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Arms race among online financial advisors gives investors much more, for less

Michael Santoli
Michael Santoli

When robo-advisors compete, human investors win.

The group of fast-growing software-based investment firms casually known as robo-advisors are hustling to deliver more-sophisticated portfolio-management services as they compete for client dollars and public attention against one another and entrenched wealth-management powers.

In the latest bit of oneupmanship, online-advisor pioneer Betterment is launching a new tax-management tool meant to minimize tax exposures throughout every customer transaction, collecting tax losses opportunistically while maintaining target asset allocation for customers with at least $50,000 in their account.

Betterment, which has $650 million in assets under management, claims the incremental after-tax returns from using its system, just now being announced to clients, are an extra 0.77%  a year using conservative assumptions and up to an average of 2% a year using others (with annual savings reinvested)  substantially more than the added return estimated by rival Wealthfront for its own tax-loss harvesting approach.

Called TLH+, the tool monitors a Betterment portfolio of low-cost exchange-traded funds constantly – just as all tax-optimization programs do – but adds a layer of analysis to avoid certain short-term timing inefficiencies.

Without delving into all the technical details (which are detailed in a white paper here), the tool prowls a portfolio for tax losses to collect opportunistically, integrates user-initiated transactions into the tax-management process and utilizes added tax considerations in the portfolio rebalancing.

Jon Stein, founder and CEO of New York-based Betterment, says, “I see this as the next step in a series of optimizations and performance improvements we’ve been making,” adding he believes it can deliver twice the tax-smart gains as competing services.

This is exactly the way all the players in this emerging business are approaching things. Wealthfront  the Silicon Valley software-centric advisor that recently surpassed $1 billion in assets  just a few months ago introduced the Wealthfront 500, a product for accounts of at least $500,000 that owns each of the Standard & Poor’s 500 stocks individually, the better to sift among them for clever ways to pocket tax losses while staying invested.

Wealthfront also rolled out a handy automated way for individuals with a big block of employer stock (an early Twitter Inc. [TWTR] employee, say) to sell a defined amount of it instantly and diversify across asset classes.

Betterment, for its part, is offering trust accounts and a retirement-income product for its tech-attuned customer base.

This budding industry is premised on a few basic market realities: ETFs are plentiful and highly efficient; electronic-trading services are cheap for these firms to access; younger people prefer a clean software interface over human transactions; and most investors are probably well served by a simple, low-fee, diversified portfolio monitored and rebalanced automatically.

Players such as LearnVest and Personal Capital are also growing quickly with more of a hybrid human-advisor-plus-machine approach, offering financial plans and tools to consolidate one’s financial life and specific guidance or referrals to actual advisors. Myriad services such as FlexScore offer inexpensive analysis of a person’s financial well-being with guidance for doing better.

The main criticisms by industry veterans of these services are that they’re insufficiently personalized, will see customers “graduate” to traditional advisors when they grow rich enough, and might see clients bolt in a bear market because they lack the soothing reassurance of an advisor behind a desk.

These quibbles are both somewhat true and not very relevant now. Unlike most new financial products, these robo-advisors are pretty unassailable from a cost and transparency perspective, rooted in smart, sober research on what works for most people – passive, low-cost, tax-aware, diversified investing.

The other knock is that, as businesses, they might never become big enough to be particularly profitable or to outlast the big guys. This case is laid out here in a thoughtful blog post at www.iheartwallstreet.com.

And in a virtual roundtable on the subject with investment advisors on Abnormal Returns this week, the consensus was that they will likely be acquired or simply copied by some of the multi-trillion-dollar giants of the business. Sure, there seems to be a lot of aggressive venture money flying around this segment and maybe a good return will elude most of it. But the proper customer response to this is, "So what?"

One or two of the new guys will probably get big enough, fast enough, backed by patient enough venture investors that they live on independently and spread into more areas of personal finance. Besides, most upstarts acknowledge the opportunity to work with traditional advisors by offering their platforms and tools at some point for them to run their practices.

But even if it’s true that these firms will be ingested or replicated before attaining profitable scale, a client need not worry about this – in fact, investors can only benefit over time.

Starting with essentially commoditized ETF portfolios, risk-profiling software and account-monitoring tools, these firms need to continue serving up higher-value services once reserved for very large accounts at full-service brokers.

This raises the industry standard for staying in the game. And with annual fees generally below 0.35% a year, depending on account size, the Betterments and Wealthfronts of the world are putting downward pressure on fees and forcing the rest of the business to raise its game in order to hang on to investor assets and loyalty.