As advancements in technology enter the financial advising industry, clients seeking financial advice face a major choice: consult a robo-advisor, or make use of a human portfolio manager? While using the services of a robo-advisor can be convenient for investors, the effectiveness of a robo-advisor over time is far lower than what a human advisor can provide.
What Are Robo-Advisors?
Robo-advising is a term that refers broadly to a whole class of investment management tools that rely on algorithms to create investment portfolios, based on basic information the client provides about their finances and goals. While some robo-advisers are completely automated, others offer access to human assistance as well. Robo-advisors often advertise themselves as offering lower fees than what human advisors and portfolio managers will provide; however, these claims are misleading, as the costs of the two can oftentimes be comparable.
The Cons of Robo-Advising
Human emotion and creativity is a key ingredient of smart investing.
Experts say that one of the most important components for establishing trust between advisor and client is human emotion and sympathy, which robo-advisors are unable to provide. The ability to determine which market factors are most important for clients on a case-by-case basis requires a level of creativity and problem-solving that robo-advisors are not yet capable of.
- Robo-advisors rely on basic algorithms that won’t make sense for everyone.
Leading financial experts suggest that while robo-advisers may be somewhat useful for providing rudimentary financial advice, the current technology makes it impossible to offer sophisticated advice uniquely tailored to each client’s financial situation, especially in the event of sudden market changes. - Human advisors use a greater wealth of information.
A robo-advisor’s financial plan for you will be based purely on the numbers you give it, as it’s often difficult for robo-advisors to synthesize additional, non-financial information into a financial plan that works for you. Conversely, if you are saving for a vacation, have an aging parent you’ll be caring for in the next few years, or have a child with health problems, a human advisor can tailor an investment portfolio to your unique concerns. - Robo-advisor algorithms and human driven markets
“Investing is both an art and a science.” It wasn’t in the too distant past that an algorithmic-based hedge fund almost brought the financial system to its knees. Long-Term Capital Management was a hedge fund run by some of the brightest minds in the world. Its team included finance veterans, PhD’s, professors, and two Nobel Prize winners. By 1998 the fund had exposed U.S. banks to $1 trillion in default risks. In less than a year, $4.4 billion of its $4.7 billion capital was lost and a bailout had to be organized by the Federal Reserve and some major U.S. banks. What this team of some of the brightest minds in the world ignored was that markets are ultimately human driven and humans are governed by emotions. Sentiment and emotion are realities of investing and still remain largely unquantifiable.
The advancements in investment technology are ultimately good news for clients, as human advisors have more market information available to them than ever before. However, the consensus among financial experts is that very few clients will be well-served by robo-advisors without some kind of human advice and input.
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