At first glance, the reason why robotic financial advising startups (such as Wealthfront, SigFig, or Betterment) are getting a lot of attention from investors, but also from the banking industry, is obvious: they are sexy!
For starters, robo advisors offer sophisticated investment advice for only a fraction of the cost compared to traditional wealth management firms. They guarantee a wonderful customer experience through websites and mobile apps, following all the latest UX trends. And last—but certainly not least—their assets under management (how much money they manage on their platform) are growing at an exponential rate.
Past first glance, though, scratching below the surface reveals that the path to success will not be easy for robo advisors. I think they will struggle to find differentiation.
Similar portfolio performance
When you sign up for a robo advising service, you start by answering a series of questions that evaluate your investment needs and set your risk tolerance. You then get an allocation that mixes exchange traded funds (ETFs) and bonds.
The truth is, portfolio allocation is very similar from one advisor to the next and their investment strategy relies on the philosophy that you should not try to beat the market. While I strongly believe in this principle, it is a major issue for robo advisors. None of them will be able to brag about having the best portfolio performance because, by design, they offer the same return on your investments.
Robo advisors are racing to offer new features that will make their product better than the competition. For a while, this was the space where robo advisor could find some differentiation but now most of them offer the same basic features: personalized allocation advice, automated tax loss harvesting, automated rebalancing, and automated dividend reinvestment.
When investing using a robo advisor, you are charged a 0.25 percent monthly fee. While it is very competitive compared to traditional wealth management firms, robo advisors apply their same old-fashioned business model: a proportional fee.
This is “Silicon Valley Tech at Wall Street Prices” as Blake Ross puts it. He goes on to explain that, even if lower in percentage, fees are too expensive knowing that the marginal cost of automation is close to zero. In the long run, there is a lot of room to lower the fees and drive the cost down for investors.
Robo advisors will become a commodity
When there is little to choose from between brands, consumers focus only on the price and the product becomes a commodity. Taking that path often means facing escalating price wars that make it difficult to survive.
This is exactly what happened to many industries: airlines, hard disk, banks, telecommunications, and cloud service. Aspiration is the first robo advisor to start the battle by introducing a “Pay What Is Fair” fee.
So now what?
While I believe it will be difficult for robo advisors to find differentiation, I’m convinced they will play a strategic role in helping traditional financial institutions. Automation dramatically decreases the cost of portfolio management, which will allow banks to offer sophisticated retirement planning to customers that wouldn’t otherwise be affordable.
If the mass market can get access to it, entrepreneurs will have once again succeeded in leveraging technologies to transform an industry for the better.