Top 10 Robo Advisor Myths Debunked
With the explosion of the digital wealth industry (aka “robo advisors”) over the last 6–12 months, there has also been a lot of misinformation circulated by those who aren’t on the front lines in the industry. Mostly, these opinions and reactions have come because firms are scared. The market is moving extremely quickly. It seems like every day there is a new player or entrant into the market. Startups are raising boat loads of cash and even starting to run television commercials.
As an entrepreneur working and innovating in the digital wealth space every day (I am the co-founder of Hedgeable), I thought it was important to dispel some common myths that often come up in conversations:
1. Robo advisors are only for 25 year old kids
FALSE
The average age at a wirehouse advisor is roughly 60. One of the knocks on robo advisors is that they aren’t for grown ups. Only a kid a few years out of school would ever use one. You want to guess what the average age of our clients at Hedgeable is? It’s not 25 or even 30. It’s 40! While half of our clients are millennials (born 1980–2000), roughly half of our clients are in their 40s, 50s, 60s, and even 70s.
2. Robo advice is only a good solution for clients with “small” account sizes who don’t meet advisor minimums
FALSE
One of my biggest pet peeves about the investment management space is the way large institutions talk about their clients. Phrases like “the bottom of our book of business,” “the unprofitable clients,” or “clients too small for us to service” make me cringe. When you meet with decision makers at these places, they talk about people in terms of numbers. People are average account sizes, not a teacher in Milwaukee who worked her entire life for her “measly” $150,000 savings.
Acorns is an example of an innovative business model that takes advantage of smaller, even micro account sizes. Instead of charging an AUM-based fee on small accounts, they charge $1 a month. With a normal asset management model, they would be making relative peanuts with an average $100 account size. Instead, with hundreds of thousands of clients, 12 bucks a year adds up quickly to some large revenue.
Startups have been creative with their business models to compensate for lower account sizes, but that doesn’t mean that digital platforms can only acquire customers traditional wealth managers “don’t want”. It is often said in the industry that there is a line drawn at the $250k or $300k level, whereby an individual has needs that can only be met by a hand-holding wealth management firm. These include estate planning, college savings, tax, legal, trust etc. However, with hundreds of millions of venture funding pumped into technology startups, it would take extreme hubris to think that tech companies full of the smartest Stanford engineers and PHDs can’t add offerings that go beyond asset allocation and go up the value chain. I project that in the next 6–12 months robo advisors will roll out platform additions including estate planning, budgeting, financial planning, and even more complex wealth management tools. If you couple more robust software with a dozen or so planners and tax experts in a call center, why couldn’t a robo advisor compete against a more high touch provider?
This is why I like the term “digital wealth manager” more than robo advisor. It’s where the space is heading and where Personal Capital already is — software hybrids combined with some human touch when needed. This should make every broker dealer and advisor in America pretty scared. The money that has been poured into a handful of startups and the sky high valuations will be good for the industry in the end, because it will force those that have been afraid to adapt for decades, to quickly change their business models or face extinction.
3. Robo advisors will put all traditional advisors out of business
FALSE
The first phase of robo advisory has disrupted the bottom tier advisor who was charging 1–2% to allocate to some Vanguard mutual funds and do a quarterly call. There are probably tens of thousands of these, for which the jig is finally up. They deserved to be disintermediated. However, there is a large sect of advisors who actually add a lot of value, especially for those with more complicated financial situations that arise when you come into more money - e.g. tax, estates, trusts.
I do believe that all advisors, both on the low end and high end of the spectrum, will need some kind of digital solution as a feature add to their business in the next 5 years. The adoption of digital platforms by both the young and old across the financial services spectrum has forced banks and broker dealers to increase their technology footprint. At Hedgeable, we have begun to build out our Hedgeable Next partner network, which allows any wealth manager, CFP, RIA, CPA, or planner to partner with us. It is our hope to refer clients whom we can’t service effectively back to these professionals, who will use our product in tandem with their advice.
4. Robo advisors are dependent on our historic bull market continuing. Once the market has a correction, clients will have no one to panic to on the phone, and will run back to more high touch solutions.
