Low fees drive rise of 'robo' financial advisers

There’s a lot of buzz on Wall Street these days about investing technology and so-called “robo-advisers” — automated investment services that use algorithms and Internet tools to manage your portfolio.

With good reason. Countless studies have shown that active portfolio management, with human beings trying to pick the best stocks, consistently underperforms the market in general. Consider S&P Dow Jones Indices data through 2014 that show almost 89% of actively managed funds posted worse five-year returns than a plain vanilla index like the S&P 500, and about 82% posted worse returns across the prior 10 years.

In addition to better returns, passively “indexing” your portfolio also can save you a bundle on management fees, because it requires much less expense to manage the fixed list of stocks that make up the S&P 500 than to actively research and trade stocks based on complex strategies.

So why not simply set a long-term plan to track those benchmarks, then, and concentrate on keeping costs low while taking what the market gives you?

It’s this focus on low-fee, passive investing that has given rise to a host of new products in recent years, including robo-advisers. Roughly 30% of investors with more than $100,000 in assets are already using some form of robo-adviser, according to a recent analysis by brand research firm Market Strategies International.

Of course, that means a scramble among new providers to enter this marketplace. And as is typically the case when ambitious firms with big marketing budgets fight for attention, consumers aren’t always sure which product — if any — is best for them.

So here’s a look at a few different forms of robo-advisers, and what they can offer investors like you.

Fully Automated Robo-Advisers

The most obvious benefit of a digital investment adviser is the reduced cost.

Take leading robo-adviser firm Betterment, which boasts $2.8 billion in assets under management and roughly 115,000 customers. Betterment charges 0.35% for accounts under $10,000 in assets, 0.25% for accounts between $10,000 and $100,000, and just 0.15% annually for accounts over $100,000. That’s significantly cheaper than the 0.64% charged by the typical mutual fund or ETF, according to a recent fee study by Morningstar.

But Jon Stein, founder & CEO of Betterment, is quick to point out that the savings come from best-in-class technology, and not from overly simplistic financial advice.

“I would strongly reject the idea that there’s a correlation between personalization and human involvement,” Stein said. “Our portfolios are probably more personalized than what you would get from most live advisers because we ask you about your goals.”

Consumers don’t see all the complex algorithms and “gross stuff” on the back end, he notes, because “we’ve put advice at our core.” But investors can have confidence that Betterment is offering very prescriptive advice on how much to save and where to invest based on the personal goals they’ve provided.

These include big-picture goals like how much you plan to spend in retirement, as well as sophisticated strategies like when to sell certain investments for maximum tax efficiency.

“You can have a conversation with us about what your financial needs are that’s much more in-depth than you may get from a lot of financial planners,” Stein said.

Betterment isn’t alone in seeing the power of robo-advisers. Rival Wealthfront is also growing fast, with $2.6 billion in assets, and waives advisory fees to any account holding $10,000 or less in assets. Even legacy financial firms offer automated advisory services, including Charles Schwab with its Intelligent Portfolios service.

The services differ, but one thing they all share is a reliance on technology and a commitment to significantly lower fees as a result of fewer human advisers demanding a cut.

Technology With a Human Touch

Given the growing popularity of these high-tech investing algorithms, there will only be more options as time goes by. But as with any financial service, consumers should shop around for the best deals and find the product that best fits their needs.

Personal Capital is one example of a service like this. It offers a free app available for iPhone, iPad and Android that links your financial accounts and provides lots of data and a bit of automated advice. The tools will not just tally up your wealth, but also analyze the fees you’re paying.

If you find you’re ready to take serious action or that you need help just making sense of things, Personal Capital will connect you with a human adviser for a 1% fee, getting you beyond the app to act on your financial goals.

“We share a belief that technology should be used to make investing more transparent and accessible,” said Bill Harris, CEO of Personal Capital. “At the same time, while low fees are absolutely important, we believe that the human element is still necessary, particularly when it comes to challenging questions and complicated financial situations.”

Harris also is quick to point out you don’t have to choose between getting gouged by humans or going for a cheap but automated robo-adviser solution.

Traditional brokers have “incentive structures to sell whatever they make the most money on,” Harris said, and consumers are right to be skeptical of that model. But “a Personal Capital adviser, a fiduciary, has the legal obligation to do what’s in the client’s best interest and does not take back-end fees or anything else.”

One of the biggest names in retirement planning, The Vanguard Group, also sees tremendous opportunity in marrying digital products with human advisers.

Vanguard has some $3 trillion in assets under management, and roughly $25 billion of that cash is in its Personal Advisor Services segment. It’s like Personal Capital only in reverse, enlisting a human financial adviser at the very beginning to set your personal goals, then using sophisticated digital services to keep you in the know as you save.

Frank Kolimago, principal at Vanguard Personal Advisor Services, said those who only know Vanguard as a provider of low-cost mutual funds shouldn’t be surprised it has a robo-adviser service.

“At Vanguard, we have a mission to lower the cost and complexity of investing. We’ve been doing that essentially for our 40-year history,” Kolimago said. He added that while many investors have often sought personal advice from Vanguard, in the past such services were offered only to high-net-worth clients because those services couldn’t be made affordable to those with fewer assets.

“Technology really became the enabler to allow us to scale the program at an attractive price point,” Kolimago said.

That price point is 0.3% of assets annually, or $300 each year on a $100,000 portfolio. The downside to some smaller investors, however, is that Vanguard requires a minimum of $50,000 to join the program.

But interestingly enough, Kolimago doesn’t worry at all about losing business to the other robo-advisers that are catering to investors with fewer assets by waiving fees or offering low minimum accounts. That’s because many of these firms are actually Vanguard customers themselves, using the investment group’s low-cost mutual funds and other products to serve their clients.

“Whether you’re getting Vanguard funds directly through us or getting us through the robo side of the business or the full-service side, low-fee and well-designed and well-diversified funds are ultimately great for investors regardless,” Kolimago said.

No matter what your platform, the benefit of keeping costs low for individual investors with high-tech tools is one thing that all these firms can get behind.

“This is an exciting time for all investors because it’s one of those rare times when investing is really changing for the better,” said Jon Stein of Betterment. “This time, instead of being driven primarily by regulation, it’s being driven by technology.”

Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor's Guide to Finding Great Stocks.