Jim dives into the difference between traditional and robo-advisors. As seen in CPA Magazine:
Robo-advisor. While this term might initially conjure up the image of a space-age consultant – everything from Rosie the Robot in The Jetsons to R2D2 – it also generates the need for careful consideration when it comes to financial and wealth management.
By definition, robo-advisors (ROBOs) provide digital financial advice based on mathematical rules (algorithms) that are devoid of virtually any human intervention. As might be expected, these self-guided investment platforms are unequivocally cheaper than advice received from most financial advisors. The bullish case for ROBOs is this: their algorithms, net of fees, will do a better job than human advisors in asset allocations and managing client assets.
In essence, the distinction between ROBOs and traditional advisors is being shaped by a marketing-driven “Man vs. Machine” argument (and I am not referring to the solid gold album by rapper Xzibit). This is, unfortunately, the wrong conversation.
The choice between a digital and human advisor is 1.) NOT a zero-sum game and 2.) NOT a winner-take-all proposition. There is no doubt ROBOs are helping fill a void that many asset management firms find unprofitable with regard to small account balances. ROBOs typically utilize low-cost index-based investments as a means of gaining market exposure. Non-ROBO advisors have an expanded investment universe from which to work, including traditional and non-traditional investments. In turn, asset management firms gain and maintain one incredible advantage – the ability to connect and communicate with their clients.
Emotionless Advice vs. Financial Integration
While it’s true a ROBO advisor is void of emotion, since the software cannot be influenced by greed and fear it does require a participant to have complete and total faith in the algorithm-based program. This unwavering confidence in a software program can be tested in times of heightened volatility. In contrast, a human advisor can be of tremendous assistance during market turbulence, especially when it comes to encouraging clients to stay the course when their emotions are tempting them to do the exact opposite.
In addition, human advisors have one tremendous advantage over a ROBO – they possess the ability to create total financial integration for their client. A properly credentialed and experienced advisor can assess variables that extend far beyond asset allocation and portfolio rebalancing. Pertinent examples include an upcoming change in the tax code or individual tax status, a pending business sale, a short-term deficiency in cash flow, a concentrated investment, a change in employment or marital status, the dove tailing of a 401(k) plan into an overall investment strategy, prohibited investments and specific customization, to name a few. These scenarios, which are quite common over the course of an investment cycle, tip the scales toward having a trusted go-to advisor or advisory team.
Make no mistake: competition is fierce among ROBO advisory firms. In addition to competing against traditional advisors, they also are vying for clientele alongside other ROBO advisors. Each distinguishes itself based on different algos, asset class choices, requirements and unique features. Adding to the competition are “hybrid” ROBOs, which offer some level of human interaction. Is it part marketing or can a ROBO, hybrid or not, truly replace or replicate a dedicated, independently certified and/or credentialed human advisor? If you consider yourself a ROBO candidate, proceed with caution. Choosing a platform requires the same due diligence on your part as would choosing a traditional advisor.
Financial and wealth management professionals and their clientele can find some comfort in the fact that all ROBOs should be registered investment advisors. As such, they are subject to the jurisdiction of the Securities and Exchange Commission and the substantive and fiduciary obligations of the Investment Advisors Act of 1940 (the “Advisors Act”).
When considering a ROBO, the bottom line is this: price is not by any means the only key variable for choosing the right advisor. Asset levels, complexity and the need for human interaction are also strong considerations. Of course, it is imperative to be mindful that ROBO and human advisors are not necessarily mutually exclusive. Perhaps, in some cases, each may represent the smarter choice for the greatest gains.
Case Study: The Power of a ROBO/Personal Advisor Collaboration
An investor would like to contribute a modest monthly amount into a diversified, age- and risk-appropriate portfolio. The contributed capital amount is expected to tally $250,000 over the next three years. The investor would like the account to be periodically rebalanced and have losses harvested to minimize capital gains at the end of each year. A broker quotes an all-in cost of 1.50% per year. The pricing represents their typical “outsourced” approach and low associated asset balance. A ROBO advisor in this case can make sense.
The same investor receives “sudden wealth” of several million dollars and is uncomfortable with having a digital relationship for these funds. As the result of being discouraged in a previous broker search, the investor identifies a registered investment advisor held to a fiduciary standard just like their ROBO advisor. Their independent personal advisor becomes a cost effective, intelligent choice for creating an integrated investment strategy.
This article is published in the NJCPA Magazine