What is a robo-advisor?

• A robo-advisor is an online platform that provides investors with a suite of algorithm-based investment management services.
• Typical robo-advisors charge a management fee of between 0.25% and 0.5% as compared to the 1% to 2% charged by financial advisors. 
• High advertising costs, low account sizes and slim operating margins mean that robo-advisory firms have a long way to go before they achieve economies of scale

Have you heard about robo-advisors yet?

A robo-advisor is an online platform that provides investors with a suite of algorithm-based investment management services. Robo-advisors typically start by asking investors a few questions about their goals, finances and risk tolerance. Based on the answers to these questions, robo-advisor algorithms determine the investor’s risk appetite and accordingly allocate their assets. As market conditions change, the robo-advisor’s algorithms automatically alter the investor’s portfolio to match their risk tolerance. Robo-advisors primarily invest in ETFs. 

Basically, a robo-advisor seeks to emulate the services of a financial advisor, while charging lower fees and smaller investment minimums. Robo-advisors cost less than financial advisors. Robo-advisors typically charge a management fee between 0.25% and 0.5% as compared to the 1% to 2% charged by financial advisors. Lower management fees mean that investors get to keep a greater portion of their returns. 

Another advantage of robo-advisors is their ability to take advantage of tax-loss harvesting to enhance after-tax returns. Tax loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. For example, if you invest $100 in stock A and sell at $90, you realize a $10 loss. However, if you reinvest the $90 into another stock, you are keeping your market exposure constant. The $10 realized loss can be used to offset your taxable income and yield tax savings. 

History and future outlook of robo-advisors

Robo-advisors first emerged in 2008, against the backdrop of the financial crisis. Betterment was one of the first robo-advisors and started accepting clients in 2010. Another popular platform is Acorns. Thanks to the growing interest of investors and a growing underting of robo-advisors, the next few years saw the rise of many new platforms, buoyed by an influx of over $300 million of venture capital money. By 2015, established financial institutions like Charles Schwab, Blackrock and Northwestern Mutual had all acquired robo-advisors and began to offer their own services. Many consider these platforms as technology that could potentially disrupt the wealth management industry.

A 2015 Morningstar Equity Research report offered a rather bleak outlook on the future of robo-advisory firms, predicting that they would require anywhere between 8-20 times the assets under management they had to reach a profitable scale. In order to achieve that scale, robo-advisors would have to divert much of the capital they raise towards marketing. Furthermore, slim operating margins and a low average account size mean that it might take over a decade to recoup advertising costs. A 2018 update of the report sees the trend moving towards established financial institutions co-opting the technology of robo-advisors. To stay competitive with the products that financial institutions provide customers, standalone robo-advisory firms have also begun to offer hybrid services, bringing the human element back into the mix. 

The future for robo-advisors is going to be interesting. They provide many benefits to the consumer and are changing the industry. But they face challenges like attracting enough customers. The path forward for Physis Investment may be challenging but it will be worth it for clients that do not have financial advisors.  

References:

The Evolution of Robo-Advisors

Robo-Advisor Upgrade: Installing a Program for Profitability