Robo-Advisers

Online advice has had limited acceptance among 401(k) participants. “Computerized advice has been around for a long time,” says attorney Thomas Roberts, a principal at Groom Law Group in Washington, D.C. “There are lots of examples where defined contribution [DC] plan sponsors have sought to facilitate the delivery of computerized models to participants.” However, these were often ignored because participants preferred to get personalized advice in a conversation with a human, he says.

Robert Cirrotti, managing director and head of retirement solutions at Pershing LLC in New York City, also notes the long-time availability of online advice to defined contribution clients. “While there are some well-established players, they are not as broadly used as some might have hoped when these services first came to the marketplace,” he says, pointing to price sensitivity. “Yes, participants all said they wanted advice, but when they were told they had to pay for it, they didn’t want it,” he says.

With that context in mind, what is the role of the rapidly growing robo-adviser technology in defined contribution retirement plans?

“From our perspective, it’s the next evolution in the retirement space, beyond target-date funds [TDFs],” says Steve Anderson, president of Schwab Retirement Plan Services, in Richfield, Ohio. “Ideally, what you will want is for everybody in a 401(k) plan to have a planner sit by his side and talk at least once a year. But that’s not going to happen. The next best thing is a managed account that uses the robo-style technology,” he says, adding that to create a more customized portfolio using low-cost index investments, demographic data from an employer’s payroll provider and plan recordkeeper are also important.

Unlike earlier models of computerized-advice providers, he says, robo-advisers have an improved and more scalable technology, supporting an approach that incorporates lower investment-management fees, a focus on passive investments that reduces all-in costs further, and a more user-friendly interface and communication style backed by phone-based help for investors. Also, sponsors now have the option to use automatic features to help increase employee acceptance, Anderson says. He sees increasing sponsor and adviser interest in utilizing computerized investment advice for re-enrollment, with managed accounts as the default. About 85% of re-enrolled participants remain in the managed account, Schwab has found.

While the advice vehicle has yet to make inroads into the retirement market, the presence of robo-advisers has grown rapidly in retail. The 12 digital wealth adviser startups tracked by financial services researcher Aite Group LLC saw a 156% jump in assets under management (AUM) in just 12 months—from $2 billion at year-end 2013 to about $5.1 billion at the close of last year.

In the first half of 2015, assets grew by nearly 60% to a little more than $8 billion, says Sophie Louvel Schmitt, a senior analyst at Aite, who works out of Boston. That is still hefty expansion but less than the 2014 growth rate (on an annualized basis), a slowdown she attributes largely to this year’s entrance of two industry giants with new retail digital-advice offerings. As of mid-year, she says, Schwab Intelligent Portfolios had $3 billion in assets, while Vanguard had approximately $17 billion on its Personalized Advisor Services platform—a $20 billion total that already substantially exceeds the robo-adviser startup group’s assets.

Past Results, Future Players
Going forward, both newcomers and traditional players likely will offer robo-adviser technology to retirement plans. In early September, robo-adviser Betterment announced the upcoming launch of Betterment for Business, a new 401(k) platform, in the first quarter of 2016. It will offer personalized investment advice for all participants. “Current 401(k) offerings—and we have examined them all—have poor user experiences, high costs and a clear lack of advice,” says Jon Stein, CEO of Betterment, in Manhattan. “It’s time that all Americans have low-cost, unconflicted advice and smarter technology for retirement planning,” he says.

Stein believes Betterment’s portfolios would work as a qualified default investment alternative (QDIA). “A target-date fund is fine, but most of them are more expensive than Betterment, and they are not personalized to individual investors,” he says. What Betterment offers “is actually an account managed exclusively for you.” He says that a retirement plan version of the service would have very competitive fees. For its retail offering, investors pay 35 basis points (bps) for up to $10,000 in assets, 25 basis points for assets between $10,000 and $100,000, and 15 basis points for assets greater than $100,000.

In the retirement market, Vanguard offers participants two online advice-service options, powered by Financial Engines Inc., with varying degrees of personalization, says Karin Risi, principal and head of Vanguard Retail Investor Group, in Malvern, Pennsylvania. Much of the retail interest in Vanguard’s Personal Advisor Services—a hybrid offering that blends use of robo-style algorithms with investor access to conversations with Vanguard staff advisers—has come from pre-retirees and recent retirees attracted to features such as a customized drawdown strategy, she says.

Retail investors pay 30 basis points for Personal Advisor Services on accounts up to $5 million in assets. Presuming someone’s portfolio gets invested in Vanguard index funds, the all-in fee runs about 45 basis points, Risi says. “It’s right in the range of many of the robo-advisers, but lower than many of the more traditional competitors for comparable offerings,” she says.

