The Rise of Robo Advisors and the Death of Traditional Financial Advice

October 23, 2017 Updated: October 8, 2018

When BlackRock, the world’s largest asset manager with USD 5.7 trillion in AUM, decided to layoff talented stock pickers in favor of machines for portfolio management in March, it was a sure sign that times are changing. In the asset management industry, the tide is turning toward software-driven robo advisory services and away from financial advisors as the sole form of advice.

Robo advisory is an automated form of financial advice that reflects an investor’s risk/reward profile but commands no real human touch. As a result, this approach significantly decreases the likelihood of human error. Fees are lower, with robo advisory firms attaching fees as cheap as 0.5% or less of total assets invested. Financial advisors are known to charge fees of 1-2%.

Performance from the robo advisory crowd isn’t too shabby, either. The top performer in a group of the five leading robo advisors in the first eight months of 2016 generated returns that were encroaching on double-digit territory, and in some cases outperformed their more expensive mutual fund counterparts.

Meanwhile, if you want to speculate on the individual investor’s willingness to entrust their capital with a machine over a person, consider the rise of fintech, where consumers and small businesses alike are increasingly turning to online lenders for capital and embracing a peer-to-peer model for investing.

Robo advisory is also a style that’s quite popular among the millennial generation, as it continues to attract more capital and jobs at the expense of traditional asset management.

This is not to say that traditional financial services are going anywhere. But it’s those traditional firms that embrace a hybrid approach, combining both a software-driven and human advice offering, that appear to be gaining the most traction.

And it’s not just BlackRock that’s demonstrated a willingness to favor machines over stock pickers. Robo advisors as a category, which is comprised of approximately 100 firms, oversee USD 60 billion in AUM as of year-end 2016 across 15 countries, according to Deloitte. That amount is expected to balloon more than fivefold to USD 385 billion in a half decade, according to Cerulli Associates research. While it may seem like a drop in the ocean compared to the trillions of dollars that traditional asset management industry still manages, momentum appears to be on the side of automation, lower fees and technology.

And in some ways, it depends on how you group the market. For instance, if you draw a bigger circle around robo advisory to include firms that manage assets with some integration of robo advisors, the market projections quickly surpass the trillion-dollar threshold for AUM in the coming years.

Millennial Movement

The millennial generation is a major driver, which isn’t surprising given they are a product of the sharing economy across industries ranging from hotel reservations, to ride-sharing, to the peer-to-peer investing model. While some argue that millennials aren’t embracing robo advisory, it really depends on where you look.

A recent Capital One Investing survey says in times of extreme market volatility, millennials are the least likely generation to turn to a person for financial advisory services at 69%. In fact, millennials are the generation that place the highest value on robo-advisory services, evidenced by 65% of them saying automated financial advice “enhances their financial peace of mind,” according to the poll.

Market Landscape

Take Kansas-based Bloom, a robo-advisory firm that recently surpassed the USD 1 billion threshold for assets under management. The firm reached this milestone faster than its industry behemoth predecessors that laid the groundwork for the robo-advisory movement, Betterment and Wealthfront. Bloom seems to be the Vanguard of the robo advisory market, undercutting its competitors on fees and charging as little as USD 10 per month to manage a 401(k) or 403(b) account.

Leading the charge is robo-advisory firm Betterment, which boasts 270,000 users and USD 10 billion in AUM. In a surprising move, Betterment recently inked a deal with Wall Street mainstays Goldman Sachs and BlackRock in what’s been dubbed a “bionic” and “cyborg” approach to asset management. These monikers reference the scale and prowess of traditional asset management and the automation inherent within fintech.

Wealthfront, Betterment’s biggest rival, oversees about half the assets of its larger competitor, and its chief executive has reportedly said he wants nothing to do with human stock pickers. “Young people would prefer to deal with software rather than people,” according to Wealthfront president and CEO Andy Rachleff quoted in CNBC.

Blindsided                                                                                           

The asset management industry used to boast the 2/20 model for fees based on assets under management and performance for hedge funds. But again, times have changed and there are more ways to achieve alpha. There’s been a paradigm shift with the transparency that ETF investing has introduced to the financial markets.

Financial advisors who refuse to acknowledge the shift to robo advisory are going to find themselves blindsided, much like those firms that refused to believe that passive management had a shot to attract the massive inflows that it has secured. Investors have demonstrated they are willing to trust a machine for financial advisory services if it translates to comparable or better returns for lower fees. And that is exactly what is happening.

Gerelyn Terzo is a financial journalist and contributor at www.roboadvisors.com