Across the country, thousands of brick-and-mortar offices bear the stately logo of Edward Jones, one of the biggest investment advisers in America, whose more than 13,000 advisers help 789,000 clients manage their money.
SigFig Wealth Management, by contrast, is five years old and runs out of an office in San Francisco’s Mission District less than a mile from Twitter’s headquarters. SigFig already boasts 845,000 clients―about 56,000 more than Edward Jones―and with barely any human touch at all. SigFig has fewer than 100 employees.
It's hard to imagine a more disruptive innovation than the "robo-adviser"―shorthand for software that uses algorithms and data to replace human experts with fully automated investment advice. SigFig is one of the new generation of upstart financial firms built entirely around this idea, giving its clients access to algorithm-driven tools to fine-tune their portfolios. A SigFig client can call the company to speak with a human, but that’s not the selling point. Their clients, many of them young and fully at ease with technology, log on to entrust their money to software.
In the past 10 years, dozens of new robo-advisers have been launched, and a handful have cracked the top ranks of investment advisers: SigFig is the eighth-biggest adviser in America by number of clients, according to data compiled by the Investment Adviser Association. Other robo-advisers that have registered with the Securities and Exchange Commission in the past eight years―Acorns, Betterment, StashInvest and Wealthfront―are among the top 50.
The upstarts still have only a small slice of the investment-advisory universe of some $67 trillion under management; many of the accounts they manage are tiny. But there's no question they're growing―and fast. Goldman Sachs estimates the potential market for digital financial advice―for both the robo-adviser firms and traditional players who also use the technology―is approaching $2 trillion and says it will rapidly expand, with young investors driving future growth. As Baby Boomers prepare to transfer their prodigious wealth to a new generation, that growth could be breathtaking.
In the industry, their arrival has already set off a scramble: Old-line firms are building their own robo-advising technology, or simply buying some of the industry disruptors. The counterattack is so furious that some analysts say it is the standalone robo-adviser businesses that might struggle to survive. Their future may lie with teaming up with the established firms.
Robo-advisers are also increasingly drawing concern from regulators, who worry that the startups might not be giving customers enough information about services. SEC Chairowman Mary Jo White said in March that agency staff had begun to examine “automated investment models.” And twice this year, Massachusetts Commonwealth Secretary William Galvin issued regulatory guidance for businesses using robo-advising technology, putting his state at the forefront of efforts to scrutinize the new businesses.
As with many threatened industries, the established players are encouraging regulators to get involved: BlackRock Inc., one of the world’s biggest money managers, released a report this month pointing out areas in the new sector where regulators might want to look. “Regulation is going to become a big topic for robo-advisers,” said Alois Pirker, the wealth-management research director at Aite Group, a research and advisory firm.
As regulators get more involved, the industry is bracing itself: The more it has to comply with new rules―like being compelled to ask customers enough questions to guarantee that their cash is being invested as advertised―the further it could move from the simple, low-cost investing it promises. “The compliance burden is the enemy of the user experience,” Pirker said. And beneath that concern is a deeper tension: that any increase in human intervention could well hurt an industry that believes it's better without involvement from any humans at all.
IT’S NOT HARD to see why investment advisers are worried: They are typically compensated by a small percentage of their clients’ assets; it's the kind of comfortable arrangement that brings in money in bull and bear markets. But the value to clients, beyond reassurance, isn't always clear―numerous studies have cast doubt on the value of active human money management―and the robo-adviser threatens to take human investment advisers out of the loop entirely, rendering them as useful as elevator operators.
A typical robo-adviser works something like this: Once investors sign up with a service, they plug in their age, ideal retirement date and how risky they want to be with their savings. The robo-advisers’ algorithms put the client’s cash in appropriate investments and then automatically rebalance the portfolio as needed. The investor doesn't need to give it active attention and pays only a fraction of the 1 percent of assets under management that human advisers typically charge.
Unlike financial advisers who strive to beat the market, robo-advisers do not promise riches for their customers, but rather aim for stable growth. Instead of picking hot stocks they stick with exchange-traded funds, which are baskets of stocks, bonds or other securities that track indexes and cost less than mutual funds. The goal is to fine-tune customers’ finances rather than outperform the market.
