Over the last seven years, an automated investment service that is commonly referred to as “robo advisors” has received a lot of attention. Robo-advisor is any service that uses specialized software to perform what investment advisors and wealth managers normally do. Typically, robo-advisors let the investors answer some questions to determine their appetite for risk. Then, using proprietary algorithms, they spread investor’s money into the most appropriate investment, making changes as the investor’s situation and the market change.
In other words, robo-advisors are online wealth management services that offer computerized, algorithm-based portfolio management without using human financial planners. Normally, Robo-advisors only provide portfolio management and do not involve themselves in more personal wealth management aspects, such as retirement and taxes or estate planning.
The first robo-advisors were made in 2008. Initially, their innovation was to rebalance assets of investors within target-date funds, and offer investors a contemporary, online interface. Since robo-advisors have a tendency to buy, hold, and rebalance only when market changes skew a portfolio’s allocations among debt, equity and other assets like real estate investment trusts, the strategy is basically passive.
Before 2008, only human financial advisors used the wealth management software to automate their job and charged a fee of 1% and 3% of investable assets. The use of automated portfolio software became widespread in the mid-2000s. After the advent of robo-advisors, the wealth management software was sent straight to customers without intermediaries.
According to FutureAdvisor, Silicon Valley saw that habits of consumers were changing for good after the success of Mint, an online checking account aggregator that was founded in 2006 by Aaron Patzer and sold for $170 million to Intuit in 2009. That success made a groundswell of funding in the investment community for robo-advisors.
Robo-advisors such as Wealthfront and Betterment began by managing target-date funds and required investors to move assets to a new custodian. Later, robo-advisors added services such as tax-loss harvesting; a service that allows investors to harvest losses they experience on the stock market, once their stock value lowers, by selling in the trough. Then, they use those losses to balance profits they experience elsewhere, thereby lowering their overall tax bill.
As of December 2014, robo-advisors directly managed US$19 billion, according to Corporate Insight. According to a study by MyPrivateBanking Research, the assets under management of robo-advisers are expected to grow to US$255bn by 2020. As of August 2015, Betterment was the leading in collecting assets regarding robo-advisors. Launched in in 2010, the company boasts of hundreds of thousands of happy customers and billions under management. Being the largest independent robo-advisor, its assets under management has reached US$5 billion. In 2011, Betterment had only 10,000 customers, but today it serves over 175,000 customers.
As technologists continue to develop advanced wealth management softwares, it will soon be possible to automate all financial advisory services. Automation allows those services to become more accessible and scalable to many investors. In future, expect to see Robos democratizing access to services such as college savings, tax planning, cash-flow management and other types of investing.