How Does FinTech Affect Inequality?

Michael Reher - Rady School of Management;

Stanislav Sokolinski - Rutgers Business School.

-- The past decade has seen a burst of innovation in financial technology (i.e. the FinTech revolution). Will this burst of innovation reinforce long-standing inequalities in households’ access to financial services? Or, will it give less-wealthy households access to professional portfolio management historically only available to the very wealthy, thereby reducing inequality? In our working paper “Does FinTech Democratize Investing?”, we find that the answer is mixed. We study a specific form of innovation – namely, automated portfolio management – which delivers substantial gains to households with intermediate levels of wealth (i.e. the middle class) relative to wealthier households. However, it has no effect on households with relatively-low wealth (i.e. the lower class), which suggests that innovation can reduce inequality between the middle and upper classes, but increase it between the middle and lower classes.

Our setting is the $750 billion market for automated (i.e. robo) portfolio management. Unlike traditional wealth managers, robo advisors use automation to manage large numbers of accounts at low per-portfolio cost. Consequently, they can significantly lower or even eliminate account minimums. These minimums are often in the tens of thousands of dollars and thus prohibitively high for most U.S. households, given that the median U.S. household has only $17,000 in liquid assets. But there is much to gain for households who are able to access a robo account: robo accounts tend to be better-diversified than non-robo accounts, and they come with fees that are often a tenth the size of those charged by traditional wealth managers.

The paper’s focal point is an unexpected reduction in a large U.S. robo advisor’s account minimum from $5,000 to $500. Immediately after the reduction, the wealth distribution of robo investors shifts leftward to become more representative of the U.S. population (i.e. more “democratic”). In addition, the reduction increases stock market participation among households form the middle brackets of the U.S. wealth distribution, raising their risky share by 27 percentage points and their total return on liquid assets by 2 percentage points. This means that a household whose liquid wealth currently grows at a rate of 2% per year – the rate of return on most savings accounts at this time – would double their wealth in half the time. Moreover, the investors brought into the stock market by this reduction tend to come from less financially-developed parts of the U.S, and they span all segments of the age distribution. This means that the reduction is giving truly financially-constrained households access to professional portfolio management services, rather than just moving forward investments that young households would have made later in life.

However, the reduction has no effect on households from the bottom fifth of the U.S. wealth distribution. This suggests that automation has an ambiguous effect on inequality in access to financial services, since it favors the middle class over both the lower and upper classes. As a result, long term wealth inequality may decline between the middle and upper classes, but it may also increase between the lower and middle classes. To give the poorest households access to financial services, FinTech may need to couple low account minimums with other features – such as financial planning or educational products.

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