The Rise of the Robo-Advisor

Artificial intelligence is changing the world of retirement planning. By using improved datasets and algorithms to efficiently deliver solutions tailored to people’s needs, AI can help them save, invest and retire better. One of the hottest trends to emerge in this area in recent years is the use of robo-advisors. These are software programs that use the data supplied by clients to create and automatically manage their investment portfolios. They’re gaining in popularity, but are they better than human advisors?

“Robo-advisors are a potential solution to the complexities of financial decision-making,” particularly in retirement planning, said Jill E. Fisch, law professor at the University of Pennsylvania. “But at the same time, there’s a lot we don’t know about robo-advisors — exactly how they work and how effective a solution they’re going to be.” She and other experts from Wharton and elsewhere spoke at a conference hosted by the Pension Research Counciltitled “The Disruptive Impact of FinTech on Retirement Systems.”

Robo-advisors, or robos, are online services that use algorithms to automatically perform many investment tasks done by a human financial advisor. Initially offered by startups, robos are now part of the suite of services offered by major financial institutions such as Vanguard, Schwab and Fidelity. Since they are less expensive than a human advisor, they democratize access to financial advice. Robos can take on customers with little savings since adding one more person wouldn’t cost much more.

Signing up starts with consumers filling out detailed questionnaires online about their financial goals, risk tolerance and investment timeframes. Robos take the information and use computer algorithms to come up with an asset allocation that fits the customer’s needs. Once the portfolio is created, robos also manage it, doing things like rebalancing the portfolio, executing trades, performing tax-loss harvesting and other actions.

“This is really something that’s welcomed by the vast majority of retail investors who find themselves inadvertently … tasked with the responsibility of managing their financial well-being,” Fisch said. “People don’t want to do this and they don’t want somebody to give them advice on how to do this. They want somebody to do this for them. That’s the space … robo-advisors are going into.”

Robos came on the scene about a decade ago, and two early startups were Wealthfront and Betterment. Today, there are dozens of robos in the market, Fisch said. There are pure robo services, as well as those that offer the option of talking to a human advisor, with or without an extra fee. Since they’re automated, robos can more easily avoid conflicts of interest that could beset a human advisor, who might push investments that pay the highest commissions.

Robo fees can range from zero — if the investor has less than $10,000 to invest — to as high as 0.89% of assets under $1 million in some cases, said Brett Hammond, research leader of Capital Group. But 0.25% to 0.30% of assets is more typical, he added. (The fee is on top of the cost of the investment itself.)

As for performance, it’s a mixed bag with some robos doing better than others, Hammond said. The big question is how they will do in the long run, especially during a big market crash, since they don’t have an extended track record yet. “We don’t know in a complete cycle what these [robos] are going to deliver,” he said. “The real issue is, does it improve outcomes?”

Kent Smetters, Wharton professor of business economics and public policy, has his doubts. Robos put investors into ETF portfolios for “professional fanciness” but they are “not really a better value” than three Vanguard index funds invested in the U.S. total stock market, international securities and bonds, which are more tax efficient and costs even less, he said.