Other parts of this series:
Letting a robot make high-stakes financial decisions for you might seem like the stuff of science fiction. But people have been turning over their investments to “robo-advisors” for nearly a decade. Today robo-advisors control tens of billions of dollars in assets. The history of robo-advisors in wealth management provides an interesting case study for insurers curious about the impact of robo-advisors on their industry.
Robo-advisors automate asset management. Instead of working with a flesh-and-blood financial planner, consumers fill out a survey on their risk tolerance, investment timeline, and financial goals. A proprietary algorithm—the robo-advisor—analyzes the results and allocates the customer’s investments according to their financial needs, historical data on investment performance, and a pre-determined menu of low-cost investments like index funds ant ETFs. Robo-advisors also monitor investment portfolios as markets move, reallocating funds to make sure a customer’s investment allocation doesn’t stray from the balance prescribed by the analysis.
Robo-advisors allow savings on labor and real estate, two of the largest costs for traditional investment management firms. This lets robo-advice firms charge users between 0.15 and 0.5 percent of the fees invested per year; much lower than the one to three percent commonly seen with flesh-and-blood advisors.
The first robo-advisors hit the market in the aftermath of the 2008 financial crisis. Initial uptake was slow, with many customers skeptical of trusting machines with their money. But as technology continued to spread into every corner of our lives, some people became comfortable with the notion of putting their retirement plans in a robot’s “hands.”
Today, robo-advisors manage over $50 billion worth of assets. Industry reports project that figure could reach $7 trillion in the next 10 years. The growing marketplace is becoming more competitive. Relatively small startup firms like Wealthsimple and Betterment now compete with robo-advisors offered by established industry titans like Vanguard Group, Schwab, and the Bank of Montreal.
Robo-advisor firms are also diversifying their target markets. Their low fees, minimum investment requirements, and reliance on technology made robo-advisors a natural fit with digital-savvy millennials. But that’s changing. Betterment reports that a third of its assets under management belong to customers over 50. In May of 2016, Ellevest launched, which offers automatic asset management tailored to women, who live longer than men.
Automating financial advice has made it accessible and scalable like never before. But despite its growth, the use of robo-advisors for investment management is subject to important limitations. Robo-advisors still can’t replace humans in all situations. For instance, if you need help negotiating the finances in a divorce or saving to send a child to college, you will likely need to pay for an actual, flesh-and-blood financial advisor. Many robo-advisors also can’t properly account for 401(k)s and other tax-advantaged investment vehicles.
The biggest unanswered question about the market’s appetite for robo-advisors is what will happen when global markets crash. It remains to be seen if consumers’ growing comfort with automated financial processes will persist in the face of a 2008-style market contraction. Without another human being to phone for reassurance, will customers be more inclined to panic and cash out their portfolios in a market crash? There is no way to be sure until the rubber meets the road.
But it is unlikely that robo-advisors will disappear entirely. As we’ll see next week, their influence is beginning to spread to other industries—including insurance.
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