The term “robo advisor” was first coined in a March 2002 article in the Financial Planning Magazine, in which the author, Richard J. Koreto, described a new generation of automated, digital advisors.
Nearly 20 years later, robo advisors, known as “robos” in Canada, are still the subject of heated debate in the finance world. After a meteoric rise in adoption and popularity over the last decade, the industry has been on a downward trajectory since the beginning of the pandemic.
Before taking a look at the key drivers behind this decline, let’s take a step back and refresh ourselves on what a robo advisor is and why they’ve been so popular.
A Quick Primer on Robo Advisors
Put simply, a robo advisor is an automated investment advisory service that uses algorithms to make investment decisions on behalf of its clients.
The robo advisor industry is broadly comprised of two categories of products:
- Fully automated robo advisors use sophisticated machine learning algorithms to make investment and financial planning decisions on behalf of their clients, and require minimal human intervention.
- Hybrid robo advisors use a combination of human and automated decision-making to deliver generalized investment recommendations.
While the client interface will vary, these products may also include additional features in the form of education resources, tax minimization strategies, and automated portfolio rebalancing.
An Industry in Decline
With venture capital investment soaring and tech commentators waxing lyrical about the potential for low-fee robo advisors to democratize access to investment advice, the industry looked set to take off in 2021.
The reality, however, has been quite different.
Despite a surge in investment in the industry, robo advisor adoption has been sluggish and, in some cases, outright negative since the outbreak of the COVID-19 pandemic.
At its peak in 2020, the industry boasted some $460 billion in assets under management. However, pandemic-induced volatility in the global economy has caused a precipitous drop in the industry’s fortunes. To better understand the situation, let’s take a look at the key drivers behind this decline.
1. The “New Normal”
The first factor to consider is perhaps the most obvious: the COVID-19 pandemic has changed the way that most people live, work, and invest.
While the inconvenience of social distancing and limitations on travel were quickly overcome with remote work platforms and telecommuting, the impact of the pandemic on the stock market, and the global economy more broadly, has been profound.
The pandemic has already resulted in massive job losses, protracted supply chain disruptions, unprecedented debt loads, and a lengthy global economic slowdown. With economic uncertainty at record levels, investors are reluctant to cede control over their portfolio to a third party, especially one that may be operating in a “black box” environment.
2. A Pivot Towards DIY Brokers
In the early years of the industry, robo advisors were largely seen as a complement to the traditional advisor space, providing an additional layer of advice to help clients navigate the increasingly complex financial world.
However, the rising popularity of do-it-yourself (DIY) brokers has made robo advisors look decidedly old school. With a DIY broker, you are in control of all your portfolio decisions and can trade your own account at your own pace. The economic implications of the pandemic have made this service even more attractive, giving retail investors — flush with government stimulus — the ability to quickly and seamlessly trade and hedge on intuitive, low-cost, online platforms and apps.
As a result, the DIY broker movement has been gaining pace in recent years and has seen a surge in adoption over the last 12 months, especially among millennial investors. With DIY brokers steadily encroaching on the automated investment market, robo advisors have struggled to maintain a competitive foothold in the space.
3. Bringing Back the Human Element
The pandemic has highlighted the limitations of automation in the financial world. The complexity of the financial markets, the ever-changing regulatory landscape, and the need for human interaction to foster a relationship with clients all pose challenges that robo advisors have struggled to overcome.
In the current climate, investors are taking notice of the value of human interaction, and they expect their advisors to have a genuine human touch, especially in times of crisis. In comparison to more human-facing services like traditional and DIY brokers, robo advisory platforms have consistently failed to capture the full context of client risk tolerance, often leading to a misalignment between client expectations and advisor recommendations.
The Bottom Line
The robo advisor industry is a rapidly evolving space and there are many factors driving the decline in the industry’s fortunes. I am optimistic about the future of robo advisors, but we are in uncharted territory and the industry is in the midst of a massive adjustment period.
In the coming months and years, we will see a number of robo advisors try to adapt their business models and offerings to meet the needs of their clients in this new landscape. The winners will be those that can successfully reinvent themselves and adapt to the new realities of the post-COVID-19 world.
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