FALSE
While I do agree that a market correction will be problematic for robo advisors, who have succeeded largely in part to a huge run up in equities, I don’t believe it’s the fiery Death Star end to robo advisors that many experts have prognosticated. One of the problems with having a digital solution that you can access 24/7 via phone, tablet, or desktop, is that you become more responsive and anxious about short term moves in your portfolio than you would normally with a quarterly call. This causes people to pull their money out of the market, especially those with taxable or cash accounts, and is an inherent flaw with the digital business model. There is a reason why there is no transparency in investment advisory, because transparency leads to asset outflows.
This being said, I don’t think the market going down 20% will be the end of Wealthfront or Betterment. Both of these firms have done a great job of educating their clients into sticking with them through the ups and downs. Betterment has even gone as far as hiring behavior experts to try to modify the behavior of their clients. Another thing people discount is the fact that not all robo advisors are buy-and-hold, set-it-and-forget-it investors. At Hedgeable, we specialize in downside risk protection, through drawdown and risk control. This more dynamic approach will allow our clients to wither a downturn rather nicely. In fact, risk management is our main selling point.
5. Robo advisors are in a “race to the bottom.” Eventually everyone will charge zero because investment advice has become commoditized.
FALSE
While there has been much fee compression in the space, even in traditional high fee businesses such as hedge funds, the notion that eventually everyone in asset management will have to charge zero is completely absurd. Asset allocation has become commoditized. Anyone with a computer software program can do a Modern Portfolio Theory portfolio and press one button on a broker dealer platform to rebalance it. However, there are some things that people will pay more for: risk management, hedging, extra advice, financial planning, better service, cooler brand, exclusivity, rewards, more customization, more expansive product suite, access to alternatives, better returns etc. At Hedgeable, we offer a premium digital service 2–3 times more expensive than other startups (but still ½ the price of a traditional advisor) and we don’t plan to ever lower the price. Why? We believe our solution is just flat out better and we don’t want to cheapen our brand.
In every market there are cheap, commoditized products and then there are premium ones. I don’t see why the digital advice industry should be any different than a consumer brand. In the beer industry, there is Bud Light and Miller Light which have huge market share and are inexpensive, and then there are microbrews like Sierra Nevada and Sam Adams, that charge a premium because some people prefer the taste. If you went to Macy’s and saw a Kate Spade bag for $500 and a knockoff brand for $100, which bag do you think would be more fashionable, desirable, and better made? Even if the $100 bag was great, charging a premium price for the Kate Spade still makes it seem more appealing. When you have a $100,000 IRA that you have worked all your life for, don’t you think you would want to pay a little more for something that could be better?
6. Only people on the coasts, primarily in California or New York, will ever use a robo advisor.
FALSE
While it is true that computer engineers and startup employees located in tech hubs such as San Francisco, Silicon Valley, and New York City, have been the earliest adopters of robo advisor solutions, their reach spreads far beyond these pockets. Betterment has clients from all 50 states and their user base looks more like the Verizon coverage map from the TV commercials. While it would be no surprise to anyone that clients from California and New York make up our largest geographical segment at Hedgeable, you want to guess what states aren’t too far behind? Places like Georgia, North Carolina, and Colorado.
7. Robo advisors are only for men.
FALSE
There is a perception in the investing industry that robo advisors are only used by geeky guys in Silicon Valley, who get excited reading nerdy finance white papers with formulas and code. While this is probably true in large part because early adopters of any tech product are those in the tech community, and most people in the tech community are dudes, I don’t believe going online to manage your money is only built for men. Although I don’t know exact stats, Betterment has a lot of female clients. We at Hedgeable have historically seen anywhere from 20–30% female adoption, and many of our advisor partners are young females. We have an especially strong appeal to women, especially those with families, because of our investment philosophy focused on protecting against downside risk. Women want to protect their family and they feel comfortable with the fact that someone is looking out for them while they are busy.
