The Jury's Still Out on Robo-Advisers

By David Martinez - Community Partner - Newark, NJ & FinTech Connector Member

So, it was only a matter of time, huh?

Financial technology companies have long found it easy to sit back and bemoan the ethical failures of traditional Wall St. banks and financial institutions. However, when the Securities Exchange Commission (SEC) dinged prominent robo-advisor Wealthfront ($11B AUM) last month for violations of the Investment Advisers Act of 1940, it came hardly as a surprise to many outside observers. After all, most fintech startups are still profit-driven, accountable to shareholders, and operate by similar business models to incumbent banks. The SEC agreed to settle with Wealthfront for $250,000 — a drop in the bucket compared to the $414.7M in total fines assessed by the SEC in 2018. And technically speaking, this wasn’t the first time a startup robo-adviser has been fined by a regulator. In fact, the Financial Industry Regulatory Authority (FINRA) slapped robo-adviser Betterment with a $400,000 fine over the summer for a variety of violations including non-compliance with the Customer Protection Rule, improper book-and-record-keeping pursuant to FINRA and SEC rules, and for ‘window dressing’

Should this give pause towards utilizing a robo-adviser as the primary alternative to a traditional financial adviser?

In a word, no. Wall St. banks and traditional financial services companies have long contended that regulatory fines are simply the cost of doing business. And thinking of fintech firms and robo-advisers as any different would be naive. Rather, instead, potential investors should look inward and have a thorough and honest assessment of their current financial situation, their time horizons to achieve certain financial milestones, and their capacity to have the knowledge and time to actively (or passively) manage their investments.

Chat bot , artificial intelligence , robo advisor , robotic concept. Source: ©zapp2photo, Adobe Stock -  FILE #:   161459463

Chat bot , artificial intelligence , robo advisor , robotic concept. Source: ©zapp2photo, Adobe Stock - FILE #: 161459463

The biggest differences between robo-advisers and a traditional financial adviser is cost and level of service.

A traditional adviser is much more personalized and therefore considers all of your financial assets, consequently at the expense of higher fees and higher minimum investment quantities. Also, traditional advisers often have the benefit of working within larger financial institutions and are able to provide additional banking services e.g. mortgage loans. Typically, customers of traditional advisers are high income-earners, own multiple assets, and are comfortably able to meet minimum investment requirements (some require that new clients have a balance of $250,000 or more to manage).

A robo-adviser is slightly less personal but the algorithms that run their online platform still take into account the same investment criteria a traditional adviser would including your risk tolerance and investment type preference i.e. passive vs. active.

How have robo-advisors historically performed?

Well, it’s not entirely clear-cut. Only certain robo-advisers provide publicly available data regarding their respective portfolios and performance. Also, some argue that a true test of an advisor’s aptitude (robot or otherwise) is during times of severe market stress and economic turmoil. Up until the latter part of 2018, the US stock market has been in a bull run since the Great Recession of 2008. Nevertheless, there are several independent studies and in-depth analysis available online that dive right into each robo-advisor at the portfolio level and assess their respective performances. One study available that I found particularly insightful was commissioned by Nummo, a privately held company with no ties to any financial institution or current product providers.

What’s the bottom-line?

Choosing between a robo-adviser and traditional adviser is a decision based entirely on one’s personal financial situation and preference. However, it has become increasingly apparent that robo-advisors provide the average American with a cost-effective alternative to help secure their financial future.