” is becoming more mainstream as evidenced by the news from Charles Schwab this week (Schwab is one of the largest retail brokerage firms with close to 10 million brokerage accounts):
From NY Times:
The brokerage firm Charles Schwab said on Monday that it would enter the online investment advice market early next year and would offer its advisory services to those customers without charge. In the last few years, companies like Wealthfront, Betterment and FutureAdvisor have made a big splash building software that puts customers in a collection of low-cost exchange-traded funds.
For a fee of roughly 0.15 to 0.5 percent each year on the assets, the companies help people assess their risk tolerance, put them in an appropriate mix of these index-fundlike investments and rebalance back to the original allocation as the markets move. They also can help with optimizing sales to save money on taxes.
Investment News notes how this offering from Schwab will disrupt financial advisors who provide investment advice at much higher fees:
William Trout, a senior analyst with Celent’s wealth management unit, said the product could be disruptive to investment advisers who custody [editor’s note: custody means to hold investment assets] with Schwab because even if the service appeals to a mass affluent clients who may not need a full adviser relationship, it is likely to put additional pressure on advisers to drive down their fees. “Schwab’s decision to offer its platform to consumers for free is unlikely to go over well with its captive network of adviser,” he said.
Reuters notes the much lower fee structures for the Schwab offering vs. standard brokers:
The program, to be marketed as Schwab Intelligent Portfolios toretail investors and independent investment advisers, will create portfolios of exchange-traded funds managed by Schwab and other providers.
In foregoing management and transaction fees, Schwab intends to be “disruptive” to competitors, company officials said in a conference call. Most automated investment programs charge about 0.25 percent of the money that clients invest. Traditional brokerage firms, including Schwab and competitors such as Bank of America’s Merrill Lynch and Morgan Stanley, typically charge 1 percent or more of clients’ invested assets in advisory programs.
SF Business Journal spotlights a local start-up company, Wealthfront, which pioneered this trend toward automated advice:
Wealthfront CEO Adam Nash says he’s not surprised to see Charles Schwab disclose plans this week to enter the robo-advisory business as his firm pocketed another $64 million in venture capital. “There is a once-in-a-generation opportunity to build a company from the ground up to focus on the millennial investor,” Nash wrote Tuesday in a company blog.
How will this change my classroom instruction? As I noted in an earlier post, there are certainly many shortcomings in using the currently popular Stock Market Game as a learning device. This trend towards robo-advisors I think is a positive one for investors. Why?
- This approach focuses on buying asset classes (e.g. U.S. Stocks, International stocks, etc.) and not individual stocks thereby providing investors with diversification.
- Significantly lower cost; .25% vs. 1.00% may not seem like a big difference but compounded over many years it adds up.
- Most robo-advisors will rebalance an investor’s portfolio which over time tends to enhance returns as it automatically sells the appreciated asset and buys the lower-performing asset (so hard for investors to do!) to bring the portfolio into balance.
Our upcoming investing unit (released next week) will cover topics such as asset allocation, asset classes and the importance of fees. We will also include a performance task where students will make decisions about an asset allocation that is right for them given their risk profile, time horizon and investing goals.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.
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