New start-ups in the wealth management industry, such as Betterment, FutureAdvisor and Wealthfront, are changing the way that investing is being done. Rather than a do-it-yourself approach, or meeting with an investment advisor for face-to-face financial planning, automated investing platforms offer investors a low-cost way to invest capital, design a portfolio and rebalance the asset mix using software that is accessible from any device connected to the internet.
According to MyPrivateBanking Research, the automated investing market will experience significant growth from the current $14 billion in assets under management to $255 billion by 2019. Further, automated investment services are expanding globally. For example, Australian start-up, Stockspot, is getting first-mover advantage in the space, offering automated portfolios of Australian Securities Exchange exchange traded funds (ETFs).
How Automated Investment Platforms Work
Automated investment platforms use software to determine an investor’s level of risk tolerance and investment goals, and then uses algorithms to select and manage a personalized portfolio for the investor based on their individual needs. After an account is established, the automated software platform automatically rebalances the portfolio as needed.
Automated investment platforms use a step-by-step process in working with investors. For example, the system used by start-up FutureAdvisor helps investors determine which existing investments should be sold, what new investments should be purchased and why. The tool also allows investors to reject some of the recommendations, in which case FutureAdvisor will reevaluate the remaining investment recommendations.
There are three main advantages of using an automated investment platform. The first is that it automates the process of tax efficiency. For example, Betterment uses ETFs and municipal bonds, tax efficient buying and selling and tax smart dividend reinvesting as ways to embed tax efficiency into a portfolio. The more sophisticated automated platforms continuously harvest tax losses, that is, the selling of a security that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. With automated software platforms, the sold security is automatically replaced by a similar one, maintaining the optimal asset allocation and expected returns.
The second advantage of automated investment platforms is that they automate the process of trading and transactions. This disciplined approach avoids market timing and avoids irrational and emotional decision making that is characteristic of human investors. Automating the buying and selling of investments can help reduce the irrational tendencies of investors who try to time the market.
The third advantage of an automated platform for investing is that the system automates portfolio management. Taking the investors risk tolerance into account, the automated platform puts the portfolio on auto-pilot and sends reminders when a human touch is needed.
One of the approaches to automated platforms for investment management is to offer the client the best returns for the lowest risk. “Beta” is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
Smart beta strategies attempt to deliver a better risk and return trade-off than conventional market cap weighted indices by using alternative weighting schemes based on measures such as volatility or dividends. The use of “smart beta” by automated investment platforms is linked to a desire for portfolio risk management rather than only investment return. And automated investment platforms that follow a smart beta investment strategy seek to passively follow indices, while also taking into account alternative weighting schemes such as volatility. Generally, smart beta emphasizes weighting schemes based on fundamentals or market inefficiencies and can add greater diversification and improved returns over time.
In response to the success of start-ups in attracting assets under managements, Schwab, Vanguard and Fidelity have entered the field. For example, Schwab’s automated service for consumers uses “Intelligent Portfolios,” which are heavily weighted toward smart beta ETFs. Schwab’s “Intelligent Portfolios” combine cash allocations with a mix of market-cap and fundamental index ETFs.
Automated investment platforms using smart beta strategies may cost less than active management, since there is less day-to-day decision-making for the manager. However it will, at the very least, have higher trading costs than traditional passive management in an index fund (which minimizes those costs) and is a pricier option.
It is not uncommon for financial investment advisors to charge 1-2 percent annually or more via the loaded investment tools they may recommend. As history has shown, this is a steep fee to overcome in order to beat the performance of a passively managed index of the market. While there are different automated platforms and fee structures, most fees range from 0.40 percent to 0.60 percent of assets managed. For example, Future Advisor charges 0.50 percent for their investment services and others have flat rates.
Do Automated Investment Services Have a Future?
The automated investing space is new and evolving. As yet, most entrants in the field are not profitable. Instead they are relying on significant venture capital funding. Still, the industry is growing with several companies already having over $1 billion assets under management. The ease in which new investors can open an account and have a portfolio selected, rebalanced and monitored for tax consequences is an attractive option for many investors just beginning the process of accumulating wealth through the stock market.