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How Automation Is Disrupting the Market for Financial Advice

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28 August 2014
William Trout
My most recent report explores the competitive threat that online firms pose to traditional providers of financial advice, particularly in the area of investments. Some observations:
  • The portfolio construction and monitoring process has been commoditized. What a human advisor can do, an algorithm can do at least as well, and at much lower cost (typically under 35 bps). This means that automated investment managers such as Betterment, Wealthfront and SigFig have a built in competitive advantage over traditional (real life advisor) Brokerage and RIA models, especially if they can achieve some sort of engagement or relationship with the client.
  • A further competitive advantage is that because they are data driven, automated investment managers are naturally disposed to using data to improve both the client experience (for example, through better analysis and reporting tools) and portfolio performance. Algorithms can be used to test and develop new investment ideas, for example, as well as to monitor portfolio exposure or risk. Traditional advisors may be able to provide these functionalities but at much higher user cost and friction: that is, their delivery may not be as good, particularly if they have limited digital capabilities.
  • RIAs are under threat but the wirehouses and the discount/online brokerages are in a real pickle. Wirehouses recognize the need for automated advice but fear creating channel conflict with their sales force. The online brokerages also understand that automated advice is valued by clients (a few such as TradeKing are introducing algorithm driven platforms) but they will find it tough to overcome challenges of legacy technology (systems dating back to the early 2000s will need to be updated) and culture (the automated investment managers are mostly software engineers, while the discount brokerages are a mix of techies and investments people).
Given the deepening public embrace of ETFs and passive investment strategies, which enable automated advisors to manage money in a customized and highly efficient way, it may be that the online brokerages emerge as the most natural competitors of Wealthfront, Betterment et al. Most will want to launch their own platforms. The question then is whether to build or buy.

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