Would you hand your cash to a robot to invest?

Are automated advisors about to overrun the financial services industry? The world's biggest wealth manager is taking no chances. Cris Sholto Heaton investigates.

At the end of August, BlackRock, the world's largest investment manager, bought a small San Francisco-based firm called FutureAdvisor, which looks after less than $250m in assets. What could BlackRock (with $4.7trn under management) gain from such a minnow? The answer is that the firm is a "robo-adviser", one of the hottest fields in financial technology, and the deal shows how quickly asset managers think these firms could reshape the industry.

Robo-advisers provide an automated alternative to traditional investment advice. After signing up for an account online, you are asked a series of questions about your circumstances, goals and attitude to risk. Based on these, the software assigns you to one of a number of portfolios that have different levels of risk and potential return.

For example, a 35-year-old with a high risk tolerance might get a portfolio with 90% stocks and 10% bonds, while an investor nearing retirement would have a far higher weighting to bonds. Each portfolio will hold a range of investments: stocks from your home country, international stocks, government bonds, inflation-linked bonds and so on. The proportion in each portfolio is calculated based on the expected returns and volatility for each asset class, and aims to deliver the highest return for the lowest amount of volatility.

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You could just take the asset allocation the software suggests and buy the funds in your existing brokerage account, without paying the robo-adviser anything: the sites currently offer these tools for free to attract potential customers. That's because they hope you'll take up their paid-for services that manage the entire portfolio for you: buying the investments (most robo-advisers build the portfolios with cheap exchange-traded funds or ETFs), reinvesting the dividends and rebalancing the portfolio back to its target weights.

And, at least in the case of the US providers, they do this for much less than the cost of a traditional managed portfolio: for a $10,000 portfolio, both Betterment and Wealthfront charge 0.25% a year (plus the underlying fees charged by the ETFs they use). The UK is still pricier Nutmeg charges 1% for a similarly sized portfolio but competition is likely to bring this down over time.

So that's the premise does it make sense? While it's no substitute for a consultation with a good financial adviser, robo-advisers offer a quick way to check whether you are saving enough (many people aren't). They encourage you to invest in a steady, sensible way into a diversified portfolio. And while a reasonably experienced DIY investor could manage an ETF portfolio for less than these sites charge, they take away the hassle of doing so.

Whether they are likely to deliver better returns than a sensible DIY investor could is another matter. Some robo-advisers (especially in America) give the impression that their approach is a route to earning 4%-5% a year more than the average investor but they are comparing their strategies to relatively expensive portfolios of actively managed funds. There's nothing ground-breaking about the robo-adviser approach that could lead to market-beating returns.

They are likely to beat the model portfolios of active funds offered by many wealth managers, but won't do any better than a typical well-diversified portfolio of low-cost index funds (and possibly worse, depending on the asset allocation process).

Perhaps the biggest concern about robo-advisers is that they promote a black-box approach to investing: you hand over money to be managed by an automated process that most users won't fully understand. In an ideal world, more investors would be taking responsibility for their own decisions (which could be as simple as holding a single broad index fund, such as one of Vanguard's LifeStrategy funds). Even so, if these services encourage people to focus on costs and to invest more systematically, they could still be a net benefit for the many investors who are currently paying excessive fees for poor results.

Will the 'robo-advisers' take over?

Established financial services firms have also launched their own services, with Charles Schwab managing around $3bn through its Schwab Intelligent Portfolios business andindex-fund specialist Vanguard looking after $2.4bn through Vanguard Personal Advisor Services, a hybrid service that combines online tools with access to human advisers by phone.

The UK market is still far smaller. Nutmeg, the best known, does not disclose client numbers or assets under management: it says it has 55,000 users on its website, but only a small proportion of these are likely to be actively investing via the service. But with BlackRock set to bring the FutureAdvisor service to Europe, and other firms such as InvestYourWay (now owned by IG) gaining attention, we may be set for rapid growth.

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.