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October 26, 2016
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How RoboAdvisors work..

Millennials want “finance at their fingertips”..they want to be able to email and text the financial advisors and talk to them on a real-time basis,”– Greg Fleming, Ex-Morgan Stanley Executive
The first post in this series on Robo-advisors,  touched on the fact that Wealth Management has been an area largely untouched by automation as far as the front office is concerned. Automated investment vehicles have largely begun changing that trend and they helping create a variety of business models in the industry. This three part series explored the automated “Robo-advisor” movement in the first post.This second post will focus on the overall business model & main functions of a Robo-advisor.Introduction –FinTechs led by Wealthfront and Betterment have pioneered the somewhat revolutionary concept of Robo-advisors. To define the term – a Robo-advisor is an algorithm based automated investment advisor that can provide a range of Wealth Management services tailored to a variety of life situations.Robo-advisors offer completely automated financial planning services. We have seen how the engine of the Wealth Management business is new customer acquisition. The industry is focused on acquiring the millennial or post millennial HNWI (High Net Worth Investor) generation. The technology friendliness of this group ensures that are the primary target market for automated investment advice. Not just the millenials, anyone who is comfortable with using technology and wants lower cost services can benefit from automated investment planning. However,  leaders in the space such as – Wealthfront & Betterment – have disclosed that their average investor age is around 35 years. [1]Robo-advisors provide algorithm-based portfolio management methods around investment creation, provide automatic portfolio rebalancing and value added services like tax-loss harvesting as we will see. The chief investment vehicle of choice seems to be low-cost, passive exchange-traded funds (ETFs).What are the main WM (Wealth Management) business models as applied to Robo –Currently there are a few different business models that are being adopted by WM firms.

  1. Full service online Robo-advisor that is a 100% automated without any human element
  2. Hybrid Robo-advisor model being pioneered by firms like Vanguard & Charles Schwab
  3. Pure online advisor that is primarily human in nature

The Robo-advisor can be optionally augmented & supervised by a human adviser. At the moment, owing to the popularity of Robo-advisors among the younger high networth investors (HNWI), a range of established players like Vanguard, Charles Schwab as well as a number of FinTech start-ups have developed these automated online investment tools or have acquired FinTech’s in this space.e.g Blackrock. The Robo-advisor is typically offered as  a free service (below a certain minumum) and typically invests in low cost ETFs.  built using digital techniques – such as data science & Big Data.


                                                          Illustration: Essential functions of a Robo-advisor

The major business areas & client offerings in the Wealth & Asset Management space have been covered in the first post in this series at

Automated advisors only cover a subset of all of the above at the moment. The major areas of functionality are as below –

  1. Determine individual Client profiles & preferences—e.g. For a given client profile- determine financial goals, expectations of investment return, diversification etc
  2. Identify appropriate financial products that can be offered either as pre-packaged portfolios or custom investments based on the client profile identified in the first step
  3. Establish correct Investment Mix for the client’s profile – these can included but are not ,limited to equities, bonds, ETFs & other securities in the firm’s portfolios . For instance, placing  tax-inefficient assets in retirement accounts like IRA’s as well as  tax efficient municipal bonds in taxable accounts etc.
  4. Using a algorithmic approach, choose the appropriate securities for each client account
  5. Continuously monitor the portfolio & transactions within it to tune performance , lower transaction costs, tax impacts etc based on how the markets are doing. Also ensure that a client’s preferences are being incorporated so that appropriate diversification and risk mitigation is being performed
  6. Provide value added services like Tax loss harvesting to ensure that the client is taking tax benefits into account as they rebalance portfolios or accrue dividends.
  7. Finally ,ensure the best user experience by handling a whole range of financial services – trading, account administration, loans,bill pay, cash transfers, tax reporting, statements in one intuitive user interface.


                                                          Illustration: Betterment user interface. Source – Joe Jansen

To illustrate these concepts in action, leaders like Wealthfront & Betterment are increasingly adding features where  highly relevant, data-driven advice is being provided based on existing data as well as aggregated data from other providers. Wealthfront now provides recommendations on diversification, taxes and fees that are personalized not only to the specific investments in client’s account, but also tailored to their specific financial profile and risk tolerance. For instance, is enough cash being set aside in the emergency fund ? Is a customer holding too much stock in your employer? [1]

The final post will look at a technology & architectural approach to building out a Robo-advisor. We will also discuss best practices from a WM & industry standpoint in the context of Robo-advisors.


  1. Wealthfront Blog – “Introducing the new Dashboard”

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