By Angus Woods, MD, Adviser Ratings
A lot has been made in the last 2 years of the rise of robo-advice, but do the technology and numbers support the hype?
Robo-advisors are old news
I can’t help but think, that all the platforms out there are taking advantage of this new term to push up their own valuations. Robo-advice is definitely not new – it is basically merging nicely-designed “personal financial management” tools (think www.mint.com) with Exchange Traded Funds (ETFs). This is robo-advice today! Companies like BT and ING with their respective BT Super for Life and Living Super products, tapped into this “simpler wealth” solution through superannuation, many years ago. It has now moved into wealth management with admittedly far-bettered designed tools - wealth meets Fitbit!
Is the advice industry under threat? Not yet. The one area that human advice really differentiates itself from the more simplistic investing model, is in attending to the complex needs of individuals. Nicely-designed apps and investing tools are great for consumer engagement and getting people to talk about money, but they do little in addressing key life events (ie. estate planning, tax issues from windfall gains or losses) or what I would term – “non-linear investing psychology” – that is, where investing falls outside the norm defined by the robo-tool. An example of this sort of investment would be investing in particular types of asset classes based on personal beliefs, values or opportunities.
The graphic below from Deloitte (2015), sums up the optimal model based on the current landscape today.
The current flaws of Robo Advice
Robo advice today is flawed, because of it's inability to take into account complex needs or investing that falls outside the "norm" as defined by the robo-advice tool. Another flaw, is that it assumes some level of financial literacy of the person using the tool. Every app and tool on the market today assumes this. For example, most users still have to input their financial needs, know what type of investors they are and understand the output of the tool/advice. Perhaps, this is more a flaw in our education system and lack of mathematical teaching, rather than the apps inspired and engineered by “numbers people”.
The numbers don't support the hype
Also, the numbers just aren’t supporting all the noise – The United States biggest robo-advisor is Betterment. It was founded in 2008 and how has $5BN in funds under management.
This represents just 0.025% of the $20 trillion wealth market. The whole robo-advice industry of $20 billion has just 0.10% of the wealth market. There are more than 200 robo-advice start-ups in the US... most will fail, or their technology will be consumed by a big corporate/wealth management firm (to add to their suite of investing tools).
In Australia, this number is approaching 30 from last count (no doubt there are more "in the wind").
Robo Advice in Future?
I think the robo tools of today will hit a ceiling – and some, will do well. I highlight Acorns as case in point (one of our platinum advisers, Joshua Stega, wrote a great review on them) – a cool investing app that uses sleek design and gamification to engage its mostly millennial customers.
However, it still doesn’t tackle those complex needs.
But I do believe certain organisations can really disrupt the advice and banking space, And I refer to the non-banks – Facebook, Google, Snapchat, potentially even Coles and Woollies.
The data these organisations hold on us, is far-reaching. With consumer trust in banks and financial service providers so low, the rise of alternative companies to encroach on this space is ripe. Consider this:
1. Facebook knows where you go on holidays, what accommodation you stay in and what type of gifts you are buying for your friends and family, indicating how affluent you are.
2. Social networks often know where you work, potentially how long you’ve worked there (and in what job), indicating how you could potentially service credit.
3. Social networks probably know what university you went to as you post your alumni Instagram shots, indicating how aspirational you may be in your career, and how financially knowledgeable you are.
4. Once you jump off Facebook onto Google search, Facebook can follow your internet history (as you are browsing websites and looking up terms like "what is a loan?" or "what is an ETF?"). This could indicate how financially literate you are. For example, are you searching "get rich quick schemes", are you "nervous about the market crashing"... your internet history reveals a lot about you.
5. Social networks know how much you drink - from all those cheeky nights out with friends, indicating how “risky” you are to insure.
6. Social networks also know how much you love your grandchildren, indicating the future planning requirements you need to put in place.
If Facebook know all this about you (which is often much more than any credit agency or your own bank), it is this behavioural snapshot of an individual that economists are now saying is fundamentally a far more accurate picture of that individual - which gives technology and data-driven companies a far greater edge to manage your money more responsibly. They can actually tap into your behavioural biases and anticipate what you will do with your money - more than a credit report will show.
Graphic courtesy of Deloitte (2015)
So in a few years’ time, don’t be surprised that you post an update to your friends saying: “trudging the streets of Melbourne looking for a new home”, and two minutes later, Facebook sends you a message, saying “based on your life goals, which we’ve been mapping, we have approved you for $1.5M for any new home you want to buy - press the green button and we’ll transfer the cash into you Facebook Home Loan Holding Account."
And we'll be using the blockchain to record the home loan transaction and transference of deeds in a de-centralised ledger (explaining THAT is a blog entry for another time).
*Exchange Traded Funds are pooled assets, like a "basket" of assets (stocks, bonds or commodities), that trades close to it's net asset value (by tracking an average of, for example, the ASX200 companies' performance) and mirroring that performance. It is a passive investment in the stock market where you have lower fees (because you aren't paying for an investment manager).