It's a nascent but fast-growing industry, propelled by hundreds of millions of dollars in venture capital and a confluence of technological changes that have helped turn the often opaque world of money management into a breezy online experience with colorful graphs—and plenty of advice.
"I've been watching this space for more than 10 years and I've seen this movie before," says Bill Doyle, a principal analyst at Cambridge, Mass.-basedForrester Research FORR +0.49% . "I'm paying a lot more attention this time around because the software required to transform this industry finally works."
There are other factors fueling the fire: For younger investors, it's almost second nature to embrace online tools. And "the financial crisis created a lot of disgruntled investors" who may be open to alternatives to traditional companies, says Grant Easterbrook, who follows the industry as a senior research associate at Corporate Insight, a research and consulting firm in New York.
Some of these firms are backed by big names. Burton Malkiel, a Princeton University economist and author of the investing classic "A Random Walk Down Wall Street," leads Wealthfront's investment team, while distinguished investor Charles Ellis, author of "Winning the Loser's Game," is an adviser. Personal Capital's chief executive, Bill Harris, headed PayPal Inc. and Intuit Inc. Betterment LLC has Steve Lockshin, founder of Convergent Wealth Advisors, as an adviser. Jemstep has a partnership with Windham Capital Management LLC, an asset-management firm for institutional investors.
Old-school financial advisers will tell you these services won't give you a holistic, tailored financial plan, which is true. A financial planner will spend hours getting to know your specific situation. Of course, they may charge a middle-income client around $200 to $300 an hour, or 1% or more of assets annually, to do it.
But for investors who either can't or won't go to a traditional advisory firm—maybe because of a small account balance or distrust of established providers—online services could offer big benefits at a fraction of the cost.
How They Work
Many of these online services aim to act like an investment adviser by either evaluating and advising you on your current investments or managing your money for you.
Firms like Wealthfront and Betterment fall into the latter category. They will invest your money in one of a number of portfolios made up of ETFs at a cost of about 0.15% to 0.35% of assets annually. Exactly which portfolio usually depends on your answers to a short set of questions related to your finances, goals and tolerance for risk.
Generally, your account is rebalanced for you, so that your asset mix stays close to the original plan without you having to push yourself to sell securities that have gone up in value and buy those that have fallen. Some offer tax-loss harvesting—that is, selling securities that have dropped in value to recognize losses that can offset taxable gains in your portfolio.
Services such as Wealthfront and Betterment, which have about $300 million and $250 million in assets under management, respectively, can get investors into low-cost, diversified portfolios and provide continuing oversight that helps control risk and taxes. But many of these tools don't consider your overall financial life; you are simply investing one chunk of money.
Other companies, such as Jemstep, Personal Capital and FutureAdvisor, are aggregators: You provide login information for your brokerage and retirement accounts, and these services display and analyze all your holdings together. They may tell you which investments to buy or sell, based on your goals, financial situation and risk tolerance.
Most of these companies offer a large chunk of their online advice free, and then charge for additional services. Jemstep, for example, offers free asset-allocation advice based on your current holdings and retirement goals, but charges for buy/sell advice on specific investments, plus other services. Jemstep's fee starts at $216 annually for customers with assets of $25,000 to $150,000 and increases for larger accounts. Personal Capital and FutureAdvisor, meanwhile, offer account-management services for a fee.
Some of these firms include access to a financial adviser, often by email or phone, as part of their paid service—or even free, in some cases. Investors who link accounts with $100,000 or more through Personal Capital's free aggregation service, for example, can talk with an adviser at no charge.
As with traditional advisers, portfolio suggestions will vary by company, as this writer found. For my retirement portfolio, Personal Capital suggested I increase my U.S. and international stock exposure. Jemstep said I'm weighted too heavily in U.S. stocks and should increase my allocation to international equities. FutureAdvisor suggested I increase my exposure to international real-estate investment trusts, emerging markets and small-cap stocks.
SigFig Wealth Management LLC's service, known as SigFig, wanted to move me into some different (often higher cost) funds that had significantly outperformed my holdings over the recent three-year period.
Do Your Homework
Evaluating an online asset manager may mean testing its free product to see whether the investment strategy suits you. Betterment's current bond-fund selection, for example, is limited to ETFs that hold short-term Treasurys and Treasury inflation-protected securities, though the company has said it will soon add five more bond ETFs.
Advice might vary, too, because each company uses a different measure to gauge your needs. Wealthfront has a 10-question tool. Betterment asks questions about your risk tolerance and goals. SigFig evaluates your needs based on what it can glean from the investment accounts you link to it.
Mr. Easterbrook warns investors that unless the online service they are using includes access to a financial adviser, the advice they are getting is based on limited information. "These questionnaires do a horrible job of understanding what your financial situation is," he says.
The companies say online investors won't stick around for an in-depth intake form, and that they base their advice on more than questionnaires—for example, they look at the investor's age and current allocation, which they see as a signal of risk tolerance.
When choosing a service, ask yourself what you want: a service to handle a portion of your investment portfolio (say, a cash inheritance) or advice on your entire financial outlook? Are you happy working only with an online interface, or do you want the option of talking to a professional should the need arise? Companies such as LearnVest and RebalanceIRA, for example, focus on the adviser relationship.
This is a fast-changing niche, so watch for new arrivals, departures and product evolution. In July, Bloomberg LP withdrew a pilot online-advice product called BloombergBlack, and in August LPL Financial Holdings Inc. said it would close Nestwise, its online adviser service. Some of the other startups say they are launching new or expanded services in coming months.
"Ten years out, this is going to be a different market," says Mr. Doyle. Younger investors, who by then will be older and wealthier, "have a different set of preferences," he says.
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