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A comparison of strengths and weaknesses

 

Are you better than a robo-advisor? The answer is yes. And no. Human advisors are better than robos at some things. Robos at others. What’s interesting here is the intrinsic advantages each hold and the potential for what each can do. This, more than the current state of play, will inform the future shape of the wealth management industry on the assumption that, overtime, robos and human advisors will each specialize in what they do better. So, what can robos do as well as advisors? What can they do better? And where will human advisors continue to have an edge?

 

Where Robo-Advisors and Human Advisors are Equal

Robos and advisors tie in three areas of intrinsic ability: pre-tax, pre-expense performance, customization and tax, and convenience.

  1. Pre-Tax, Pre-Expense Performance
    In principle, robos can invest in anything an advisor can, so there’s no built-in advantage to one or the other. In practice, robos tend to use simpler products like ETFs. This enables them to lower costs and serve smaller investors. But it’s a choice, not a limitation of robos.

  2. Customization and Tax
    Traditionally, high levels of customization and tax management have been associated with the type of labor-intensive portfolio management provided to high net worth or ultra high net worth investors. But most forms of customization (including customized asset allocation, customized product choice and ESG screens) and most forms of tax optimization (including tax-sensitive transition, year-round tax loss harvesting, and long-term gains deferral) can be automated.

    Most robos currently keep things pretty simple, but, again, this is a choice. There’s nothing stopping robos from offering the type of customization and tax management that used to be the exclusive preserve of ultra high net worth investors.

  3. Accessibility
    You’d think accessibility and convenience would be a clear win for robos. But nothing stops human advisors from offering all the same 24/7 reporting and self-service options a robo does (e.g. putting in a withdraw cash request late on a Sunday night). The “tech-enabled advisor” is basically an advisor with all the tools a robo has.

    Most advisors haven’t yet rolled out this type of functionality, but this is just a matter of time. Robos have no intrinsic advantage.

 

Where Robo-Advisors Beat Human Advisors

Robos have the potential to outperform advisors in terms of price and post-expense performance, as well as trust that is based on transparency.

  1. Price
    Robos charge less than human advisors (or at least they should) — after all, they don’t have to pay advisor salaries. There’s no way around this, and it’s a pretty big deal. The robo cost advantage leads us to the second area where robos can (or at least should) beat advisors:

  2. Post-Expense Performance
    Robos have lower fees, and, in principle, robos can invest in anything a human advisor can. So, net of advisory fees, you’d expect robos to outperform human advisors, on average.

    This assumes we hold investor behavior constant, meaning we assume that investors who work with robos and investors who work with human advisors will behave the same in terms of things like the amount they invest, their predilection to market timing, etc. This is a big assumption. More on this later.

  3. Trust via Transparency
    Trust? For a computer? Surely this is where humans win? Well, as we’ll see, yes, it’s an area where humans can do better. But not always. Robos have the advantage of transparency. Robo offerings are automated and systematized, and this makes it possible to know precisely what you’re getting. It’s public and transparent.

Form ADVs notwithstanding, what human advisors do can be pretty opaque. That makes it harder for investors to judge the quality of human advisors. And investors are justified in having some trepidation about what their human advisor is really doing, and why. For example, advisors tend to invest in more expensive products, despite a dearth of evidence that they serve investor interest. One common explanation is, to quote an old Wall Street saying, “the margin is in the mystery,” meaning you get to charge more for products that customers don’t understand. This is not meant as an indictment of advisors, only a reminder that human advisors shouldn’t take for granted that they, not robos, are going to win the trust war.

 

Where Human Advisors Beat Robo-Advisors

We see advisors beating robos in three areas: coaching, advocacy and trust.

  1. Coaching
    Arguably the most important part of financial advice comes under the heading of “coaching” — helping clients set realistic goals, guarding against panic and excess enthusiasm, and changing spending and saving habits. Each of these can change investors’ lives. And, for now at least, human advisors have a clear advantage.

  2. Oversight and Advocacy
    Human advisors can act as the hub of all your financial concerns, coordinating the activities of your CPA, your trust and estates attorney, your mortgage broker and your insurance agent.

    We spoke with one RIA who described it this way, “If a client ever has to ask us whether they should refinance their mortgage, we’ve failed. Our advisors should know enough about their clients and the current market to tell their clients when refinancing is in their interest. And they should do this even though we don’t get paid on mortgages or refinancing.”

    Another said, “We’re not (all) CPAs, but we know accounting pretty well, we’re not (all) insurance agents, but we know insurance well, and we’re not trust and estate attorneys, but we know trust and estate law pretty well, too. We know enough to be the financial hub, making sure all the players are acting together in our clients’ interests.”

    Dreams of robos powered by AI notwithstanding, no robo can touch this level of service.

  3. Deep Trust
    We listed “trust” as one of the strengths of robos over human advisors. Here, we list it as one of the strengths of human advisors. This is not contradictory. Many investors are distrustful of human advisors, as a group, and these investors may have an easier time trusting robos, in the sense that they will be charged a fair price. But deep trust, the willingness to let someone be a coach and advocate, is still the exclusive preserve of human advisors.

 

There are all sorts of ways in which the above lists of strengths and weaknesses doesn’t fit the current state of the market. But the potential is there, and we think this heralds a fundamental shift in the role of the human advisors. In the long run, human advisors can’t base their value proposition on services that robos can provide just as well. And that means human advisors will lose to robos if they compete solely on security selection and performance. What’s the alternative? Competing based on holistically overseeing and guiding the client’s financial wellbeing. We’re not alone in thinking this. Most of the wealth managers we speak to are steering their firms in this direction. The shift won’t be easy (knowing where you want to go and getting there are different things, but that’s a topic for another day). Nevertheless, the consensus we hear is that the question isn’t if. It’s when.

Written by Gerard Michael on May 30, 2019

Posted in: Investing