What can an in-person Financial Advisor provide that a Robo-Advisor cannot?
I've been bombarded with ads featuring robo-advisory platforms that have a lot of online financial planning tools. What do these tools lack that an in-person financial planner can provide?
In the financial industry's dilemna of humans over machines, I am predicting that people will prevail. I do not believe machines will be taking over portfolio management using little human intervention. Robo-advisors is a one size fits all financial solution. Everyone gets the same portfolio which means everyone owns the same stock, when they all decide to sell you could experience selling your position with added downside volatility.
Lets first make a distinction:
1) Robo-advisors offer financial services with minimal human intervention. They provide digital financial advice based on mathematical rules or algorithms. These algorithms are executed by software and thus their financial advice does not require a human advisor. The software utilizes its algorithms to automatically allocate, manage and optimize clients’ assets. Most robo-advisor services are instead limited to providing portfolio management without addressing issues such as estate and retirement planning and cash-flow management, etc which are also the domain of financial planning.
2) A discount brokerage is a business that charges clients significantly lower fees than a traditional full service brokerage firm but without providing financial advice. Discount brokers typically allow investors as well as consumers of financial services to buy and sell on-line while offering comparatively fewer services and/or support.
3) A full service brokerage financial advisor is a licensed financial broker-dealer firm that provides a large variety of services to its clients, including research and advice, retirement planning, tax investing strategies, and much more. Full-service brokers can provide expertise for people who do not have the time to stay up-to-date on complicated issues such as tax or estate planning.
Depending on what your inidividual needs are would determine your choice of financial advice. Retaining the services of an experienced financial advisor far out weigh the services of a robo advisor or even a discount firm. There are many variables and personal financial differences that cannot be evaluted by mathematical algorithms. Also, your financial advisor is a trusted advisor available for consulting with you during the ups and downs of the market. Dealing with a small independent advisor will enable you to customize a portfolio specifically for you and your family.
Financial advisors used to offer much more individualized advice, and some still do. But the majority tend to follow what all other financial advisors are doing. So if they're all heavily buying U.S. stocks, and the U.S. stock market suffers a severe bear market--as it has already done in 2000-2002 and 2007-2009 and probably again in 2017-2019, they can't be sued because they're doing the same as their competition. Naturally, if financial advisors are all following nearly identical formulas, then why not use a computer which can do the same with more efficiency and accuracy? Thus the robo-advisor was born.
What the robo-advisor can't do is what financial advisors are supposed to be doing--recommending real advice, not just copying what everyone else is doing to avoid losing in a lawsuit. A computer or robot will never be able to replace true judgment and intelligence.
The two key things that robo-advisors cannot provide is perspective and discipline in keeping you committed to your long-term financial plan. The most expensive cost an investor incurs is when they decide to deviate from their long term financial plan because markets are in turmoil and research shows that most investors cannot stay committed on their own to be able to ride out market turbulence.
Working with an actual human advisor who can act as a “sounding board” for your questions and concerns is one of the most important features of the advisor/client relationship. Online financial planning tools are only as useful as the investor’s ability to stay committed to the results that those tools produce. Advisors can bring perspective about the current market and help bring you peace of mind about your long-term financial success.
Robo-advice is mostly an asset-allocation model. It does not coordinate all different account types, cash flows, taxes, and client goals and risks. Even the upcoming AI in the next 5-10 probably won't do this.
Will a robo EVER say an I-Bond is great for an emergency fund and education funding? NO, they will not. I could go on and on. The robo will never say to keep your old 401k, because they want the assets. They will never say to use a Roth, a 529 PrePay, and Loan Forgiveness to pay for college. It can't put all the pieces together. Again, it is a very basic asset allocation model.
If your needs are very simple then yes, the basic asset allocation model is just fine. If a robo-advisor were truly advice, why would Betterment be bringing on a CFP(r) call center? It is because there are too many variable and too many pieces to put together -- even if there is no value to speaking to a human.
Vanguard did a study that acutally broke out the value of human advice and it is around 3%. Other studies show between 3-4%. Vanguard has no horse in the race and the study is available on their website.
There are 7 parts of the CFP(r) process:
- Insurance (Disability, Life, Property and Casualty)
- Income Planning
- Retirement Planning
- Long-Term Care
It will be some time before robos can actually coordinate all the risks and opportunities of these areas, if ever.
In addition, the "risk" questionnaires are just a start to know the true risk profile. I have had clients score a 31 on the computer questionnaire but when I actually explain what they are looking at and the risks of inflation are over several decades and what a "31" portfolio would look like, they quickly change their minds.
Baby Boomers were sold fake advice by the salesman and now GenY is being sold fake advice by robots.
Robos have their place but to say its advice is just not true. You can do a lot on WebMD, but I am not sure I would base a life-changing decision on it. I prefer to go to my doctor.
Mark Struthers CFA, CFP®
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This is for informational purposes only. Your specific situation would need to be taken into account. All information is subject to change. Not to be considered investment, tax, or legal advice.
As you mentioned, some investors have started to use new do-it-yourself investing and planning apps rather than hiring a human. In fact, a recent KPMG study estimates robo assets under management will reach a staggering $2.2 trillion by 2020. While these tools offer a streamlined and intuitive experience for the masses, they lack the most critical component of advice: personal accountability. Clients will likely never feel accountable to a computer screen. Using a faceless app, you won’t feel as guilty about going against the long-term plan. You won’t worry as much about overspending, forgetting to sign your will, or disregarding life insurance. The best advisors harness new technologies while still providing personal, individualized advice.
In reality, the human element has always been our most important differentiator. Our distinguishable worth was never based on our “unique” portfolio strategy. Even the best analysis can’t always avoid the unpredictability of poor performance. Instead, an advisor’s ability to coach and deter clients from poor decisions represents the biggest differentiator from the robo platforms. A Vanguard study quantified this “advisor alpha” and showed that investors missed out on 3% in returns per year without professional help. Behavioral coaching, or hands-on guidance in all aspects of a client’s financial and personal life, constituted the largest piece of that increase. (For more, see "Coaching Clients Through Financial Planning: How Advisors Add Value By Managing Behavior.")