Napala Pratini is a growth & business strategy consultant to early-stage technology companies. She has led marketing initiatives for NerdWallet and Earnest. In past lives, she was a ballet dancer and a cancer researcher.
Trusting a car to drive itself is a big leap.
Trusting our money to do the same seems, if possible, even riskier. But that will change.
For example, individual consumers have only been paying for personal financial advice for about 50 years. In just a few decades, developed societies have more or less accepted that giving a planner—often someone you’ve only just met—full control over your financial future is a reasonable thing to do. How much longer until that someone is a machine? (article continues below)
courtesy of Napala Pratini
To get an idea, we’ll look at several of today’s semi-autonomous products and services, then speculate about what a fully automated future might look like. Bringing it about will require technological innovation—but also the right financial infrastructure, new business models, and a significant trust leap on the part of consumers.
We’ll see that, in the race to write the future of self-driving money, several contenders have already emerged.
The rise of the roboadvisor.
Until recently, the only way to put your money on autopilot was to pay someone to make decisions for you.
Then, just over a decade ago and on the heels of the financial crisis, new technology and increasing consumer distrust in banks created an opportunity for entrepreneurs. Betterment and Wealthfront were among the first “roboadvisors,” many of whom saw growth rates in assets under management (AUM) of 100%+ in the years following their launches. (article continues below)
Like a financial advisor, these platforms ask your age and goals, investing timeline, and/or risk tolerance—then invest your money accordingly. Once your portfolio is set, the roboadvisor automatically rebalances it, reinvests your dividends, even helps reduce your tax burden.
A recent Charles Schwab report found that 58% of Americans expect to use robo advice on a regular basis by 2025—and it’s estimated that nearly $1T is already managed by roboadvisors.
Still, roboadvisors have to make up a lot of ground if they want to compete with established firms. The number of Americans using roboadvice is expected to grow to 17m by 2021—just 5% of the population. Vanguard—a single asset manager—had more than $5T AUM as of last September, making roboadvisory’s collective $1T appear slightly less spectacular.
It’s more than just slow adoption; the issue seems to be trust. In 2017, 34% of Americans said they didn’t want any automated financial services whatsoever. An additional 26% said they don’t mind advice from algorithms—but no decisions, please. Only 7% were willing to fully trust a computer with their financial decisions.
Learning to trust the robots.
Establishing that trust with users will require three things: attractive cost, frictionless user experience, and competitive return-on-investment.
From a cost perspective, most roboadvisors are indistinguishable to the average investor. Wealthfront, Betterment, and SigFig all charge 0.25% annually for access to their basic services (which don’t include expense ratios associated with the funds themselves). For context, human financial advisors charge an average of 1.02% of total assets under management.
But startups are no longer the only robots in town. Many banks and wealth managers have started offering their own roboadvisors—sometimes at a lower cost, presumably with the intention of upselling clients on additional products and services.
Establishing that trust with users will require three things: attractive cost, frictionless user experience, and competitive return-on-investment.
For example, Schwab Intelligent Portfolios incurs no advisory fee and has an account minimum of just $5,000. Just three years after its launch, the Schwab product was managing $33B, more than 6x the AUM that Wealthfront managed to reach after nine years of operation.
Despite the fact that their user experience often leaves something to be desired, firms like Schwab carry a distinct advantage: they already manage billions in assets which their users can easily transfer to robo services.
Of course, the ultimate test for roboadvisors is their performance. If they can deliver a return-on-investment as good as or better than other financial advisors—while offering competitive cost and user experience—their long-term prospects are rosy.
Fortunately, we don’t have to speculate. For the last three years, Backend Benchmarking has tracked the performance of various roboinvestment vehicles in its quarterly Robo Report. Here is a snapshot of returns for some of the top roboadvisors. (article continues below)
As you can see, the top performers (for those players who have existed for at least three years) include SigFig (with 6.04% 3-year trailing annualized returns), Schwab (5.92%), and WiseBanyan (5.48%). All performed well relative to the Vanguard 500 Index Fund, which returned 4.81% annualized over the same time period.
The race to become the hub of consumers’ financial lives.