Vanguard may decide to bring Personal Advisor Services to the retirement market, Risi says. “We definitely see a need for advice within that particular audience. And we continually look at ways to lower the cost and complexity of investing. So it’s something we’d consider. Absolutely, the service is in the ‘sweet spot’ for pre-retirees and early stage retirees,” she says.

Potential Retirement-Market Impact
Eighteen percent of advisers—including retail and retirement plan advisers—surveyed by Pershing said they see digital-advice providers as a major threat to their practice in the next five years, and 55% see them as a minor threat, according to a survey released in June. “I think that advisers believe the threat is real, in terms of the disruption it will cause to traditional business models,” Cirrotti says. “But I don’t think they see the threat as imminent.”

It is too early to predict how much in assets a robo-adviser approach could gain in the 401(k) market. But it likely will affect participant-level advice in several ways:

• Lower, more transparent fees. Most advisers surveyed by Pershing anticipate an impact on fees for advice: 26% characterize the low cost of digital advice as a major threat to their practice in the next five years, and 50% envision it as a minor threat. “This will certainly put pricing pressure on traditional advice services,” Cirrotti says. He also thinks that, as these services become more broadly available and better understood, more plan participants “will come to see the reasonableness of the fact that there is a fee.”

Digital advisers offer fairly “cookie-cutter” investment recommendations, Louvel Schmitt says, but they do it at a substantially lower cost than more traditional advisers. Their offering “responds to a need among investors for a low-cost, professionally managed service,” she says. “They haven’t been able to get that fiduciary, fee-based service from advisers in the ‘old world.’ For about 25 basis points, [robo-advisers] will provide you with a fiduciary-level investment management service.” Among more traditional advisory firms, she says, the comparable retail fee for that advice often runs closer to 100 basis points.

The very upfront disclosure about their fees also attracts investors, particularly younger ones who want to understand how advice-givers make money, says Laura Varas, a principal at financial researcher Hearts & Wallets LLC, in Rye, New York. “Millennials see that clarity as distinctive.They say that they’re making it honest,” she says.

• Better approaches to engaging investors. This new generation of digital-advice providers has brands with “really distinctive personalities,” Varas says. “And they use design as a competitive weapon.”

Louvel Schmitt thinks the digital-advice startups have some lessons for traditional advisory firms. “Their websites are more personalized, more authentic and simpler,” she says. “The experience they’ve created is something that is nice to look at, and they talk about the services they offer in plain language.”

Their success in the retail marketplace demonstrates that “a financial adviser needs to be much more transparent, hand-holding and human in all channels—most especially, digitally,” she says. If all people see when they look on advisory firms’ websites are “pictures of gray-haired men,” unfamiliar investing terms and self-promotional talk about that business, many investors will not engage, she adds. “Often, it’s all about them and ‘Here is what we do,’” she says of traditional players’ websites. “It is not about the needs of the client.”

Today’s online advice providers are gaining a better understanding than previous iterations had of how investors like to interact with an adviser, Cirrotti says. “These firms are trying to figure out what combination of human interaction versus digital interaction is attractive to investors,” he says. Vanguard Personal Advisor Services customers always talk by phone or video conference with a Vanguard adviser when they start the service. Subsequently, they can do so by request.

About half the time, investors choose to consult with advisers by video conference, Risi says. That allows investors to have something akin to a face-to-face conversation—but one that is scalable for Vanguard.

• A more holistic view of saving. Today’s digital advisers look at financial goals more broadly than just retirement and help people put together a cohesive saving strategy, Varas says. Hearts & Wallets has studied what attracts investors ages 21 to 39 to robo-advisers and finds that this approach appeals to them.

“The best experiences set retirement savings in the context of what these investors are trying to achieve,” she says. That may mean saving money for an emergency fund, a home down payment, a child’s future college education and, possibly, retirement. More traditional players tend to stress how people should focus on saving a large percentage of their income for retirement, she says. That fails to resonate with many Americans under 40, who have competing financial priorities, a large percentage of whom anticipate that they will continue to work part-time or even full-time as they age, she says.

Betterment looks at an investor’s whole financial picture and can put together a different portfolio for each of his different savings goals, Stein says. “Nobody else is giving that type of holistic advice. I can’t believe that nobody does that today” in the retirement market, he says, adding that Betterment has been looking into whether the proposed new fiduciary rules would affect the ability to offer that service. “It’s such a huge opportunity for improvement.”