They've also given normal Americans access to some tricks normally used by the rich. For example, robo-advisers have made the lucrative but tricky tactic of “tax loss harvesting” available to the masses. This tactic involves selling securities at a loss to maximize tax savings. The service used to be available only to customers with millions of dollars in investments, but now robo-advisers and their software can make it affordable enough to offer ordinary customers.
So far, robo-advisers haven’t grown by poaching clients from the traditional investment advisers. Instead, they’re scooping up clients that the old guard has often ignored: People who have little cash to invest and who tend to be under 35. Though the big robo-advisers may be getting customers, they are not scoring the wealthy clients yet; if you rank investment firms by assets under management, rather than number of clients, none of the robo-advisers cracks the IAA’s top 50. The threat robo-advisers pose lies firmly in the future, as they rack up a huge number of millennials that more established firms will need to recruit as clients someday.
As they grow, the financial-advisory business has mounted a counterattack, warning that the upstarts are vulnerable to malicious hacking and are too limited in the advice they can give. When people accumulate significant assets, they often have more specialized investing needs than a mass-market algorithm can account for.
There's also the question of what happens in a crisis: This is, after all, a business that mostly started after 2008 and has yet to weather prolonged market turbulence. Humans might be able to react more quickly to unforeseen market conditions than the methodical robo-advisers. And panicky investors are usually going to want to talk to somebody fast.
Michael Wong, an analyst at Morningstar, says the next financial meltdown will put the model to the test: Even though technology is making driverless cars possible, he says, there’s no guarantee people would agree to a ride through a blinding snowstorm in a vehicle navigated by a computer. “Even if the robo-advisers become moderately sophisticated, trust from a human goes a long way toward keeping a client,” said Wong, adding that he expects a “cyborg” hybrid to evolve where algorithms and humans work together for customers. “The only way to handle really complex situations is with the assistance of a qualified human financial adviser.”
THIS POINTS TO a tension in money management that only grows more acute as models shift toward software. The human touch can be crucial in holding on to clients, especially when it comes to calming nervous investors and keeping them dedicated to their investment plans. But human intervention in the actual investment decisions is anathema to computer-driven businesses. That’s because emotion interferes with investing, online wealth managers argue. Data-driven computer models, on the other hand, operate with stoic indifference to the market's animal spirits.
“Our whole philosophy is there are a ton of people out there who try to beat the market,” said Mike Sha, SigFig’s co-founder and CEO. “It is extremely hard to do that reliably, consistently and at scale.”
Sha sees his company as a new iteration of the investment philosophy that made Vanguard one of the world’s largest asset managers. Vanguard founder John Bogle gave higher priority to low fees over beating the market as the ideal way to save for retirement. In the days before robo-advising, Bogle built funds to track stock indexes rather than trade in and out of different stocks―a radical idea at the time that has now become common.
“Fee efficiency, tax efficiency and―honestly―keeping things simple: Those are the things that can help you get returns,” Sha said.
"The traditional industry has not yet come to terms with the fact that the promises they make to retail investors are the problem,” said Adam Nash, CEO of Wealthfront, a robo-adviser located seven miles from Facebook’s headquarters.
As the industry grows, it's bumping up not just against people's assumptions about money management, but against much bigger players in finance. To continue improving investment advice, robo-advisers need all the financial information they can get about their customers. This is putting them in an increasingly hostile situation with banks, said Bill Harris, CEO of Personal Capital, a digital wealth-management company based in San Carlos, Calif.; the robo-advisers want banks to let their customers grant them access; banks, claiming it’s a security issue, are digging in against it.
The competition between robo-adviser startups and big Wall Street firms is likely only to heat up as each fights for the other’s core customers. Robo-advisers have made inroads in getting retail clients. Big firms have the wealthy clients the robo-advisers want. “They will be battling it out in terms of the mass affluent and the mass retail assets,” said Pirker.
Though there's a conflict unfolding over style, philosophy and regulation, close watchers of the industry know that the two sides have more in common than they may let on. A lot of traditional firms, such as Charles Schwab, already have algorithmic management software underneath their advisory operations. And so, in many ways, this is really a question about who gets to be the front man for a robot takeover that is already underway.