Is AI the New RIA?
Due to the proliferation of new computer-assisted advisory platforms, it’s natural to ask what investment advisers of the future will look like and whether they’ll be humans or robots.
A fast-growing segment of the investment advisory market focuses on providing low-cost advisory services using high-tech advancements. These platforms use computer algorithms to determine appropriate investment products and optimal portfolio composition and then use the internet to deliver information to clients.
These new entrants are commonly referred to as robo-advisers, although some prefer the term “algorithmic investment services.”
Some of these platforms, such as Betterment, Wealthfront, and LearnVest, are building a significant client base and have recently raised a notable amount of venture capital. This is an indication that computer-assisted investment advice and financial planning is a sustainable business model that has already gone mainstream.
Opportunities and Drawbacks
These companies fill a need by giving an under-served part of the market, clients who cannot afford or attract the services of traditional providers, access to financial advice.
Many companies in this space assure investors that they can provide services equal to or better than those of traditional financial advisers at a much lower price point: They advertise fees of 35 bps or less on total asset value because they have reduced or eliminated many fixed costs (labor, rent, etc.) and have automated a number of their business processes.
Replacing people with processors is what fuels the chief and most pertinent criticism of these platforms, which is a perceived inability to customize advice. Many believe that each investor is unique and that his or her individual financial goals, risk preferences, and investment constraints are too complex to be effectively captured by a computer.
These companies take a one-size-fits-all approach to analyzing client needs, which is then used as the basis for investment planning and ongoing financial advice. For example, Wealthfront has a 10-question tool that may not offer a complete assessment, and Betterment merely asks its clients questions about their risk tolerances and goals, which for many are hard to objectively evaluate.
It seems possible that an algorithm could determine a person’s financial ability to take risks, but an algorithm is assuredly less effective than a human practitioner in determining a client’s emotional ability to take on those same risks. Because investor behavior and behavioral biases will have a direct influence on investment decision making, the inability to determine these traits could be problematic.
What Product and for Whom?
These platforms try to mitigate concerns by focusing on individuals with smaller-than-average account sizes, who historically have not had access to investment advice. People without a significant amount of capital are not often in need of complex portfolio strategies or investment products.
Some of these companies are focusing solely on financial planning and helping clients develop fiscal discipline. Another strategy is limiting investment strategies and financial products to passive ones, such as index funds and exchange-traded funds. By restricting clients to taking only market risk, online service providers can offer simple but suitable investment services at the lowest cost available. By targeting high volume, there is the possibility that the providers will find a sustainable business model despite low margins.
As start-ups, some companies originally targeted younger clients because of their trust in technology and comfort with receiving a multitude of services online. Wealthfront, which has amassed more than $800 million of assets under management (AUM) and recently surpassed both Betterment ($500 million) and Personal Capital ($200 million) to become the largest of these advisers, says that more than half of its clients are 35 years old or younger (85% are under 50). But Wealthfront, because of its almost-exclusive focus on upwardly mobile tech professionals in Silicon Valley, may not adequately represent the rest of the tech-assisted advisory market.
In order to develop a competitive advantage and diversify product offerings, some advisers are bundling other financial services, which is also helping them to broaden their customer base. Betterment has attracted older clients by providing a service to reduce longevity risk by determining a safe amount that clients can withdraw from their accounts each month. Wealthfront and Future Advisor are providing tax-loss harvesting performed throughout the year in an attempt to optimize their clients’ portfolio returns.
Full-service financial planning, including personal finance tools, is also included with certain platforms. In fact, there is a focus on delivering basic, intuitive, easy-to-understand financial planning, instead of on complicated or customized investment strategies. The goal is to direct, limit, or change client behavior so that individuals abstain from irrational decision making and instead follow a more appropriate and rational financial plan.
Are These Platforms Changing the Market?
During a panel at this year’s CFA Institute Annual Conference, Fortigent’s Chief Investment Officer Scott D. Welch discussed the competitive challenge that these services may pose for traditional investment advisers in the long term. Although they do not currently present an obvious competitive threat for traditional advisers, they soon may, as individuals from Generation X and Millennials come to make up the majority of advisory clients.
In addition to being comfortable receiving computer-assisted services online, according to Welch, these younger generations “speak technology. . . . It is their native tongue. If you can’t speak to them using that medium, it’s going to be a hard row to hoe.” He also counsels,”What you better be prepared to do as an adviser is have a good answer when they walk in the door and say your proposal looks a lot like this one that is going to cost me 10 bps, so why are you charging 1%?”
In terms of business and market development, it is difficult to argue that computer-assisted investment advice is not a mainstream and growing trend. Well-known traditional advisory companies have entered the market, and traditional advisers can broaden their service offerings by adopting similar methods.
Vanguard has recently started a pilot program (Personal Advisor Services) to assist people who want to make their own investment decisions. Although Vanguard’s fees (30 bps on account value) match competitive programs, their minimum $100,000 account requirement (if successful, to be reduced to $50,000) is still out of reach for the multitude of investors.
But Vanguard’s reaction to their client’s requests for ongoing advice and hand-holding with a low-cost service delivered online indicates that Vanguard believes that a significant group of clients would prefer to receive financial advice in this manner.
These new platforms are finding markets in other countries as well. The United Kingdom has had Nutmeg for a while, and Canada, a country known for having higher-than-normal fees on financial products, has just seen the launch of a new low-cost provider, Nest Wealth.
Business News Network host and Nest Wealth founder Randy Cass, CFA, says, “Nest Wealth gives investors a choice that lets them both rest easy and keep a lot more of their money in their own pockets. Everything being done at Nest is built off of the concepts that large institutions have been using to manage their money for decades, so why shouldn’t individuals be given the same opportunity?”
