Impact of Robo Advisors
As seen in the Forum Magazine
Robo-advisors have become a favorite topic for the personal finance press. They would have readers believe that traditional financial advisors should begin packing their desks and updating their resumes. The end is nigh! The truth is, while some advisors may feel pinched by competition, many will not. A parallel can be made to concerns by tax preparers in the CPA community when TurboTax and similar products debuted. Rather than destroy the tax practice of CPAs, it enabled them to focus on value-add services. Financial advisors may see a similar outcome, with traditional advisors continuing to play an indispensable role for many clients.
So, what is a robo-advisor? A robo-advisor is a low-cost, online financial advisor that uses an algorithm to allocate a client’s assets among a set of funds according to the risk tolerance and income needs expressed in a questionnaire. The algorithm automatically reallocates assets at a predetermined periodicity. Robo-advisors began as an asset allocation service but have since begun offering tax loss harvesting and retirement calculators. Some even help with selling employer stock.
What causes investors to go robo is the combination of ease, cost, and near-index returns. For individuals with simple portfolio management and financial planning needs, a robo-advisor can make sense. For investors with complicated portfolios and complex financial planning needs, a traditional advisor’s expertise and attention is likely worth the cost. Importantly, that expertise extends to risk management. This may take shape in the form of more-thoughtful asset allocation and asset selection. The latter point is important, as index investing—a fixture of robo-advisors—presents more risks (e.g. interest rate risk and following the herd) than is typically admitted by its proponents.
While costs and returns get the most attention, investors looking for an advisor should consider the value of proper financial planning. Personalized advice from an advisor familiar with a client’s unique situation can supplement or enhance returns. Poor retirement distribution planning, for instance, can wipe out the benefits of lower costs via higher taxes. Personalization can go a step further with client-centric portfolio management. A traditional advisor can more easily arrange a portfolio that meets a client’s personal values or income needs, especially one using individual securities instead of funds.
Many robo-advisors acknowledge the value of financial planning and are increasing their financial advisory offerings by hiring human advisors. This so-called “hybrid” approach is good for consumers but comes at an increased cost and often with investment minimums, making the new kids look awfully like the old-timers.
One facet of the traditional-versus-robo debate that should be appreciated is that having the debate at all encourages consumers to more deeply consider who they are trusting with their money. The fact is there are bad advisors out there, and hopefully the emergence of robo-advisors helps to eliminate them from the market. Talented traditional advisors should have little to fear, though. There continues to be