Many of these companies are quickly diversifying their product offerings. For example, Wealthsimple recently expanded to include savings accounts. Online lender SoFi now offers its users high-interest hybrid accounts and a roboadvisory service.
What’s missing is a centralized view of an individual consumer’s financial life. Such a snapshot would enable firms to offer financial products and services that were even more targeted, more optimized for the individual user.
For example, you can use Betterment to start a retirement account, but Betterment doesn’t know when you get a raise, nor can it help you find a mortgage (yet).
The top performers include SigFig (6.04%), Schwab (5.92%), and WiseBanyan (5.48%). All performed well relative to the Vanguard 500 Index Fund (4.81%) over the same period.
Further down the road, your investment advisor (be it human or robot) will automatically become aware of your additional income and tailor your investing strategy appropriately. It will select the best mortgage for you, given your retirement goals and spending habits. It will even be able to recommend a few nice homes in neighborhoods you frequent.
In so doing, it will become the hub of your financial life—the place where the money is kept, the command center where products are evaluated and decisions made.
Such a system will require the right plumbing: a financial services infrastructure that enables users to instantly and securely link accounts and transfer money. It will also require an extensive list of safeguards, either to prevent the software from making certain decisions (such as exceeding a certain allocation for tech stocks) or to prompt human intervention when needed.
It leaves open the question of what human involvement might look like—if it existed at all. Would these new platforms offer the ability to talk to a person? How about branches or in-person relationships? Will consumers ever be willing to give those things up?
Capture the flag.
Today’s automated financial products are at a developmental stage similar to that of self-driving cars. Much of the necessary technology is available, but pulling the pieces together into an autonomous (and widely-available) whole remains, for the moment, elusive.
Significantly, the lack of coherent, modern regulatory framework makes it challenging for financial services firms to manage legal risk and government relations, a huge barrier. Thus we can’t yet know what such a world would look like—or who will occupy the hub position. (article continues below)
In one scenario, banks become the hub, leveraging APIs to determine which third-party financial apps and providers are best for each customer, and when.
The challenge is that such a move would require business-model innovation by banks. Rather than trying to get customers to buy their own products and services, they would need to monetize based on the recommendations they provide. Rather than competing on financial product offerings, they’d compete on the quality of the outcomes their customers experience.
In another scenario, fintech challengers become the platform. In fact, companies like CreditKarma and NerdWallet already seem well-placed to play such a role.
Rather than offer financial services of their own, they act as marketplaces for other institutions’ products and services. In so doing, they have adopted an affiliate revenue model, helping consumers make better choices by offering them elegant comparison tools and customized recommendations.
The challenge for these players is, as previously mentioned, trust. The experience has to be so good that users are willing to share their sensitive personal financial data.
Trust is not sufficient. To occupy the hub position, platforms like CreditKarma and Nerdwallet must become indispensable to their users.
But trust is not sufficient. To occupy the hub position, platforms like CreditKarma and Nerdwallet must become indispensable to their users. That means consistently offering recommendations that are smarter, cheaper, more personalized than their competitors’—rather than simply flogging the products that earn them the most affiliate revenue.
The final scenario is that a single institution eventually becomes both the platform and the financial service provider.
While regulatory barriers make this virtually impossible in most Western markets, it’s less farfetched in a country like China. China may more receptive to this type of innovation due to a lack of existing infrastructure and a more centralized regulatory landscape.
A long and winding road.
To be sure, we are in the early days of automated personal finance. While many exciting and innovative products are already available, the industry is still small when compared with traditional asset management—and we’re far from fully self-driving money.
Getting there will require platforms capable of aggregating various financial products and services, as well as algorithms that can leverage consumer financial data to recommend the right solution at the right moment. It will require the right financial infrastructure, business models, and a conducive regulatory environment.
Most important, it will require a trust leap on the part of consumers. But if all these conditions are met, it will enable a new generation of financial services, one that has the potential to serve customers better while requiring less of them.
Napala Pratini is a growth & business strategy consultant to early-stage technology companies. She has led marketing initiatives for NerdWallet and Earnest. In past lives, she was a ballet dancer and a cancer researcher.