Although there is little question that they are here to stay, the big question facing these platforms is whether they can evolve with their clients over time. Will these platforms be able to provide more customized services, access to other asset classes, or more advanced strategies as clients save or invest their way into larger investment accounts?
Will they be able to leverage new advancements in behavioral finance, automation, and artificial intelligence (AI) to compete more effectively with traditional investment advisers?
In the interim, the market will evolve so that some traditional advisers begin offering similar tech-assisted products to profitably service smaller accounts.
Getting the most out of these platforms will require some introspection and review of product offerings. Although some of these platforms may take a one-size-fits-all approach, in addition to bundled services, their primary product offerings are very different. Some focus primarily on money management and financial planning, some focus on providing advice for the user to execute, and others focus on investing and investment management. To find the right platform requires a good understanding of your financial needs and the type of service and interface you want.
Because most of these services collected information using questionnaires, it is important to understand your financial goals, risk profile, and investment constraints. It can be difficult for a computer algorithm to determine the nuances in your investment philosophy and ability to manage risk, so it is important to provide this information as candidly and accurately as possible.
For example, it would not be to your advantage to commit to accepting more risk for the potential for additional return to have any commensurate increase in price volatility keep you awake at night. Because the method for collecting information may be limited (bad info in = bad info out), it falls on you to know the right information to provide.
Finally, each provider has different fee structures and account restrictions. Although almost all are inexpensive in comparison with other traditional investment advisers, which can charge as much as 1% – 2% of asset value, it is important to understand and be comfortable with what you are paying for.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
6 thoughts on “Is AI the New RIA?”
First, there is no “AI” involved in robo-advising. They all use a relatively simple algorithm that assigns predefined weights to customer responses in a simplified questionnaire to determine the target asset allocation. Then they pick plain ETFs to implement each asset class in the portfolio.
Second, many of these robo-advisers will die soon. The reason is that newcomers give out their services for free to gain market share from the more established ones. It is a race to the bottom in fees. Basic asset allocation is already free, and soon periodic rebalancing of the portfolio and the tax-loss harvesting will be free as well (BTW, read Michael Kitces’ post on the dubious value of the latter).
Third, for an investor with the same risk profile and goals, each of these robo-adivsers produces a different target portfolio. So much for being a “TurboTax for investments,” as some of them tout (TurboTax and similar software produces the same tax return given the same set of inputs). Some of them even recommend half of equity assets in foreign stocks on the premise of world market allocation (good luck with unmanaged currency risks!).
As investors become better and better educated, there is no reason for them to tolerate any fees, whether from robo- or regular advisors. There is simply no reason to let anyone insert themselves between an investor and his/her ETFs, even with a few bps.
As far as I know, currently there isn’t a platform that has incorporated AI into their advisory platform. However, due to the focus on integrating behavioral finance into these computer- assisted service offerings, programs that could learn more about clients and provide more customized solutions would be valuable, so I can see advancements in AI being implemented at some point in the near future.
There is a multitude of people that are in need of investment advice. There is also a segment of the population that doesn’t want to be educated about finance and investing above a level where they can protect themselves against fraud and other threats. There will always be a demand for advisory services from people that need hand holding, that do not have confidence in their own investing capabilities, or that simply want some confirmation supporting their investment decisions. Considering the amount of people that do not have access but want advice, the best of these low-cost providers of advisory services should be able to develop a sustainable business model.
As far as providing a different strategy or portfolio composition for the same risk profile and goals, this also takes place when humans provide advice, and is not a weakness specific to computer-assisted platforms. I see a greater threat to these platforms coming from traditional advisors that adopt these advisory models to broaden their client base, than from individuals becoming better educated and not needing someone to be between them and their ETFs.
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> As far as I know, currently there isn’t a platform that has incorporated AI into their advisory platform.
Well, so why is the title of your post “*Is* AI the New RIA?” The present tense implies this is happening now, not in the future.
The business model of even the biggest (which is not the same as the best) robo-advisors is NOT sustainable. A large team of software developers needed to implement and run these websites cannot be sustained on a few tens of bps quickly going down to zero due to the “land grab” by new entrants.
> There will always be a demand for advisory services…
Wishful thinking. If the younger investors are Internet-savvy enough to currently use robo-advisors, they are also smart enough to in the near future figure out the basic premises of asset allocation and get rid of intermediaries sandwiched between them and their ETFs. Just wait and see.
> As far as providing a different strategy or portfolio composition…
It is a fundamental weakness throughout the entire advisory industry. Why? Because as a prospective client, I would have *zero* faith in any robo- or traditional advice if I were presented with drastically different asset allocations based on my identical inputs.
> I see a greater threat to these platforms coming from traditional advisors…
Again, wishful thinking. The real threat to robo-advisors currently comes from discount brokers and ETF firms (re: Vanguard), who will develop the same or better capabilities in-house and offer them for free or close to free. That implies no acquisition of robo-advisors, and hence no lucrative exits for VCs who by now pumped hundreds of $ million into these ventures.
Actually the title of the post is in the form of a question. In this case and in the immediate future the answer is no.
This is a new frontier and before there is significant amount of data to track there will be differences of opinion. The rest is yet to be seen.
Great article Robert and interesting to see it has taken nearly two years for Wealthfront to be the first to wake up to this!
We firmly believe the future of saving and investing is in A.I.
We are also the only dedicated A.I. robo-saving and robo-advisor app in the UK.