Skynet’s Picking Stocks
Technology has a long history of disrupting industries by replacing human labor with machines and software. In most instances, this trend has led to greater scalability, lower costs over time, and productivity gains.
The financial services industry is no different, and a recent advent in the investment arena that has gained a tremendous amount of attention from financial advisors and investors alike are “Robo-Advisors.” These are web-based wealth management tools that provide automated portfolio management advice with little to no interaction from financial advisors. Some even offer cool features like tax minimization strategies and automatic reinvesting of dividends.
These technologies usually cost less and require smaller account minimums when compared to traditional financial advisory firms because they are built to eliminate or dramatically reduce the need for personal service. Like most technology solutions, their focus is more on scale because that’s what makes them profitable over time.
On paper, the notion of technology disrupting financial services makes a lot of sense. There’s no question that fees impact performance, so why pay a human more for something that a computer can replace at a fraction of the cost?
Furthermore, many of these robo-advisors employ investment strategies predicated upon the same financial theory used by traditional advisors. This may appeal to investors that are only looking for help with basic asset allocation and security selection.
Consider a twenty-something earning enough to contribute to a retirement fund that will not be touched for several decades. This investor has rather simplistic needs, and if her portfolio dropped 30% or more in the near future, there should be more than enough time to recover and avoid any permanent damage to her retirement.
However, a retiree who needs income to pay bills and/or has complex needs like tax and estate planning will likely have a much harder time letting a computer manager his money. There are just too many services offered by advisors that cannot be replicated by a computer.
Of these, the single most important function is keeping emotions in check. Advisors are psychiatrists first and financial professionals second. Keep an investor from making the worst possible mistake at the worst possible time, and an advisor has earned their fee in perpetuity. Because meeting financial goals is just as much about keeping the right mindset as it is about owning the right stocks. There’s even data to support this.
The chart below shows that the average investor (orange bar) earned a fraction of a balanced portfolio (both blue bars) over a 20-year period. Two main reasons why individual investors have seen such paltry returns are they chase performance and sell into panic.
Source: J.P. Morgan Guide to the Markets 3Q2020
Panic selling is by far the most effective way to permanently alter an investor’s financial future because it converts short-term pain into long-term misery. If an investor feels they are susceptible to panicking, then they are probably not a suitable candidate for a robo-advisor.
The Bottom Line
To combat this hurdle, several robo-advisor solutions on the market now offer access to human advice over a phone to answer questions and get market insight. But the notion that an investor would take advice during times of panic from a complete stranger working in a call center somewhere who knows nothing about their goals and/or financial situation seems debatable.
The entire financial services industry is built on trust, and the rapport established by working with a trusted financial advisor is not built over the phone. Nor is it something that can be created instantly. Relationships like these take time to cultivate because it goes both ways. The advisor also needs time to learn about an investor’s personality just as much as their financial goals so they can best serve them.
The bottom line is that “robo vs. traditional” is not a worthwhile debate. One is not better than the other because they both have their place. Just be sure that you are not putting a right shoe on a left foot. If you just need basic services for the next few decades, then there may be little reason to pay up for a professional advisor. But for those who need the guidance and acumen, the true value of an advisor will likely never be replicated by a robot anytime soon.
Three Key Points
1. The rise of “Robo-Advisors” has created a tremendous amount of buzz throughout the financial community.
2. These low-cost solutions are mostly geared for those who have a longer time horizon and who can stay invested through volatile times.
3. Although robo-advisors may be beneficial to a select few investors, the overwhelming majority of retirees should strongly consider the risks associated with these tools.
Disclosures
This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.