We live in an age where algorithms and ‘apps’ increasingly determine how we receive services. They are particularly useful for the discretionary services we often use for getting from point A to point B (Uber), finding an economical and unique place to stay (Air BnB) or getting the best price for an airline ticket (Expedia, Priceline, etc…).
But, could these programs also apply to receiving financial advice?
There’s a growing industry that says it might and that investors of the future will be using “robots” as their portfolio managers. If you’re skeptical about a computer program managing your nest egg, it’s probably for good reason. While there are some benefits to the robo-advisor model, there are also a few things you might consider before handing over your assets to a “Watson.” Here are four:
- Robo-Advisors Have a Singular Function – that is to build a diversified, passive asset allocation, and to rebalance it so that it remains that way. If you want actual advice beyond an asset allocation, you are generally outside the capabilities of a robo-advisor.
- They Cannot Adapt to Evolving Needs – as you transition through your retirement, your financial needs are likely to change as your interests and goals change. Whether it’s because you have a new need for additional cash flows, have a health issue to address or your family needs capital for a particular need, those are all adjustments that could influence your overall approach and asset allocation. A robot can’t respond to such changes.
- They Cannot Provide Retirement Income Advice – most retirees have planning needs beyond just asset management. They need help determining what levels of income their portfolios should produce, where they should take cash flows from and more. A robo-advisor lacks these abilities.
- They Cannot Provide Personalized Service – because, well, they are not people! In some cases a financial advisor may be attached to a robo-advisor, but we’re wary of this model. In our view, that financial advisor has no incentive to understand the capital markets or become vested in your long-term financial situation or success. Given the passive nature of the investment, the advisor will probably spend more time trying to sign up new clients than manage existing ones.
The Bottom Line for Investors
To be fair, robo-advisors can provide some utility. They are a great solution for younger, working savers who do not have enough assets to necessitate working with an investment manager. In those cases, having an automated system that can help you avoid making emotionally-driven changes to your portfolio is positive, and resourceful. Those types of investors don’t need too much advice or planning, they just need an investment discipline and long-term growth.
However, for investors at or near retirement, there is a much higher likelihood that you will need an engaged advisor who can provide advice and service that evolves with your financial needs. Robo-advisors aren’t quite there yet.