Financial tips from the robo-advisor algorithm are rather unpopular

Fintech software, modern digital global business and market analysis, online stock trading and investment helper apps, robo-advisor concept design – Image: Jozsef Bagota|Shutterstock.com

Robo-advisors are a type of digital financial advisor that offers financial advice or investment management with moderate to minimal human intervention. They provide digital financial advice based on mathematical rules or algorithms. These algorithms are developed by financial advisors, investment managers, and data scientists, and coded into software by programmers. These algorithms are executed by the software and do not require a human advisor to provide financial advice to a client.

The software uses its algorithms to automatically allocate, manage, and optimize clients' assets, either for short-term or long-term investments. Robo-advisors are categorized according to the degree of personalization, discretion, involvement, and human interaction.

There are over 100 robo-advisory services. Robo-advice in wealth management is considered a breakthrough for what were once exclusive wealth management services, as it is offered to a wider audience at a lower cost than traditional human advice. Robo-advisors typically allocate a client's assets based on risk preferences and desired target return. Although robo-advisors are capable of investing client assets in many investment products such as stocks, bonds, futures, commodities, and real estate, funds are most often invested in ETF portfolios. Clients can choose between offerings with passive asset allocation techniques or active wealth management styles.

While robo-advisors are most prevalent in the United States, they also exist in Europe, Australia, India, Canada, and Asia. The first robo-advisors were introduced in 2008 during the financial crisis. In 2010, 30-year-old entrepreneur Jon Stein launched Betterment, and robo-advisors gained popularity. The first robo-advisors were used as an online interface for financial managers to manage and balance clients' assets. Robo-advisor technology wasn't new to the field, as this type of software had been used by financial advisors and managers since the early 2000s. However, 2008 marked the first time they were made available to the general public, who urgently needed to manage their own wealth. By the end of 2015, robo-advisors from nearly 100 companies worldwide were managing $60 billion in client assets, and estimates projected that this figure would reach $2 trillion by the end of 2020. In June 2016, the robo-advisor Wealthfront announced a partnership with the Nevada State Treasury to offer a 529 college savings plan.

In 2015, Hong Kong-based 8 Securities launched one of Asia's first robo-advisors in Japan, followed in 2016 by Money Design Co. under the brand name THEO and WealthNavi. In 2017, Singapore-based StashAway received a capital markets services license from the Monetary Authority of Singapore. In May 2020, Webull received SEC approval to launch a robo-advisor.

A robo-advisor can be defined as "a self-managed wealth management service that offers automated investment advice at low cost and with low minimum investment amounts, using portfolio management algorithms." Some robo-advisors incorporate a degree of human intervention and oversight. Robo-advisory is also referred to as digital advisory.

Legally, the term "financial advisor" applies to any institution that provides advice on securities. Most robo-advisor services, however, limit themselves to portfolio management (i.e., allocating investments across different asset classes) without addressing topics such as estate and retirement planning and cash flow management, which also fall under the umbrella of financial planning.

Other names for these financial technology companies are “automated investment advisor”, “automated investment management”, “online investment advisor” and “digital investment advisor”.

The tools robo-advisors use to manage client portfolios differ little from the portfolio management software already widely used in the industry. The main difference lies in the distribution channel. Until recently, portfolio management was almost exclusively performed by human advisors and sold as part of a package with other services. Now, consumers have direct access to portfolio management tools, just as the advent of the internet gave them access to brokerage firms like Charles Schwab and stock trading services. Robo-advisors are venturing into newer business areas, such as retail consumer savings decisions and retirement and accumulation planning.

The portfolios offered by robo-advisors are usually exchange-traded funds (ETFs). However, some also offer pure equity portfolios.

Due to the costs of client acquisition and the time constraints faced by traditional advisors, many middle-class investors in the US are either under-advised or unable to access portfolio management services due to minimum investable asset requirements. The average financial planner has a minimum investment of $50,000, while minimum investment amounts for robo-advisors in the United States start at $500 and in the United Kingdom at £1. In addition to lower minimum investable asset amounts compared to traditional human advisors, robo-advisors charge fees ranging from 0.2% to 1.0% of assets under management, while traditional financial planners charge average fees of 1.35% of assets under management, according to a survey conducted by AdvisoryHQ News.

