Robo Advisors Come of Age: Part One
By: Barbara Novick, Vice Chairman of BlackRock, and Bo Lu, CEO of FutureAdvisor
This is the first post in a two part series on the implications of the rise of digital advice.
Technology is increasingly providing convenient and often low-cost alternatives to services that were traditionally offered in person. In the wealth management industry, digital advice (or “robo advice”) — a new FinTech innovation — has gained popularity in recent years. In a world where 90% of Millennials do routine banking online, digital advice can offer a solution to increase access to financial advice and improve financial outcomes. Here’s why.
The need for financial advice and better financial outcomes is greater than ever.
Research shows that the majority of people choose to hold their savings in cash, rather than investment options such as bonds, equities, or alternative assets. Holding excess cash — especially in low interest rate environments — delivers poor long-term returns, which weakens future spending power. At the same time, average life expectancy has increased significantly since most retirement systems were established, and studies project that consumers’ retirement contributions will not be adequate to satisfy their financial needs throughout retirement. Compounding these issues are a lack of engagement, financial literacy, and access to advice.
Use of professional advisors is declining.
Despite the increased need for financial advice, people are not seeking help from traditional financial advisors. In the US, only 28% of individuals surveyed use a professional financial advisor. Many people simply don’t know where to start investing or are worried that they don’t have sufficient investible assets to warrant a trip to a financial advisor. In some countries, the cost of traditional financial advice is increasing.
Individuals are demanding low cost financial advice… There’s an app for that!
Digital advice has huge potential to help bridge the financial advice gap. Studies show that digital advice appeals to a broad range of investors across demographics, not just millennials. Over 52% of people ages 24–44 are interested in digital advice services, while only 1% of people in that same age range already use digital advice — indicating the growth potential for this market. Total assets under management for digital advisors as of year-end 2015 have been estimated at $55–60 billion, which is quite small in comparison to the $25 trillion US retirement market.
Digital advisors provide a variety of advisory services to clients via internet-based platforms using algorithmic portfolio management strategies. The algorithms are designed to optimize different elements of wealth management from asset allocation, to tax management, to actual product selection and trade execution. Digital advisors can rebalance client accounts, meaning they can keep the asset allocation on track and protect investors from unknowingly over-concentrating their risks as a result of market movements.
There is even choice among the type of digital advice service. Digital advice can be fully automated or can be used to supplement traditional advisors. It can be accessed online or via smartphone apps. Most digital advisors offer multiple ways to engage with a human professional. Different digital advisors have different investment philosophies, methods and strategies. Algorithms can range from a simple or pre-packaged algorithm that builds a single portfolio to a complex multi-strategy algorithm that reviews thousands of instruments and scenarios in order to construct a portfolio based on an individual’s current holdings, investment horizon, and risk tolerance.
Digital advice can provide personalized investment advice at a lower cost than existing advisory models, and there is often little or no minimum balance required, allowing individuals to start investing without a large nest egg. It can also allow people to get advice from the comfort of their own homes and allow advisors to communicate quickly and effectively with clients in times of market volatility.
Stay tuned next week for our second post, which will discuss the regulatory framework for digital advisors and best practices to ensure that digital advice provides appropriate protections for investors.
For a more detailed look at the evolution of digital investment advice and BlackRock’s recommendations on best practices for digital advisors as well as relevant disclosures, click here.