Global concerns have grown since the outbreak of COVID-19, coupled with the ongoing oil-price war, rattling investors, and equity markets worldwide. Stock indices have seen a 20 percent drop from their peak less than one month ago, suffering their worst days since 2008, and investors are moving from equities to 10-year notes, causing US Treasury rates to drop to record lows. Falling markets present another test for robo-advisors – a new market entrant since the 2008 great recession.
Researchers at Backend Benchmarking, which tracks performance by opening portfolios at leading robo-advisors, reported that most portfolios managed by a digital advisor performed similarly through the market swings.3 Early indications show that robo-advisor firms such as Wealthfront and Betterment, are seeing more inflows than outflows, along with an increase in new investment account signups, and most inbound calls inquired about efficient tax loss harvesting during the market instability.3 Given the current economic environment, we see three themes emerging on the impact on robo-advisors during this time.
1. Goals-based planning will show benefits
Economic shocks like the Coronavirus highlight the power of goals-based planning. Investors following goals-based planning philosophy, via robo-advisors, base their investments primarily on the risk capacity aligned to their goals. The strength of this approach is that higher-priority near-term goals will include lower-risk asset allocation, thereby minimizing the impact of short-term economic shocks.
2. Short-term asset allocation shift and long-term perspective
An inherited feature of robo-advisors is risk-based portfolio selection. Most robo-advisors offer passive investments with low fees, though investors may adjust allocations as they see fit. Given the current market downturn, some investors are moving to less risky asset allocations, like bond ETFs, to avoid downside risk. These are market expectations, and those same investors will likely also consider returning to equities when the market bounces back to capitalize on market gains. There is often a disconnect between long-term investing and short-term economic reactions. Like other economic downturns, this one is no different. Historically, disciplined and experienced investors’ portfolios have benefitted over time due to their measured long-term approach.
3. Communication with clients is key
From wealth management firms’ perspectives, advisors are spending time guiding clients that have been affected by coronavirus impacts – both personally and economically. For robo-advisors, communication will be slightly different than traditional advisory firms. They will need to lean on digital collaboration tools at their disposal through email, push notifications, and in-app notifications. Even with a high level of digital interaction, clients frequently feel best-served by human advisors in uncertain market circumstances. Innovative tools like chat functionality or video conference to connect with a team of advisors could help robo-advisors provide a level of human touch needed to ease clients’ anxieties during troubling times. Robo-advisors, such as Betterment and Personal Capital, already offer financial advisor access with their premium services.
The path forward:
Robo-advisors may consider offering additional life-planning functionalities to prepare clients for life events such as job loss during market crises. Preparing for these events and associated trade-offs in advance helps the client reduce stress if or when the event occurs. For example, clients need to understand the trade-offs they would make if they lose their jobs. Clients will need to know how long they can afford to be out of a job, and continue paying the mortgage, paying additional premiums for continued insurance coverage for family, saving for college, and other necessities.
In order to do that, clients may have to tap into emergency savings, cut spending, cancel upcoming vacations, or spend less on aspirational purchases. Ensuring clients are prepared and know their trade-offs in advance is the real value-add of financial planning.
Coronavirus’s impact on financial markets to date looks similar to other economic downturns that have been seen throughout history, and this impact will affect the robo-advising market. However, the full effects of COVID-19 are unknown, as it remains unclear whether we have seen a peak in diagnosed cases.
A version of this article appeared in Financial Planning to view it click here.