Would you take financial advice from a robot?
Dozens of new investing and personal finance-themed startups are betting the answer is yes. In the wake of the financial crisis, which turned many consumers off of big financial institutions, an outpouring of startups aim to fill the gap. Among their offerings: algorithm-based investment advice, which crunches numbers from your life and accounts to offer investment suggestions, online financial advisor search tools and online financial planning and budgeting tools.
A new report from Corporate Insight, which performs research for the financial services industry, examined more than 100 startups through more than 50 interviews with the entrepreneurs behind them. Grant Easterbrook, the Corporate Insight analyst who wrote the report, attributes the startup boom partly to the fact that the financial crisis eroded people’s trust in large financial institutions, causing them to look elsewhere for financial advice and management.
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He says the crisis also focused many entrepreneurs – and venture capitalists with the money to fund their ideas – on the question of how to best provide people with financial services. Improved technology also makes it easier to meet people’s complex financial needs through a computer and automated services, he adds.
“The financial crisis drew a lot of attention to the industry and got a lot of entrepreneurial minds focused on it. There’s the potential to make a lot of money and cater to an underserved market,” Easterbrook says. And while consumers tend to be understandably hesitant to trust their financial information to startups they’ve never heard of, the negative publicity surrounding the bigger firms made them more open to trying something new.
The startups include the following business models: algorithm-based investment advice, like SigFig, which makes recommendations based on users’ aggregated accounts; trade mimicking, which lets users copy an investment manager's trades without giving up control of their money; online financial advisor search tools; online-only financial advisors (without in-person meetings, the service costs less); and online financial planning and budgeting tools. Some startups, such as LearnVest, include both online financial advisor services as well as free budgeting tools.
With the algorithm-based investment advice, users can upload their various accounts onto a website, and it will automatically highlight issues they might have missed, Easterbrook explains. “If you have a lot of exposure to specific stocks, it might recommend you buy into a real estate investment trust,” he says. If you already work with a financial advisor, the site could offer a second opinion and show just how much you are paying in fees based on the funds selected by your advisor.
The startups offering this type of advice are generally registered investment advisors, which means they have a fiduciary duty to act in clients’ best interest. Many of them make money off of referral fees. For example, if the startup recommends a user switch to a low-cost service such as E-Trade, then E-Trade would pay a referral fee for that customer.
Easterbrook says it’s too soon to judge how successful the startups will be and how long they might last, but he expects many of the bigger players in the financial services field to look for ways to incorporate the startups’ offerings in their own websites.”It’s such a ‘me-too’ industry,” Easterbrook says. Brokerage houses or other financial services firms could purchase, copy or simply partner with the new startups.
While the entire concept of algorithm-based investment advice runs counter to the customized service provided to high net worth clients at firms such as Morgan Stanley and Merrill Lynch, Easterbrook says that other firms, such as E-Trade or Scottrade, which tend to attract more self-directed consumers, could find the platforms more useful.
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“Through our conversations with our clients, we know there’s a lot of interest in potential partnerships. It’s only a matter of time before one pulls the trigger and a major online firm starts offering these services, and then it will snowball because others will want to make sure they aren’t left behind,” Easterbrook says.
As for the pursuit of that elusive customer trust, Easterbrook says one key will be for the startups to become even more customized, even in their automation. “The big problem is that the input they currently require isn’t comprehensive enough. To offer truly unparalleled advice, they would need to answer so much more: When will you retire, what’s your wife’s 401(k), when are your kids going to college. Many factors beyond income and retirement age. These services are really useful, but until they’re more holistic and comprehensive, they’re not competing with financial advisors,” he adds.
Indeed, Easterbook doesn’t expect these startups to completely replace advisors, especially when it comes to high net worth clients with a myriad of complex and personal issues, ranging from taxes to estate planning. Still, the startups are having an immediate impact on the industry. Their presence is already putting pressure on large financial institutions to be more transparent in their pricing, and also to be more affordable. Young clients in particular are likely to be drawn to them, he says.
If that’s the case, in 10 years, some of these startups could end up being the big players in the field.