8. Robo advisors have all fast money, taxable accounts. There aren’t any sticky long term assets.
FALSE
The raging bull market in US equities post financial crisis coupled with a near zero interest rate environment has helped the robo advisor space grow more than any other factor. If I had $50k saved up in my bank, why not try to earn 5% a year in the stock market instead of close to 0% in my savings? These accounts are fast money and they leave as quickly as they come in. In the asset management business these assets are considered “non sticky.” “Sticky” assets like those in a retirement account such as an IRA or 401k are more valuable to an asset manager because these are assets put away for the long term. It’s “lost” money that you don’t depend on to pay your bills. You may only look at how your IRA is doing once at the end of the year and you don’t worry too much about it, with the hope that over the next 20 years it will grow. If it doesn’t, well, at least it’s money put aside as extra savings.
Sticky assets are harder to get because it’s not every day that you wake up looking to transfer over your IRA. The money isn’t going anywhere soon. It’s a more drawn out decision. However, the largest problem for retail investors isn’t access to tax loss harvesting gains from selling Twitter options, it’s the lack of sophisticated solutions for the mass affluent who only invest through vehicles such as Roth IRAs or 401ks. When we built the investment technology that runs Hedgeable, every decision we made was for these long term retirement assets. There are close to 100 million Americans with retirement accounts after all. Roughly 40% of our clients hold something other than taxable accounts and trusts, such as IRAs and 401ks.
9. Robo advisor startups will get squashed by the likes of Charles Schwab, Vanguard, Merrill Lynch, and Fidelity
FALSE
The large, established retail investment management giants have all either stepped into the robo game or are planning to. Quite frankly, these aren’t even new product offerings, just repackaged managed account programs into digital platforms with some shiny new marketing. Some felt that when Charles Schwab got into the market it was a death blow to startups such as us. Yes, it is true they will accumulate billions of assets very quickly, most of which will just be transferred over from one of their other business lines. But, it has also added legitimacy and tons of needed exposure to the market. They are introducing mainstream customers to robo solutions which helps everyone in the market succeed. I think the most important point that people miss isn’t the fact that Schwab, Vanguard, and Merrill have huge brand names and reaches, it’s that even if a 30 year old Facebook employee sees an ad for Schwab Blue, why would they open account there, even for free? When Schwab started it was the cool tech startup of its day. Now, it’s an old and tired brand for 60 year old men.
This trend of rejecting the old for the new stays true across the financial services landscape. Wells Fargo can build the greatest mobile app with all the bells and whistles like digital check scanning and one touch withdrawals, but cool young people would still rather use something like Simple or Moven. Why? Because my parents have a Wells Fargo account, my cool hipster friends don’t.
10. The robo advisor space is a zero sum game. There will only be one dominant player that owns the majority of the market at the expense of everyone else.
FALSE
The retail asset management market in the United States is huge. There are trillions of assets at play and over 100 million potential customers. Because of this great diversity, there isn’t a one size fits all solution. Think about it, there isn’t one mutual fund company or ETF, there are thousands of them. Asset management isn’t like a search engine. Google dominates that space because it has the best technology, the smartest people, and the most robust results. They built a better mousetrap. Assets have been dispersed amongst many different firms in asset management because I believe brand affinity counts more in financial services than anything else. You need to trust the person that safeguards your money, and some people just trust Schwab more than Merrill, or have a deeper connection with Vanguard over Fidelity.
Incumbent startups can do the same thing. When you ask someone why they have a Wealthfront account, they normally say something like “I don’t know, it is just cool. All my friends use it and they are smart. So I must be missing something.” While there are less than 10 venture backed robo advisors in the market with traction, there are dozens if not hundreds trying to get into the market in the next 6–12 months. There are niche robo advisor platforms launching for Hispanics, women, social causes, and alternatives. I do expect there to be one or two established firms that become large in the digital space, one or two commoditized players, and a few premium providers. As more people offline come online to manage their money, and digital platforms become more robust, there will be a greater need in the market for many different solutions, rather than one cookie cutter all encompassing one. The market is big enough for all of us to co-exist and still build massive businesses.
Conclusion
In conclusion, I am excited to be at the forefront of a market that has desperately needed innovation and change for quite some time. This is truly the last frontier of financial services that technology hasn’t yet flipped on its head. We are only in the first few innings of the ball game and I can’t wait for what is next to come. The next 5 years will be a game changer in the wealth management space and I hope to look back and say I had a lot to do with shaking things up.
I have one message to anyone in the wealth management space who thinks digital is just a passing fad, or they can stick their head back in the sand and continue with the status quo:
