Is Autopilot the Answer?

Some retirement planners have no pulse. They’re that way by design. Literally.

They’re robo advisors, a swarm of about 200 startup companies that emerged from the recession to take on traditional financial advisors by offering low-cost, automated investment services.

Robos ask clients a series of online questions about their lives, goals and risk tolerance, then guide them through creation of an investment portfolio that will automatically rebalance allocations as the market changes. Typically, they charge up to one third less than what traditional stock brokers do.

So far, robos have focused on solo investors and small businesses whose assets are below the minimums set by larger stock brokerage firms—but the upstart startups are intent on capturing a share of the 401(k) space occupied by benefits brokers. In January, the leading robo firm, Betterment, launched a full-service 401(k) program, and other automated services hope to follow.

Despite their ambitions, robo advisors aren’t exactly on the verge of ousting their human counterparts from their offices, at least not yet. They have only $53 billion in assets under management, a small fraction of the $24 trillion in various types of retirement accounts nationwide.

But robos have added clients and assets at a fairly rapid clip in the past few years, and they’ve inspired established firms, such as Charles Schwab and Vanguard, to launch automated programs of their own. Together, the startups and their establishment imitators are expected to have $287 billion in assets under management next year, according to researchers at the Aite Group. The auditing firm KPMG and management consultancy A.T. Kearney see bigger things ahead—with robo assets hitting $2.2 trillion by 2020.

That doesn’t surprise the people behind the robos. They contend they’re offering an innovative approach that investors—including, if given the chance, workers saving for retirement in traditional 401(k) plans—will readily embrace.

“I think if you polled a hundred 401(k) participants at random, you’d be hard pressed to find more than, perhaps, one who really liked their 401(k) experience,” says Joe Ziemer, Betterment’s director of communications and policy initiatives.

Benefits brokers are decidedly skeptical about the reach or the staying power of robos, but they’re watching the trend closely to determine if it’s a fad, a threat…or an opportunity.

The Advance Guard

Robos began to emerge in the depth of the recession, appealing primarily to new investors looking for lower fees and greater control over their portfolios in a volatile market. That remains a vast majority of their market.

“You can see how the evolution took place,” says Lisa Kottler, senior vice president of retirement services at insurance brokerage NFP. “Most folks had one of two options when it came to managing their investments. You either do it yourself or hire a financial advisor.”

Robo advisors are taking advantage of coverage gaps in both arenas, she says. Individual investors who don’t have a 401(k) at their workplace often don’t meet minimum balances at traditional brokerages. They’re finding new, less expensive opportunities at robo firms.

A similar gap exists with smaller companies, whose owners find it difficult to start a retirement plan for their employees.

“A lot of them don’t have a 401(k) plan,” Kottler says. “They may think it’s too expensive, too administratively cumbersome, so they don’t set one up.”

Benefits brokerages such as NFP rarely try to sell 401(k) plans to companies with fewer than 100 employees. “In the small market,” she says, “it’s difficult for the providers, the recordkeepers and the advisors to make money, so they’re not really sold,” she says.

Robos are angling to change that—not only with small businesses but larger ones, too. In addition to drawing more solo investors to their offerings, they’re hoping to compete directly with firms like NFP.

Wealthfront, founded in 2008, was an early leader among robo advisors, topping $1 billion in assets in 2014, largely among Silicon Valley professionals. But fellow startup Betterment has edged ahead since then and now has more than $5.1 billion in assets, compared to Wealthfront’s $3.5 billion.

Wealthfront CEO Adam Nash, a former LinkedIn vice president and Apple software engineer, says he believes all firms offering investment and retirement plans will be using robo advice in some form in 10 years—a prediction borne out by recent investor surveys. He compares the trend to the e-commerce boom in the 1990s.

Like all robos, cost is a major selling point at Wealthfront, which is run by a mix of former executives from Facebook and LinkedIn. The company touts its ability to help clients invest “for less than a night at the movies.”

Wealthfront requires a $500 minimum balance and handles the first $10,000 in assets at no charge beyond basic exchange-traded fund fees of about 12 basis points. Accounts greater than $10,000 are charged 25 basis points, 0.25% of the amount in the account.

Betterment has no minimum and charges 35 basis points for the first $10,000 invested, 25 basis points for more than $10,000 and 15 basis points for more than $100,000.

Both firms report they’re drawing larger accounts—a potential indication they could gain a foothold with workers invested in conventional 401(k) accounts if their employers were to offer the option. More than half of Betterment’s clients and a third of Wealthfront’s have investments of at least $100,000.

The Establishment Follows Suit

The startups have drawn the attention of established firms that work with solo investors. Charles Schwab launched its own robo service, called Intelligent Portfolios, last year for investors with a minimum of $5,000. The firm charges no fees; its revenue comes from investments in Schwab funds.

Schwab officials have described robos as “an evolution, not a revolution.” About 15% of its robo investors have a balance of more than $1 million, and three quarters were already Schwab customers.

Schwab soon followed with a robo platform for institutional advisors, who are charged a platform fee of 10 basis points for less than $100 million in assets under management. Fees are waived for accounts of more than $100 million.

Vanguard also introduced a robo, Personal Advisor Service, last spring and had $12 billion in assets by the end of the year, almost entirely from existing customers. It charges 30 basis points, with a $50,000 minimum. With the success of those efforts, other investment firms—including Wells Fargo and Bank of America Merrill Lynch—have indicated they’re planning or considering robo platforms for their clients.

In a survey last fall, the research firm Market Strategies International found one third of investors with at least $100,000 in assets are using some form of robo advice, either from startups or established firms. One fifth said they were interested in shifting at least some of their money to a robo firm, another potential sign that growth could occur in 401(k)s if employers let them in the door.

“To say that robo advisors have gained traction in the marketplace would be a dramatic understatement at this point, particularly where younger investors are concerned,” Linda York, vice president at Market Strategies International, said when the survey was released.

“Furthermore, with adoption anticipated to increase rapidly, industry leaders are scrambling to figure out how to get into the game. Since sitting on the sidelines is not an option, many companies are considering whether to build it or buy it.”

Partnerships are also part of the equation. SigFig Wealth Management, another major robo advisor, has partnered with Boston-based Cambridge Savings Bank and reports that it is talking to major banks about adding its services. JPMorgan Chase has a partnership with the robo firm Motif Investing. Fidelity Institutional uses Betterment to offer robo services through its client advisors.

Betterment’s Ziemer says his firm sees its role as complementary rather than competitive. “We do have advisors using our technology to service their clients,” he says. “We’ve got more than 200 firms who use Betterment to help manage their clients’ assets.”

But competition is also part of the landscape. Last fall, Betterment announced it would expand its offerings to include a full-service 401(k) plan for employers, becoming the first robo to enter that space. Ziemer says more than 100 employers have signed onto the program, called Betterment for Business.

The number of employees in each plan ranges from 25 to several hundred, according to Ziemer, who says doctors and lawyers are among the early customers setting up plans for employees in their offices.

Other major clients include Estimize, a financial data service; StockTwits, a social network for investors and traders; and Boxed, an online service that ships bulk quantities of groceries and household goods.

More than 60% of Wealthfront’s clients are younger than 35, but the technology appears to have captured the attention of investors across multiple age groups. According to Market Strategies’ research, roughly one fourth of current users are millennials, and the remainder are close to evenly divided among baby boomers and Gen Xers.

Surprisingly, older millennials—who typically have more money in their accounts—appear to be more interested in robos than other age groups. A study by Phoenix Marketing International found that roughly half of millennials with at least $100,000 in assets wanted a mix of robo and human advice.

Allison Winge, executive vice president of retirement at Plexus Financial Services, says the emergence of robos is definitely on the minds of benefits brokers. But there’s little movement to adopt or adapt at the moment. “I think most advisors are taking that wait-and-see approach,” she says.

Should Employees Choose?

Robo advisors say one of their major selling points, aside from cost, is a user-friendly platform.

The majority of 401(k) providers offer a “very antiquated and also very overwhelming” platform, according to Betterment’s Ziemer. “Basically,” he says, “you go in, and you’re asked to pick your funds. The majority of the public should not be picking their own funds—let’s be honest.”

Betterment guides participants through their options and helps them choose the funds that best match their goals and risk tolerance, according to Ziemer. “Employers want to provide more advice to their employees, and that’s what we’re doing,” he says.

But Winge and other benefits brokers are not convinced the experience matches what traditional firms offer. Plexus typically holds quarterly seminars for clients, developing customized education programs and helping participants set goals, she says. Regular contact is part of the standard operating procedure.

Winge is not sure robo advisors can offer adequate assistance, particularly for people on the verge of retirement. “Currently,” she says, “the technology doesn’t really address some of the advanced planning, like Social Security, and some of the decisions that you make when you reach that planning-for-retirement stage.”

Benefits brokers also point out that robo advisors typically don’t offer the same level of financial wellness services that human advisors do. Many employers, with assistance from their 401(k) brokers and providers, now offer educational programs designed to help employees better manage their credit card debt and other household expenses so they get into a position to save money for retirement.

Ziemer says Betterment plans to incorporate more wellness programs. The dashboard provided to investors does help them view their assets and debts in one place, a step toward better financial behavior. Wealthfront has rolled out a similar offering.

Despite the research showing a significant portion of investors—particularly millennials—want an automated platform, there’s considerable skepticism among benefits brokers about the durability of that interest.

Brokers see a bit of déjà vu in the robo trend. Over the years, advisors and 401(k) administrators have sought to get participants more engaged in their retirement plans through various online tools, particularly in the early days of the Internet.

“The reality is that participants didn’t really use them,” Kottler says. “The industry spent millions of dollars, and a lot of the tools sat there on the websites. The usage was probably in the single digits.”

Robyn Credico, a defined contribution consultant for Willis Towers Watson, says participation rates will be a huge hurdle for robo advisors trying to enter the institutional 401(k) market.

No matter how sophisticated the technology may be, she says, the robo platforms aren’t useful unless plan holders log on. In the past, providers found that few participants bothered to check out online tools and even fewer executed a change.

For employers pondering a shift to robo advisors, Credico says, the question will become, “Am I better off just giving my employees a target date fund if they’re not going to the trouble of putting all this information in?”

In fact, Credico says, the growth in easy-to-manage target date funds in recent years is partly the result of participants demonstrating they don’t have the time or inclination to monitor their own plans or feed extra information to the 401(k) provider.

“What these robo advisors are all trying to solve is how do we actually get something that people will use? We know that everybody needs help, everybody wants help, but how do we give them help in a very, very confusing environment without wasting a lot of their time?” she says.

Robo advisors could benefit from this spring’s fiduciary rule change by the Department of Labor. The change, which will be phased in beginning in April 2017, requires financial advisors to avoid conflicts in their recommendations. Previously, the advisors were allowed to recommend funds deemed suitable to the client’s needs even if the advisors had a financial stake in the product.

Robo advisors have touted their independence from the start. Ziemer says investors don’t have to worry that they’re being pushed into funds that their advisor benefits from selling.

“At Betterment, we don’t have any relationship with any fund manufacturer,” he says.

But not everyone is convinced that robo firms meet their fiduciary obligations.

The Massachusetts Securities Division issued an advisory to investors this spring questioning whether the algorithms used by robos are comprehensive enough to qualify as sound advice.

The Securities and Exchange Commission and the Financial Industry Regulatory Authority issued a similar joint alert last year suggesting investors carefully examine whether robos are collecting enough information.

Critics contend robos don’t factor in special circumstances in an investor’s life, such as high credit card debt or the need to save money to care for aging parents.

The platforms used by Betterment, Wealthfront and others enable users to connect to mortgage debt and other accounts on their online dashboards, but the information isn’t universally factored into investment analysis.

Robo Assimilation?

KPMG, whose research indicates automated investment services will capture $2.2 trillion in assets by 2020, expects much of that growth to come from existing clients at established firms and from hybrid programs that mix robos with human advisors, sometimes called “bionic” advice.

Although she’s skeptical that robos will gain much traction, Credico says one avenue for growth could come from reducing costs enough for their platforms to become attractive as default options in conventional 401(k) plans. “It might become a little more prevalent then,” she says.

Winge says it’s possible that scenario could play out, if plan sponsors can demonstrate that robo options will meet fiduciary obligations and there’s sufficient oversight of the automated portfolios.

“It is a scalable way to deliver investment advice to employees, so there could be that option for some of the larger employers,” Kottler adds, “but I still think the retirement plan advisor at the plan level is still going to be involved.”

Ziemer says he expects more partnerships between traditional brokers and robos, but he doubts the future of robos will simply be folding their technology into existing plans. Robos, he contends, are a superior alternative product for many investors, particularly those who are participating in target date funds offered by many traditional advisors.

Although TDFs were a major step forward in encouraging savings, Ziemer says, they’re flawed because they lump everyone together by birth year and projected retirement date.

“It doesn’t take into account your individual situation,” he says. “It doesn’t look at things like outside assets, it doesn’t look at goals, and that’s where we can do better. We can actually personalize that quite a bit more to your particular situation and your asset level to recommend things for you as an individual—and not you and 50 million other Americans who happen to have been born in the same decade.”

Even if robos don’t make major gains in the 401(k) space, they could have lasting effects on retirement planning and investing—in technology or a further compression of fees.

“If these lower-cost solutions show there’s pretty good utilization, I think the larger [plans] would be inclined to come up with a different service offering,” Credico says.

But she’s doubtful robos will gain much more ground. “I think it’s good that these providers are trying to be innovative. I just don’t know how successful they’ll be,” she says. “Most people like to talk to another human being. That’s not a comment on the product. It’s just a comment on a human behavior.”

Kottler agrees. “I think over time we’ll see more and more technology make its way into plan advising, maybe even in ways that we don’t realize yet,” she says. “But do I think it will take over the business and eliminate the human interaction, the expertise, the quality advice? No.”

Ziemer, of course, is confident that robos are here to stay and that Betterment will continue to capture more assets.

“We’re happy with the growth, but we also completely recognize that in the larger scheme of things, in the overall financial services industry, we’re still a small player,” he says. “But all those [established] companies started some place at some point in time, and we like to think that we’re building a product that will get us there in the future.”

Ziemer says there’s a huge opportunity just in setting up 401(k) plans with smaller companies that aren’t being served by brokerages. But that’s not the sole market for robos, he says.

“We’re getting interest from very large plans, and I think you’ll see us making big inroads there over the next year,” he says. Betterment for Business has been available for less than a year, which means it’s yet to be in the longer sales cycle followed by larger companies, he says.

“Without a doubt, we will win large plans,” Ziemer says. “It’s just a matter of time.”