The costs for robo-advisors in Germany can be divided into costs for asset management, i.e. the actual robo-service, and – in the case of fund-based robo-advisors – the ongoing costs for the funds.

According to a study conducted by Stiftung Warentest in August 2018, the total costs for a model investor amount to approximately 0.6 percent of the investment sum annually with the cheapest providers. The most expensive robo-advisor in the test even costs 1.87 percent per year. By comparison, balanced mixed funds cost an average of 1.92 percent per year, according to Stiftung Warentest. The robo-advisor service alone costs between 0.39 and 1.2 percent of the investment sum per year and usually also includes custody and portfolio rebalancing fees.

The ongoing fund costs depend primarily on the type of funds that the robo-advisors use for investment. ETFs are significantly cheaper than actively managed funds.

In the United States, robo-advisors must be registered investment advisors regulated by the Securities and Exchange Commission; in the United Kingdom, they are regulated by the Financial Conduct Authority.

In Australia, robo-advisors manage client funds through the Managed Discretionary Account (MDA) structure.

In Germany, a distinction is made between financial investment intermediaries and asset managers. Most robo-advisors operate as financial investment intermediaries in accordance with Section 34f of the German Trade Regulation Act (GewO). They are not permitted to rebalance client portfolios without the client's consent. The stricter Section 34h of the German Trade Regulation Act (GewO) governs fee-based financial investment advice. Robo-advisors with this authorization are not permitted to be tied to individual providers and may not accept commissions or other benefits from product providers or banks. Some providers are regulated asset managers and meet the stricter requirements of Section 32 of the German Banking Act (KWG). These are permitted to implement investment decisions directly without being requested to do so by the client or having to obtain prior approval.

Betterment is an American financial advisory company that offers robo-advising and cash management services.

The company is based in New York City, registered with the Securities and Exchange Commission, and a member of the Financial Industry Regulatory Authority. It is a registered investment advisor and broker-dealer.

The company's core service is automated targeted investing, which manages a portfolio of passive, index-tracking equity and bond funds. It offers taxable and tax-advantaged investment accounts, including traditional and Roth accounts for individual retirement plans (IRAs). More recently, Betterment has also offered financial advisors, as well as checking and savings accounts, as additional services.

In April 2021, Betterment had $29 billion in assets under management and over 650,000 customer accounts.

Betterment was founded in 2008 in New York City by Jon Stein, an MBA graduate of Columbia Business School, and Eli Broverman, a lawyer from NYU School of Law. Stein and his roommate Sean Owen, a software engineer at Google, began building Betterment's initial online platform in 2008. They used a Java application and a MySQL database running on Apache Tomcat servers with an Adobe Flash and Flex-based front-end design. Initial prototype designs were provided by Stein's then-girlfriend, Polina Khentov. Recognizing the regulatory burden associated with establishing a financial company, Stein began negotiations in 2008 to bring Eli Broverman, a securities lawyer he had met through regular poker games, on board as a co-founder.

Broverman and Stein were ready to offer financial advice online as SEC-registered investment advisors and decided to also offer broker-dealer services to advise clients. Betterment brought on Ryan O'Sullivan, a serial entrepreneur, to build Betterment's broker-dealer business.

From 2008 to 2010, the founding team further developed the platform until its market launch. Betterment received FINRA approval for membership. In 2009, Anthony Schrauth, a former colleague of Stein's, joined Betterment as Chief Product Officer, and Owen was replaced by Kiran Keshav from the Center for Computational Biology at Columbia University. O'Sullivan stepped down as president in 2010.

Betterment, LLC was incorporated as a company in Delaware on April 7, 2009. The parent company of Betterment LLC and Betterment Securities, Betterment Holdings, Inc., was incorporated in Delaware on January 29, 2008.

The company was presented at TechCrunch Disrupt New York in June 2010 and won the "Biggest New York Disruptor" award. Within 24 hours, Betterment had acquired almost 400 initial customers and began discussions with its first investors.

In December 2010, Betterment received a Series A funding round from Bessemer Venture Partners. In October 2012, Menlo Ventures, together with Bessemer Venture Partners and the Anthemis Group, provided Series B funding. By 2012, the company had launched product offerings such as IRAs, automatic deposits, automatic rebalancing, and targeted investment advice.

Screenshot of the Betterment.com website 2010 – Image: Betterment.com