by Ryan W. Smith
Technology has had a large impact on the financial advisory industry over the decades, with an outsized and growing influence in recent years. The rise of robo-advisors, the use of online brokerages, smartphone apps and programs designed to assist financial advisors have all played a role as investing and financial management have gone digital. This trend is expected to continue, with many in the industry believing it will speed up considerably.
Rise of the Machines
Robo-advisors, specifically, have become very popular in recent years, especially with younger investors. Part of this comfort stems from the younger generation’s ease with technology, another part comes from the account minimums, usually about $500,000 in total assets, that are required by many financial advisors. Robo-advisors, in many instances, have no such minimum account balance requirement.
Robo-advisors also have significantly lower costs, usually about 1-2% of the portfolio value per year, and provide a more no-frills service. Typically a robo-advisor will provide portfolio management services only, with some services allowing for tax concerns during asset sales to be considered. Tax filings, however, along with retirement and estate planning are not typically included. There are some robo-advisors that will manage the first $10,000 in an account for free, while others will use tiered fees where amounts over $100,000 will still only incur a modest 15 bps charge.
Robo-advisors are an automated computer algorithm that supplies the majority of answers investors are looking for with minimal human interaction. The algorithm will ask investors a series of questions to determine risk tolerance as well as both long and short-term goals. These responses will generate a score the algorithm uses to point the investor to an appropriate portfolio invested in passive ETFs which will be rebalanced at regular intervals.
These robo-advisory services have had explosive growth in recent years. U.S. News and World Report noted that some in the industry believe that the current $30 billion in assets managed via robo-advisors currently will balloon to over $2 trillion managed by 2020.
The Human Response is Humane
A salient question for many financial advisors in recent years is how can they possibly beat a machine? The answer, surprisingly, is relatively straight-forward: to remain competitive, advisors must be more comprehensive wealth managers. Investment management, the sole purview of robo-advisors currently, is only one facet of true wealth management. Many human financial advisors will assist clients with tax planning and preparation, estate planning, comprehensive financial planning, mortgage refinances, small business creation and structure and establishing trusts, among many others.
There is also an emotional side to financial planning, a connection between advisor and client that robo-advisors can simply not duplicate. Life events like weddings, health issues, divorce, and retirement are among the specific situations where a client might need precise financial advice and assistance from another human.
Additionally, times where there is high market volatility can be where a human advisor can shine more brightly than an algorithm. Humans can be more emotional, for sure, but will algorithm really understand how to respond when the S&P is down 10% in a week, you have less than a decade until retirement, a parent in a nursing home and a child about to begin college? Not unless they were programmed to account for those variables.
Fees for human advisors will most likely come down in the face of robo competition, but their advice, expertise and ability to deal with specific scenarios empathetically will still command a premium.
The Market’s Response is Less Humane
A study of real investor returns between January 1984 and December 2014 showed that mutual fund investors did worse, on average, than the markets overall, leading many to conclude that emotions play too great a role in investment returns. For example, in 2014 mutual fund investors were outperformed by the S&P 500 by over eight percentage points, 13.69% for the S&P versus 5.5% for the average mutual fund investor. This is a definitive plus for robo-advisors since an algorithm shows no emotion and won’t sell low on fear or buy high on euphoria, which even the best mutual fund managers and investors cannot fully avoid.
However, algorithms must be programmed by humans, using theories and models designed and implemented by other humans. The theories might very well be flawed, assumptions made could be incorrect, definitions might be too broad or too narrow or risk profiles might not be adequately considering all necessary variables.
For example, many robo-advisors use Modern Portfolio Theory (MPT) statistics as a baseline for calculations. Software used by human advisors, like AdvisoryWorld’s SCANalytics and Proposal Generator programs, also use these statistics, but merely as another tool in a human advisor’s toolbox rather than as the sole basis for any future recommendation. The final recommendation from an advisor might take that information into account, or perhaps current market conditions warrant extra caution after a strong run-up in some sectors.
Robo-advisory services have arrived and seem here to stay, so human advisors must work on ancillary services to set themselves apart. Hiring an extra staff member to make sure all phone calls are answered and responded to in a timely fashion is one thing an advisor can do. Another might be using analytical software, such as AdvisoryWorld’s SCANalytics or Proposal Generator programs, which can be very useful in the face of such competition, but it is the human factor that is the biggest wildcard. The ability for an advisor to take into account the new baby, a housing market that provides some opportunities for a new purchase, the need for additional life insurance or a more efficient way to save for a child’s college expenses are all specific situations where advisors can show their true value-add to investors.
Technology has always brought out nay-sayers and those who proclaim the end of history. When the internet first arrived, many believed brick and mortar stores would go the way of the dodo bird, that printing paper would be unnecessary and that television advertising would not be effective. While many changes fundamentally altered the world we live in, the end result was really just a faster way to do many of the things that were done before. Robots and technology will make things different, sometimes for the better, other times not so much, but humans are the ones still making the final decision and living with the results.