Technology has a way of making life easier and harder at the same time. Take investing, for example. Should you go it alone? Hire an adviser? Or use one of the many new digital investing platforms? Well, the rise of robo investing is here with new ways to handle digital investing. It doesn’t have to be an ‘either/or’ proposition. Forward-thinking investors and advisers can harness technology to work together.
Rise of the Robo-Adviser
Recently, I was featured in a Consumer Reports article, “The Rise of the Robo-Adviser”to discuss the rise of robo investing and moves toward automated investing advice. Certainly, over the past few years, we’ve been hearing more and more about the potential that technology offers to make investing simpler, more rules-based and less expensive. Right now, it’s clear to me that the rise of robo investing is a trend that is here to stay.
An assortment of Robo-Advisor firms have sprouted up. Some are extensions of existing brands like Schwab and Vanguard. Others are backed by venture-capital because they see that the space as ripe for ‘disruption’. All-in-all, these various digital platforms have attracted more than $53 Billion in investment assets. While a tiny amount compared to the more than $20 Trillion invested by consumers, it is a growing trend.
I’m a fan of these algorithm- and rules-based digital investing platforms. I’ve even adopted them to use in my own investment advisory practice for core investment positions. What’s not to like? You get access to low-cost Exchange Traded Funds (ETFs) that provide broad global diversification. You get an allocation tied to your time horizon, your goals, and your risk profile. And your allocation is rebalanced automatically. All this typically without an investment minimum.
AUM Fees: Robo vs Humans
The cost for all this? The ‘robo’ platforms offer a platform fee that ranges between 0.15% and 0.4% per year which usually covers all trading costs as well. The ETF’s that are used have their own costs but for those that use the offerings of larger brands like Vanguard or iShares these will range between 0.08% and 0.25% typically.
This is far less than the fees typically charged by flesh-and-blood advisers. The typical investment adviser may charge between 1% and 2% of assets under management (AUM). And this is before the cost of mutual funds and trading. And on top of that, getting access to advice was always a challenge unless you came to the table with a boatload of money.
Merrill Lynch and LPL
When I was working at Merrill Lynch, the minimum required to open an account and have a relationship with a flesh-and-blood adviser was $250,000. Below this number, management frowned and considered it a waste of an adviser’s time. (You could place the client in a mutual fund charging 3% to 5% in an upfront commission as an option). For a typical advisory account, the fee was about 1.5% until it was over $500,000. Then it would typically drop to 1%.
And this was before adding in the cost of the mutual funds used in an account. In a pre-packaged portfolio based on a client’s risk, you would find between a dozen and two dozen mutual funds – all of the ‘active’ variety. No individual stock. No index funds. No ETFs. And the typical costs of these active funds were about 0.80% to 1% BEFORE the underlying cost of trading at the mutual fund. That could easily add another 0.25% to 0.5% per year.
So the cost of an account where an investor delegates investment decisions to the adviser and his firm could easily top 2.25% or more per year. That’s for investment advice and hand-holding. No tax planning. No education planning. No advice or answers to non-investment questions.
Case Study: Fee Confusion
I recently completed a review for a retiree. He had a sizeable account balance at LPL, one of the nation’s largest independent broker-dealer firms. He had all his investments in a ‘portfolio advisory service’ containing nearly a dozen different active mutual funds. While he had insisted that he was paying 1% for this service, my analysis showed him – much to his surprise – that his actual cost between adviser fee (1%), fund expenses (0.81%) and trading fees due to the fund turnover ratio (0.50%) was closer to 2.3% or nearly $20,000 per year. You heard that right, ‘per year.’
His case is not unusual. This is often what I find when I look under the hood during an investment review for a client. And it’s not just Merrill Lynch and LPL. The same types of programs are offered at all the major broker-dealer firms. I find investors paying fees without realizing it and getting investments at a cost that is far higher than other options (like index funds or ETFs) that are not even offered to them.
This frustration and confusion is not new. Consumer Reports covered this. PBS did a Frontline special on it. And it was featured in a comically serious way on Last Week Tonight with John Oliver.
Compare this to the average robo that charges 0.25% and uses index ETFs that cost 0.15% to 0.25%. It’s not hard to see the appeal.
Robos: What You Don’t Get
What do you not get with a digital investing platform? Well, with few exceptions you can’t hold individual stocks or bonds through these platforms. You won’t get access to Closed-End Funds. You won’t get advice for your 401(k) investments. And, most importantly, you won’t get financial advice or answers to non-investment or tax questions.
As I noted in the Consumer Reports article, there are some things that a computer-adviser simply can’t do. It can’t help you prioritize between several financial goals (say, paying down debt vs. saving), navigate a tricky financial situation like a divorce, or offer advice about how to save for college or handle your elderly parents’ financial woes.
“The typical questions I get have nothing to do with asset allocation or investment projections. Of course, saving for retirement is important. But it’s only one of many pieces of a financial plan.” Steve Stanganelli, CFP®, fee-only financial planner
Humans and Robos: Happy Medium
For too long, the media and public have held this misguided perception that financial planning and investing are the same thing. They’re not. And for too long, investment advisers have relied upon an Asset Under Management (or AUM) pricing model for their services which almost exclusively centers on investing.
As robos clearly show, investing can be done on the cheap. And human advisers cannot really compete on price … not if they want to eat anyway. So if human advisers insist on charging 1% or more for investment management, then God bless because their days are numbered. If all a human adviser is doing is choosing a model developed by some outside source that uses expensive funds (active or passive) and not do anything else, then what value is he or she offering?
On the other hand, robos cannot come close to providing truly customized financial planning or answer questions that have anything to do with taxes, elder care, education funding or mortgages. Notice I didn’t say investment planning. Like I said, there’s more to financial planning than investing.
As I’ve said in prior blog posts, robo advisors really can’t replace human advisors. But there is room for them to work together. In my firm that’s exactly what I do. I’ve adopted a robo-advisor platform for core investing at a low cost (0.25% for the platform and another 0.25% for my services). And then I layer in a fee for honest-to-goodness planning services (0.20% to 0.75% or a flat fee based on time and complexity). I truly believe that an adviser’s value-add is on the planning side … unless you’re a star stock picker (and I’m not).
By the way, that retiree client of LPL paying nearing $20,000 for investment services? Based on my human-digital model, he can probably save himself upwards of $15,000 per year just by shifting to a lower-cost ETF digital custodian platform. And still get about 18 hours of real financial and tax planning per year included from a qualified and certified professional.
