Should A Robot Run Your Retirement Portfolio?

Should A Robot Run Your Retirement Portfolio?

Betterment CEO Jon Stein and Wharton’s Olivia Mitchell discuss robo-advisors as the future of wealth management.

Should you take investment advice from a robot? For Jon Stein, CEO of robo-advisor firm Betterment, the answer is a resounding yes. Robo-advisors are algorithms that recommend investments based on one’s investment preferences, risk tolerance and financial goals with minimal human interaction. Using this technology, robo-advisors cut the cost of traditional wealth management to the masses.

Robot Retirement Portfolio
geralt / Pixabay

Stein talked about this rising trend in the investment management industry on the Knowledge@Wharton Show, which airs on Sirius XM channel 111. He was joined by Olivia Mitchell, executive director of the Pension Research Council, who is also director of the Boettner Center for Pensions and Retirement Research at Wharton.

An edited transcript of the conversation follow.    

Knowledge@Wharton: When we’re talking about investing and people saving for retirement, would you say that we shouldn’t be surprised to see more use of robo-advisors and technology?

Olivia Mitchell: Absolutely. We have the software now, and most people have some access to the internet through phones or laptops or what have you. And these are hard problems: figuring out how much to save, where to invest, and what to do with your money in retirement. So we could use help.

Knowledge@Wharton: How quickly is the financial industry coming along right now with the use of technology?

Jon Stein: What we’re seeing is incredible growth. … We now manage over $8 billion for 240,000 customers. Our growth path over the past few years has been faster than the growth of mutual funds, faster than the growth of ETFs — even when those products were new, in their early days. This idea of technology-driven, smarter investing is really transforming the way that people think about what they do with their money. It’s taking off in a way that’s never been seen before.

Mitchell: Some of our listeners might not be terribly well versed in what the term “robo-advisor” means. It’s shorthand for a lot of different products. Give us your own take on what that term means, and talk about what kind of advice robo-advisors are providing to customers.

Stein: Yes, the products in robo-advisors can be very different.

Betterment offers customers a solution that does all of the things you should do with your money and automates them, so that you do them without having to think about them, and provides that at an incredibly low cost. We think about it as taking all the things that maybe you would get if you did everything you should do with your money, and packaging that up — using technology to drive the cost down. So, that’s obviously good. That’s something everyone should be doing, and I think that’s what’s driving the growth of the industry.

Mitchell: Let me turn it around, just to clarify: What kinds of advice do robo-advisors not provide when it comes to money?

Stein: There is a range of different services out there. I think one of the difficult things about defining a term like “robo-advisor” is that since the launch of Betterment, there are now dozens of “me-too” firms. The big firms — Schwab, Vanguard, Fidelity, all of them — are getting into the business, trying to imitate what Betterment has pioneered.

Knowledge@Wharton: Is this viewed as disrupting the investment industry?

Stein: This is, I think, where the most exciting changes are happening in financial services — and beyond just investing. If you look at what’s happening from a regulatory perspective, with the proposed Department of Labor rule about fiduciary advice, with what the CFPB (Consumer Financial Protection Bureau) is considering around access to customer data, there’s a lot of interest in how we align financial services better with the customer’s best interests. How do we provide services that customers want — which is advice, fundamentally. Eighty-three percent of retirement plan participants say they want more advice than what they’re getting, yet only 0.1% of the mass market has a fiduciary financial advisor. So there’s this huge gap in financial services. Everyone wants advice, because the world is getting more complex, and almost no one gets that advice.

This thing we call a robo-advisor — it’s really about providing guidance and support to people who need it, and otherwise wouldn’t get it. That is the future of financial services: Everything you do with your money should be optimized for you, not just investing. It should be maximized so that you make the most of your money across all the things that you’re doing.

Knowledge@Wharton: When you think of your customer base right now, what percentage of them need that guidance, that helping hand along the way, compared to the ones who have a pretty good handle on what they want to do with their investments?

Stein: There’s this challenge in investing: People think, “Oh, the best thing you can do is just figure it out yourself.” It’s as though we live in a world where everyone thinks the best thing to do is to go home and perform surgery on yourself. It’s not. You can do a lot better.

We do things for our customers at Betterment that no one else does, and that you can’t do for yourself. We can trade fractional shares for you; do tax law service for you every day; rebalance dynamically; shield your dividends across your accounts. Even if you spent all day, every day on these things, you couldn’t do it at the level that we do it, because of the technology that we’ve built, because we manage our own broker-dealer, because we’re able to optimize in ways that the incumbent giants can’t. They just haven’t been built to optimize for customers’ best interests. They haven’t been built to maximize your money.

“This idea of technology-driven, smarter investing is really transforming the way that people think about what they do with their money.” –Jon Stein

People don’t understand this, so there’s a lot of work that we’re doing to open people’s eyes. The strategies of 40 years ago — the idea that you buy and hold a single mutual fund — don’t actually maximize your money. And I realize that’s a hard thing to hear for a lot of people who’ve been doing that for a long time. It used to be the best thing you could do, but now you can do so much better, and we’re opening people’s eyes to that fact.

Mitchell: Let me ask a little bit of a background question. As I understand it, during your on-boarding process for new customers, somewhere early on, you ask the customer goal-based questions. But a lot of my research has shown that Americans are tremendously financially illiterate; they don’t understand compound interest, risk diversification, inflation, you name it. In light of that widespread financial illiteracy, might that part of the on-boarding process run the risk of asking uninformed people to set goals that perhaps are not correct goals?

Stein: I would agree with your research, which says that in general, there’s not a lot of financial literacy. I don’t think just more financial education will solve that. The problem is that people will learn something, and then years

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