The Future of Financial Planning: Robo-Advisors and the rise of AI

INTRODUCTION

Financial planning is the process of setting and achieving long-term financial objectives such as investing, saving for retirement, purchasing a larger home, sending your children to college, or leaving a legacy. It involves reviewing one's existing financial status, developing a plan to achieve the intended results, and monitoring and revising the plan as necessary.

If you’re preparing for the future—whether it’s saving for retirement, buying a home, or investing in your child’s education—it typically involves meeting with a financial advisor, sharing your goals, and relying on their expertise to manage your investments.?

In recent years, the landscape of financial planning has undergone a significant transformation, largely fueled by advancements in technology. Among these advancements, the emergence of robo-advisors and artificial intelligence (AI) has revolutionized how individuals and businesses approach investment management, budgeting, and financial decision-making. This article explores the future of financial planning in the context of these innovations, examining their implications, benefits, challenges, and the evolving role of financial professionals.

THE EVOLUTION OF FINANCIAL PLANNING

The concept of financial planning can be traced back to the late 1960s and early 1970s, when professionals from diverse fields such as accounting, law, insurance, and investment recognized the need for a? comprehensive and holistic approach to assisting individuals in meeting their financial objectives. The International Association for Financial Planning (IAFP) and the College for Financial Planning (CFP) were established in 1969 and 1972 respectively to set standards and provide education for the new profession of financial planning.

Traditional financial advisors were responsible for guiding and advising their clients on various facets of their financial lives, including budgeting, investing, tax planning, estate planning, and risk management. They would usually charge a fee based on a percentage of the assets under management or a commission based on the products they sold, such as mutual funds, annuities, or insurance policies.

Over time, financial advisors transitioned from merely offering brokerage services to a more fiduciary role,? where they were required to act in the best interests of their clients. This shift also led to the adoption of fee-only compensation models, moving away from commission-based structures that could create conflicts of interest. The industry increasingly embraced technology, utilizing financial planning software to improve efficiency and accuracy.

Tools like MoneyGuidePro, eMoney Advisor, and Right Capital allowed advisors to create and monitor financial plans, perform scenario analysis, and generate reports with greater ease, which enhanced the service quality. By integrating software solutions, financial professionals not only improved their efficiency but also paved the way for more automated solutions like robo-advisors.

The global financial planning software market was valued at $3.7 billion in 2021 and is expected to reach $16.9 billion by 2031, increasing at a 16.6% CAGR between 2022 and 2031. The primary drivers of this growth include expanding demand for digital and personalized financial solutions, increased knowledge and adoption of financial planning among individuals and organizations, and technical innovations and advancements in the financial sector.?

WHAT IS A ROBO-ADVISOR?

A robo-advisor is an online platform that uses algorithms to provide automated financial planning and investment management services with minimal human supervision. A typical robo-advisor asks you questions about your financial state and future goals via an online survey. It then uses the information to provide recommendations and automatically invest for you.

Its service is built on its ability to create an investing portfolio that is personalized to your specific needs. Once you've entered your information, the robo-advisor's algorithms go to work, creating a balanced portfolio that seeks to match your objectives and risk tolerance. Most robo-advisors today employ Modern Portfolio Theory (MPT) methods to diversify and manage your money, often investing it in a variety of low-cost Exchange-traded Funds (ETFs) and Index Mutual Funds. According to Polaris Market Research, the robo-advisory market size was assessed at $7.39 billion in 2023 and is anticipated to increase from $9.50 billion in 2024 to $72.00 billion by 2032, representing a CAGR of over 29%. This illustrates the rapid growth and value that the industry is expected to experience in the coming years.?

HOW DOES A ROBO-ADVISOR WORK?

Account Setup and Risk Profiling:

The automation begins as soon as you sign up—Users start by answering a series of questions about their financial goals (e.g. retirement, wealth building), risk tolerance, and investment time frame. This information helps the robo-advisor determine an appropriate investment strategy tailored to the user's profile.

Portfolio Management:

Robo-advisors use algorithms to allocate users' funds into diversified portfolios of stocks, bonds, and other asset classes. They continuously monitor the portfolio, rebalance it when necessary, and may even handle Tax-Loss Harvesting to reduce capital gains tax liabilities.

Automated Rebalancing:

As markets fluctuate, portfolio allocations can drift from their original targets. Robo-advisors automatically adjust the asset mix to realign with the user’s risk profile and investment goals, ensuring optimal performance over time. Robo-advisors accomplish this by utilizing Rebalancing Bands.

REBALANCING BANDS

In rebalancing bands, every asset class or individual security is given a target weight and a matching tolerance range. An allocation plan may require holding 30% in developing market equities, 30% in domestic blue chips, and 40% in government bonds, with a ±5% margin for each asset class.

Rebalancing bands provide for a ±5% correlation between emerging market and domestic blue-chip holdings, ranging from 25% to 35%. Government bonds can range from 35% to 45%. When the weight of a holding exceeds the acceptable band, the entire portfolio is rebalanced to reflect the original target composition.

EXAMPLES OF POPULAR ROBO-ADVISORS

The first robo-advisors, Betterment and Wealthfront, started in 2008. Wealthfront started as a mutual fund company. It initially intended to aid the tech community, but later discovered that computer tools could make investing advice more accessible. Betterment, on the other hand, originated with the goal of rebalancing assets in target-date funds (TDFs). It aimed to help manage passive, buy-and-hold investments using a simple internet interface.

