The Digitalization of Financial Advisors: the trend of robo-advisors

Robo-advisors are digital advice platforms that provide automated, algorithm-driven investment services without any human supervision. They are often very inexpensive and require very low opening balances compared to human wealth managers.

Since the technology behind robo-advisors is not new, given the fact that automated portfolio allocation existed in the early 2000s already, the innovation lies in the fact that they do not require intermediation from any traditional financial advisors anymore. 

You are probably wondering how robo-advisors work. They first ask information about the client’s financial situation, risk-profiling and investment goals through an online survey and then use data to offer advice and to invest the client’s assets. Specifically, many of them offer a variety of investment-related services that can be considered as an improvement from traditional investment banking, such as an easy account setup, attentive customer service, comprehensive education, and most importantly low fees.

In order to develop a profitable robo-advisor is crucial to think of an efficient revenue model, which basically indicates how the digital advice platform is going to make money. The main source of revenues is the management “wrap” fee based on assets under management (AUM), which is usually lower if compared to traditional advisors.  Apart from it, robo-advisors can make money also through the interest earned on cash balances, which becomes a significant source only if there are many users, through payments for order flow and by marketing targeted financial products and services to their clients.

There are many examples of robo-advisors that can be mentioned. However, the best-in-class robo advisors nowadays are Betterment and Wealthfront that have the significant competitive upside of having respectively no and low ($500) account minimums if compared to other competitors. Whereas in terms of AUM, the major player is Vanguard Personal Advisor Services, with an amount of assets under management equal to $170 Bn. 

The main advantages of these digital financial advisors are the fact that they are more accessible and efficient then traditional human advisors. Users can access their services 24/7, as long as they have an Internet connection and can operate on their balance within a few clicks in the comfort of their home. Furthermore, by eliminating human labor, they also represent a low-cost alternative to traditional advisors. They offer the same services at a fraction of the cost, charging an annual flat fee that ranges from 0.2% to 0.5% of clients’ total account balances. This fee is definitely convenient especially if compared to the typical rate of 1% to 2% charged by a human financial advisor. Finally, robo-advisors require significantly less capital to get started, from hundreds to thousand depending on the users’ needs and on which digital advisor they decide to opt for. This represents a huge incentive for potential users to access their services considering the fact that human advisors typically require an initial minimum capital of $100,000 to invest.

However, robo-advisors have their downsides as well. Given the newness of this phenomenon, they have been often criticized for lacking in sophistication and empathy. Moreover, they limit the options that you can make as an individual investor since users cannot purchase individual stocks or bonds nor choose which mutual funds or EFTs they invest in.

Robo-advisors are becoming increasingly popular among investors, but only the future will tell whether this is a temporary phenomenon or if it is a trend that is going to stay.

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