In decades past, Wall Street urged investors to listen when E.F. Hutton spoke and to “Talk to Chuck” Schwab about how to handle their money. Today, a fast-growing cohort of investors is entrusting their savings to the guidance of nameless software built to anticipate their financial needs.

Automated services that code prevailing investment wisdom into low-cost portfolios have hit the mainstream. Betterment, Wealthfront, Personal Capital, LearnVest, SigFig and other young but fast-expanding services each take slightly different approaches.

But all these so-called robo-advisors promise proven asset-allocation discipline and tax-minimizing strategies typically associated with human advisors. Together, they and similar services manage some $3 billion in assets, from zero a few years ago.

That’s peanuts compared to, say, the $2.3 trillion held in Charles Schwab Corp. (SCHW) customer accounts or the $1.5 trillion handled by all independent registered investment advisors.

But the robo-advisors’ rapid growth — and the hope their transparent, technology-centric pitch will resonate among younger adults – has won the backing of top venture capitalists and caught the attention of established asset managers. The firms’ core pitch is perfectly in tune with the current youth ethos of “hacking” one’s life, finding clever technology-based tools to take care of important and potentially vexing tasks — in this case, saving for a house or retirement.

How they work

Betterment and Wealthfront place client cash in a diverse array of low-cost exchange-traded funds, setting each person’s investment mix based on their financial goals and risk appetites. They both eschew the futile game of trying to outperform the broad market, and charge relatively low fees.

At Betterment, the annual cost is 0.35% of assets for accounts below $10,000, sliding down to 0.15% for accounts topping $100,000. Wealthfront charges nothing for sub-$10,000 accounts, and 0.25% for amounts above. In each case, clients also pay management fees on the underlying ETFs, which typically are 0.15% or so per year.

Betterment, founded in 2008 by Jonathan Stein, a former consultant to financial institutions, simply asks customers to enter their age and choose among a few broad objectives, such as retirement, wealth building and safety net. It then arrives at a recommended portfolio and runs on autopilot, rebalancing back to the targeted asset allocation periodically and harvesting short-term losses to minimize taxes over time.

New York-based Betterment, with more than $500 million under management, links to customers’ checking accounts and is set up to handle even small regular deposits, positioning the service as a frictionless long-term savings tool. The firm incorporates tenets of modern portfolio theory and tilts slightly toward value stocks and small-caps, which have done slightly better than the broad market over long spans of time.

Wealthfront, based in Palo Alto, Calif., manages $800 million and features Princeton professor Burton Malkiel, a leading theorist of efficient markets and low-cost index investing, as chief investment officer. The company plays off its Silicon Valley pedigree, cultivating ties inside big technology companies, often capturing employee accounts before their companies go public.

As described here recently, Wealthfront boasts some 10% of Twitter Inc. (TWTR) staffers as clients, and recently created a service to ease their initial sales of employer stock once the post-IPO lockup period lapsed. Wealthfront uses a questionnaire to evaluate new clients’ risk appetites, and its ETF selection and tax-minimizing tactics vary slightly from Betterment. But at heart they are similar services riding the same wave.

Snazzy marketing, sober advice

There’s nothing inherently revolutionary about these services. They use decades-old wisdom on smart low-cost investing, standard asset-allocation models and ETFs available to all.

Yet a new generation of potential investors is comfortable using clean, elegant, screen-based solutions to handle their money. And for younger investors who came of age shadowed by two stock-market crashes, “there is no appeal to them to try and ‘beat the market,” Wealthfront CEO Adam Nash says.

Meantime, ETFs are cheap and the technology allowing these firms to automatically implement asset shifts is well developed enough for them to charge thin fees. Other services such as Personal Capital and LearnVest begin as account aggregators, collecting and analyzing clients’ portfolios on one screen, then recommending alternative allocations. Each will also manage funds for customers if desired.

In reality, most of the virtues of the Betterment and Wealthfront approaches could be accessed using Vanguard Group’s target-date funds, which deliver cheap, one-stop portfolios geared to an anticipated retirement year. The robo-advisors have essentially just created an interface to make the experience easier, while using emails and blog posts to reinforce their long-term investing message.

Betterment founder Stein, speaking in the company’s loft-like downtown Manhattan headquarters, discusses innovation in terms of more user-friendly interfaces and personalization, rather than fancy market-analysis tools.

“If you give us five minutes, we’ll give you the best sign-up experience in the industry,” he says. “But we want it to be better.” He adds that, while now the site quizzes new clients on their goals, he wants the service to be engineered “to ask you about you” and then deliver a shortcut to the next plan.

In some respects, this emerging group of high-tech, low-touch competitors is an echo of the online-broker boom of the 1990s. Technology was allowing cheaper access to markets just as the Boomer generation was getting serious about building wealth. Each firm carved out a branding niche and claimed specific advantages. But ultimately they were all benefiting from a rising wave of do-it-yourself money looking for a better way.

Meanwhile, some entrenched competitors such as Bank of America’s (BAC) Merrill Lynch eventually created a tier of services to compete with Schwab and TD Ameritrade (AMTD) – even as the online brokers followed their clients up the wealth and service chain to ally with full-service independent advisors.

One key difference between these robo-advisors and the online brokers of a couple decades ago is that the brokers portrayed themselves as empowering the little guy. While they did, the brokers profited most when clients traded heavily – which is a recipe for lousy investment performance for almost everyone attempting it. The new class of screen-based advisors funnels their customers into a sensible, long-term investment portfolio, which has the greatest chance of resulting in a well-built nest egg.

Challenges ahead

Over time, these services face at least three obvious challenges. First is the question of how newcomers to investing who use Betterment, Wealthfront and the like will respond to a hazardous bear market.

It’s easy to outsource one’s portfolio when markets are calm and stocks are generally rising. When Wall Street panics, though, history suggests many individuals’ emotional response leads them to demand hand-holding or to scrap their well-crafted long-term plan and bolt from risk.

Stein and Wealthfront’s Nash are well aware of the behavioral tendencies of investors, and do their best to educate customers on how to sidestep them. Stein notes that 70% of his clients are on an auto-deposit plan, and if they try to pull money, the system is built to ask, “Are you sure?”

Another issue these firms will face is competition from entrenched players fully capable of creating similar services. Schwab, Fidelity and Vanguard are either already fashioning an offering in this area or certainly will. One or more of the upstart firms will be bought.

Finally, it’s unclear whether investors who appreciate these robo-advisors now will one day “graduate” from them as they age and become wealthy enough to win the attentions of bigger  firms. While the new guys point to plenty of well-off retirees who “get it” and love their service, and millennials are bred to prefer technology-based solutions, it’s natural for richer folks to desire or demand more-personal, sophisticated and fawning levels of service.

Nash believes there’s room to incorporate many of the benefits of traditional brokerage relationships into his platform: “There are lots of services the wealthy have received from private wealth managers that could be put into software.”

Ultimately, these seemingly opposed pieces of the industry will converge. Stein says, “We do see the opportunity to work with [human] advisors.”

Another online investment firm, Motif Investing, which allows users to buy and design theme-based stock portfolios, just received an investment from J.P. Morgan, among others, and is working on ways to allow high-end advisors to utilize its platform.

After all, there’s no reason low cost, transparency and ease-of-use should be denied to the wealthiest, most sophisticated investors.

http://finance.yahoo.com/blogs/daily-ticker/more-investors-intrusting-their-portfolios-to–robo-advisors-154448374.html