People don't get how robos work, and that's a problem, J.D. Power finds

Some of tomorrow’s wealth clients are today DIY investors who use robo-advisors that they don’t understand — and that dynamic stands to hurt client retention, a report from J.D. Power found.

Among more than 5,000 people who make investment decisions without the help of a full-service financial advisor, 86% of Gen Zers and 79% of millennials said they are interested in robo-advice, according to results of a survey conducted between October and January. However, only 22% of the people who use those services said they completely understand how digital advice providers manage their portfolios, J.D. Power found. That's critical, as the “net promotor scores” customers provide decline when they don’t understand how robos work, the firm noted.

“Firms need to do a better job explaining how that digital advice works and articulating a clear value proposition for investors,” Craig Martin, executive managing director and head of wealth and lending intelligence at J.D. Power, said in an announcement of the findings. “Right now, investors are interested, but if they are going to stick around for the long haul, they need to understand the value of the service they are receiving.”

The findings support other consumer-preference research. Data from Hearts & Wallets, for example, show that only 10% of customers understand “very well” how robo-only firms earn money. By contrast, that rate was 24% among financial services providers overall.

“One of the core barriers that can prevent some firms from effectively serving younger generations is seeing the competitive landscape through the traditional lens of self-directed versus intermediary sold,” Laura Varas, CEO of Hearts & Wallets, said in an email statement.

An increasing number of young investors identify as “general contractors” of their portfolios, meaning that they use a range of input sources but also make their own decisions, Varas noted. On average, those investors consult more than seven sources, including robo-advisors and human advisors.

More than a quarter of millennials (28%) identify their investing habits that way, compared with 37% of Gen Zers, according to Hearts & Wallets.

“Over 85% of millennial households with $250,000-plus in investable assets blend advice from online sources and financial professionals in a variety of different ways,” Varas noted, citing data from a forthcoming report.

The financial services firms with the highest ratings from self-directed investors who want guidance were Fidelity, ETrade and Charles Schwab, according to J.D. Power’s survey. The highest-ranking firms for DIY investors were Vanguard, T. Rowe Price and Schwab.

The findings come as demand for robos has cooled. A report last year by Parameter Insights found that just under 21% of U.S. investors used digital advice services, down from nearly 28% in 2021. The decline in use was particularly high among people with income over $100,000 and with more than $500,000 in assets.

A takeaway for firms that provide robo-advice is to avoid skimping on customer support provided by humans, J.D. Power noted.

“Self-directed investors are still looking for human support when it comes to onboarding, answering technical questions and resolving problems,” the firm said. “Human support also plays a key role in providing greater transparency and trust in digital advice.”

[More: Controversial cash allocations in Schwab’s robo protected clients in 2022]