The fintech revolution is changing financial markets all over the globe in ways both large and small. One of the most visible ways has been in the asset management space, where algorithm-powered robo-advisors are rapidly gaining traction. They've proven so popular that estimates indicate that by 2020, they will be managing $2.2 trillion in assets in the U.S. alone. For investors, this begs the question: what's under the hood of these robo-advisors and are we right to be trusting them with our money instead of hiring a traditional financial advisor?
The Rise of Robo-Advisors
At their core, robo-advisors are automated financial planning tools that rely on complex algorithms and machine learning to discern market patterns and adjust investor positions for maximum yields. They're not limited to wealth management, though, and are also gaining popularity in a number of other financial arenas, too. For example, there's an algorithm-powered mortgage advisor service that applies the same types of technology to help homebuyers find the best value from competing lenders.
How They Work
Most of the current generation of robo-advisors are based on cutting-edge economic theory and can provide expert analysis that often exceeds the abilities of a human advisor. They are connected to real-time financial data sources, such as market movement and up-to-the-minute trading information, and can synthesize all of that data to draw conclusions that might not be obvious to even an experienced financier. Some of them can even automate the process of tax-loss harvesting, for those looking to minimize their tax bills each year.
Understanding the Downside
If you've read this far, you may be wondering why robo-advisors aren't growing even faster than they are. After all, they hold several significant advantages over traditional human wealth managers, don't they? Well, the answer is yes, but they aren't the panacea many assume them to be. First, robo-advisors don't really offer any personalized guidance to investors, which means that they might not a good fit for those looking to comprehend where their money is going and why. Second, they are usually limited to a narrowly-focused asset class, like ETFs, so they don't offer the broadest range of investment types. This reduces the available investment strategies that a client may pursue, which is a dealbreaker for some investors.
The Bottom Line
Robo-advisors haven't been around long enough to make any pronouncements about their long-term viability. So far, though, the results seem promising. Most of the market leaders are posting respectable one-year returns of around 11%, which beats the average market-wide portfolio return of 7%. At the end of the day, the biggest reason that investors have that tells them to trust the technology with their money is the fact that almost every major investment firm has joined the movement and launched their own robo-advisor platforms. If they believed that their traditional advisors would eventually win the day, they wouldn't have done so.
The bottom line is: there's no reason for investors not to trust robo-advisors with their money, and they can expect better-than-average returns through them. They are not the best option for those that want granular investment controls but are a fantastic option for investors that want a set-it-and-forget-it approach. For better or worse, robo-advisors are here to stay, and as they develop, may eventually become the king of the asset management world. If that is to happen, investors should start getting comfortable with letting a computer manage their money now, since there's no real reason not to.