The technology was not new. Human wealth managers have been utilizing automated portfolio allocation tools since the early 2000s. However, before Betterment and Wealthfront launched, wealth managers were the only ones who could purchase the technology, forcing clients to hire a financial advisor to profit from the innovation.

THE RISE OF ARTIFICIAL INTELLIGENCE IN FINANCIAL PLANNING

The integration of advanced technologies is redefining the landscape of financial planning, changing how financial information is managed, processed, and analyzed. These innovations not only improve the quality and reliability of financial data but also change the dynamics of analysis and advice.

Some estimates predict that the AI market size will be worth $733.7 billion by 2027, with the financial sector accounting for a sizable share of that figure.

ARTIFICIAL INTELLIGENCE AND ITS IMPACT

AI-powered chatbots and Natural Language Processing (NLP) systems enable more efficient and personalized communication between advisors and clients.?

ChatGPT offers several potential uses in a variety of fields, including the financial sector. In fact, 81% of financial services professionals worldwide saw AI as critical to their company's future in 2020, and 75% expect to boost their AI-related investments by at least 10% in the coming fiscal year. One of the most important ways ChatGPT in financial services may help clients is by delivering tailored and interactive financial advice in natural language.

ChatGPT can be used to build chatbots capable of communicating with clients via text or voice messages. These chatbots can learn a customer's financial condition, goals, preferences, and inquiries, and then deliver relevant and personalized advice based on their facts and reasoning. They can also explain their reasons and recommendations in simple language, as well as address any follow-up inquiries or concerns from the customer. They can also learn from client feedback and behavior and gradually improve their service.

Some of the advantages of using ChatGPT for financial advisory includes:

• They can offer more personalized and targeted advice than robo-advisors, who may employ generic or predefined techniques.
• They can handle more complex and diversified circumstances than robo-advisors, who may be unable to handle specialized or unusual situations.
• They can provide a more engaging and interactive service than robo-advisors, who may be incapable of connecting efficiently or empathetically with customers.
• They can offer more accessible and convenient services than human advisors, who may not be available or inexpensive to everyone.

BENEFIT OF ROBO-ADVISORS VS. TRADITIONAL FINANCIAL ADVISORS

The rise of robo-advisors has reduced some of the traditional barriers between the financial services industry and average consumers. Because of these online platforms, solid financial planning is now available to practically everyone, not just high-net-worth individuals.

• Robo-advisors save you time and money by reducing the need for human advisors, who may charge high fees and commissions. According to research, robo-advisors charge an average yearly cost of 0.23%, compared to 1.02% for traditional advisors.
• They can offer consistent and unbiased advice based on data and reasoning, rather than emotions or prejudices. A study by Vanguard discovered that robo-advisors can reduce behavioral errors by up to 1.5% per year.
• Robo-advisors make it easier to track investments. You can log in at any time as long as you have access to the internet.
• Starting an investment requires substantially less funds when using robo-advisors. Betterment, one of the most prominent robo-advisors, offers simple accounts with no account minimum.
• Robo-advisors are efficient. Before robo-advisors and online brokerage accounts, you had to phone or meet with a financial advisor to explain your needs and wait for them to complete your trades. You can now do all of this from the comfort of your own home by clicking a few buttons.
• Using a robo-advisor may limit your investment alternatives, but this might be advantageous because buying particular stocks or attempting to beat the market can create bad results. Ordinary investors typically receive greater outcomes from an indexing strategy.

LIMITATIONS OF ROBO-ADVISORS

• Robo-advisors have been criticized for lacking empathy and complexity, owing to their existing technology capabilities and little human presence.
• If you have a modest account and no investment experience, robo-advisors are good places to start. They may fall short if you require services such as estate preparation, complex tax management, trust fund administration, and retirement planning.
• Automated services are also unprepared to deal with unanticipated crises or unusual circumstances. For example, robo-advisors will not know if you are between jobs or have an unforeseen expense, so your savings may be drained abruptly by automatic withdrawals.
• A survey conducted by Investopedia and the Financial Planning Association discovered that consumers prefer a combination of both human and technological help, particularly during difficult circumstances. According to the report, 40% of participants stated they wouldn't feel comfortable using an automated investing platform during periods with high market volatility.
• Robo-advisors work under the idea that you have specific goals and an in-depth knowledge of your financial situation, investment principles, and potential investment outcomes. For many investors, this is not the case.

CONCLUSION

The rise of AI in financial planning, particularly through the development of robo-advisors, has revolutionized the way individuals manage their investments and financial goals. From account setup to automated portfolio management, robo-advisors offer an efficient, low-cost alternative to traditional financial advisors, making financial planning more accessible to a wider audience. Additionally, the integration of advanced technologies like AI and machine learning enhances decision-making, ensures personalized advice, and offers continuous optimization through automated rebalancing and tax-loss harvesting.

Looking ahead, the future of financial planning is bright with hybrid models combining the precision of AI with the emotional intelligence of human advisors. As the industry continues to evolve, it is clear that robo-advisors are not just a trend but a key player in the future of financial planning, empowering individuals to easily and confidently take control of their financial futures. Whether you are a beginner investor or someone with more complex financial needs, the growing capabilities of robo-advisors ensure that there is a solution tailored to your goals and preferences.

This transformation, driven by AI, marks a significant step toward democratizing financial services and reshaping the way we think about personal finance in the digital age.