Rise of robo-advisors in mortgage business could have an impact

Online startups offering low-cost investment advice – widely known as “robo-advisors” – have received lots of attention lately. And reactions to these startups fall into two categories.

On the one hand, some observers view robo-advisors as a massive overreach by the technology community, similar to the failed experiments in the early days of the Internet boom.

On the other side of the argument are the tech proponents, who view online financial advisors as transformative players that will use technology to lower costs and improve client outcomes. These new firms thus are viewed as having the same impact on financial advice as Amazon.com Inc. has had on the sales of books: increasing convenience, lowering prices and putting incumbent competitors under pressure.

So, what does history suggest about the likely outcome for these new entrants? Are the advocates or the skeptics closer to the mark? Here are three lessons:

Lesson 1: Change will take longer than expected

History suggests that it will take longer (perhaps much longer) for robo-advisors to get traction than most promoters and advocates believe. That’s especially true given that most assets today are held by older clients, a group who are the least tech-savvy and most resistant to change.

As a result, chances are good that many of the initial investments in these startups will end in tears.

Railways offer an instructive example. First appearing on the scene in the early 1800s, there was a huge railway boom from the 1830s to the 1860s, in which railways displaced canals in moving freight. Most of the early investors in railways were wiped out simply because the initial optimism fuelled overinvestment and overcapacity, leading to consolidation and a shakeout.

The same thing happened to early Internet players, such as Global Crossings Ltd. and Tyco International Ltd., that spent billions in the 1990s to lay fibre-optic cable in anticipation of an explosion in Internet traffic, then ran into financial difficulty because they weren’t prepared for how long it would take for demand to materialize.

Lesson 2: Ultimately, online advice will play an important role

Over the long term, you should be cautious about dismissing technology-based advice. Harvard professor Ted Levitt’s seminal Harvard Business Review article entitled “Marketing Myopia,” first published in 1960, explored how the railway and movie industries, dominant at the time, had dismissed automobiles and television, respectively, as competitive threats when they arrived on the scene. What rational person, players in the railways and movies asked, would give up the comfort of their established offerings for these unproven, new alternatives?

When faced with an untraditional competitor that offers an inferior product at a lower price, the first response often is dismissiveness. There’s a long history of established incumbents underestimating upstart entrants with stripped-down solutions, whether it be legacy airlines scoffing at discount carriers or U.S. automakers dismissing Japanese imports. The financial services sector isn’t immune to underestimating new price-based competitors; look no further than the initial yawns in response to exchange-traded funds.

The real threat to advisors from online advice doesn’t lie in the latter’s potential to steal clients. Given inertia and a generally older client profile, the risk of client defection to online advice is quite low in the short term. Instead, the true impact upon traditional advice will come in two other areas:

First, the online option will put downward pressure upon fees. Some clients who read about online advisors’ fees of 25 or 50 basis points will question the fees those clients are paying. After all, everyone wants to feel that they’re getting good value. This was the experience with the aggressive cost-cutting by discount brokers in the 1990s and 2000s, as some clients used the pricing by these firms as a frame of reference to talk about what they were paying.

Perhaps the biggest impact relates to the image of traditional advice among the next generation of investors. It’s important to remember that image and branding matter. For example, Apple Inc.’s appeal transcends its actual functionality and value-for-dollar equation. Car brands such as BMW, Lexus and Mercedes-Benz are other examples of this phenomenon.

A warning sign for traditional advisors are initiatives such as that by Google Inc. in the U.S. to offer online advice as a company benefit, potentially positioning online advice as a superior option for younger, smarter, more discerning investors.

Lesson 3: What can be commoditized will be commoditized

Although these new online competitors are unlikely to pose an immediate threat, anyone dismissing them ignores the first rule of the Internet, which has affected almost every intermediary: what can be commoditized will be commoditized.

That has happened in the travel and retail industries. The backers who have invested hundreds of millions in online advisors are counting on a similar pattern. And based on the track record of the founders and investors in the online offerings in travel and retail, online advice should not be underestimated.

Based upon historical precedent, there are two strategies that you can employ to blunt the threat from online advice. The first is to incorporate the best features of online advice into your own offering, which is no different from the moves by traditional retailers to integrate online retailing into their strategy. One small sign of this shift is that Wal-Mart Stores Inc.’s online offering in the second quarter of 2014 grew faster than Amazon’s. Successful advisors will incorporate the key elements of online advice into their own offerings: including more transparency on fees, clearer benchmarking of performance and integrating online tools into how advisors communicate with clients who prefer the online medium.

The second strategy is to focus your efforts in areas that don’t lend themselves to commoditization. The work of professions such as medicine, law and accounting is being divided into two categories: tasks that can be automated easily, which increasingly are being outsourced and produced at the lowest possible cost, and tasks that rely upon human judgment, the area on which professionals need to focus.

The past 20 years have seen a push by advisors to automate and standardize how they operate. Although operating efficiently will continue to be important, the big push will be to personalize the advice and experience that your clients receive in a way that online advice cannot offer.

Here are some examples of how you can provide personalized advice that can’t be replicated by online robo-advisors:

> DEVELOP A FINANCIAL PLAN

Personalized advice: Talk about trade-offs in developing your client’s initial financial plan and discuss how the plan should be amended, given new developments.

Commoditized advice: Develop an initial plan and provide updates on progress.

> CUSTOMIZE AN INVESTMENT PLAN

Personalized advice: Incorporate issues that are specific to a client, such as personal investment preferences and investment sectors that are already represented in the client’s financial situation because of their occupation or business.

Commoditized advice: Use an assessment of time frame and risk orientation to tailor investment recommendations.

> COMMUNICATE DURING TIMES OF MARKET TURMOIL

Personalized advice: Call clients whom you know from past experience may be anxious and, if warranted, set up a meeting.

Commoditized advice: Send a general email or letter to discuss market developments.

> CHARITABLE GIVING

Personalized advice: Incorporate discussions on the charities that clients are passionate about into regular portfolio reviews, including talking about the merits of giving now rather than doing so as a legacy.

Commoditized advice: Online articles and emails on the advantages of using appreciated investments for charitable contributions.

> FAMILY DISCUSSIONS ON ESTATE PLANS

Personalized advice: Raise the topic of the importance of having open conversations with adult children regarding inheritance – and offer to facilitate that conversation, including meeting with clients beforehand to discuss what will be covered.

Commoditized advice: Online articles and emails about talking to adult children about inheritance plans.

> HELP CHILDREN IN THEIR TEENS AND 20s

Personalized advice: Offer to have a younger associate meet with teenagers preparing to go to college or adult children to help them plan important purchases.

Commoditized advice: Online articles with tips on managing a first credit card and about buying a first car or home.

> ASSIST WITH AGING PARENTS

Personalized advice: Have a relationship with an advisor having expertise in dealing with seniors’ financial issues.

Commoditized advice: Online articles on things to watch for in helping parents with their finances.

There are two big traps when assessing new competitors. The first is to panic and overreact. The second, and more dangerous, is to be dismissive and underreact. If you’re proactive in expanding the value offering you provide to clients and have a laser focus on the areas in which commoditized players will have difficulty competing, the new generation of online players may be as much a boon as a threat to your business.

Dan Richards is CEO of Clientinsights (www.clientinsights.ca) in Toronto. For more of Dan’s columns and informative videos, visit www.investmentexecutive.com.

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