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My first investment (not saving, there’s this big difference between savings and investments) was done, not by me, but by my dad. He enrolled me in this ULIP type of plan which assured humongous returns. As I continue to pay its annual premiums, I am still not sure how much return it will give but what I am sure about is that investment decisions are made on advises. In this case, my dad had made the decision on the basis of what he believed was a sound advice from his investment advisor.
This investment advisory business (or shall I say industry) has been in existence for a long time, perhaps since the day when investment products were created. In fact, the business has given rise to educational certifications like CFA. Any industry’s business model gets influenced by technology, leading to a paradigm shift in the way of business. However, investment advisory has remained relatively immune to the rather transformative technology changes that we see around us.
However, financial technology providers are not giving up and continue to place a lot of hope on robo-advisors. To the uninitiated, robo-advisor is a solution that provides low-cost wealth management service via automated, algorithm-based portfolio management advice without intervention of human financial planners. It aims to reduce operational cost, provide superior investment advices, charge lower fee from customer and increase volume.
Visualise a scenario wherein you do not need to check with your financial advisor (if you can afford one) or your relatives or your dad for making the next investment decision move. Imagine the next best mutual fund or fixed income plan being available right at your fingertips via the tap of a mobile button, and that too at a reduced brokerage. And since the app has the intelligence to work with your financial goals and current personal finance situations, its recommendations are trustworthy and personalised. Sounds awesome, isn’t it?
The biggest player in this robo-advisory industry has been US based ‘Betterment’, which was founded way back in 2008. All transactions occur online – it is an execution-only service with account fees tiered between 0.15% and 0.35%. Betterment does not have brokerage sales representatives or advisers. Due to the overall customer experience, including ease of use and emphasis on design, Betterment has been called the “Apple of finance.” Betterment’s core portfolio optimization incorporates insights of Modern Portfolio Theory, the Black-Litterman model, and Behavioral Asset Management. Modern Portfolio Theory (MPT) relies on diversification and asset allocation to attempt maximize portfolio return for an amount of given risk.
Companies like Betterment professed that they would disrupt the financial services industry by replacing human advisors with low-cost efficient technology, at a price point around “just” 0.25%/year (when the traditional rule-of-thumb for human advisors is a 1% AUM fee). The concept was relatively straightforward – technology could do “what advisors do”, but cheaper, and consumers would flock to the “superior” low-cost solution.
Yet the reality that quickly became apparent is that true robo-advisor platforms are rarely competing head-to-head with human advisors. Instead, their clients were far more likely to be those currently unattached to any advisor, whether a “do-it-yourselfer” who liked the robo-advisor tools, or a Millennial who didn’t have enough assets to meet the minimums of many advisory firms
While much has been written about the disruptive “threat” of the robo-advisors, the reality is that even after several years, their market share is still a miniscule fraction of 1%. Robo-advisors have had limited success, even in areas with little or no head-to-head competition against traditional financial advisors, like working with Millennial clients.
Thus, it is not clear what the future holds for these robo-advisors. Perhaps, they need to go beyond equity and mutual funds to include more investment avenues like real estate, insurance, gold etc. And maybe, their personalised offerings are still not personalised enough. For instance, Betterment claims that its operating model is not impacted by the number of customer since the advisory algorithm is the same. May be the algorithm is truly robust enough but in any case, it has not triggered any massive shift in a person’s outlook towards investment advisory services so far. Until that happens, I will still stick with my dad until I can hire a financial advisor of my won.
This article originally appeared at: Bankerschecks