Robo advisors are online services that assemble investment portfolios for clients using digital tools, ostensibly while charging a lot less than living, breathing planners. The primary appeal was that investors would incur lower fees which – in theory – would produce better investment performance.
In fact, that lower-fee-appeal was so great that futurists warned that human financial advisors were doomed, as Robos would smash their staid business model, where humans counsel clients in person.
Futurist Peter Diamandis has been warning old-school advisors that their stodgy, low-tech methods may render their firms obsolete.
“Linear-thinking companies are being put out of business by exponential technologies,” he warns. Diamandis points to the demise of Eastman Kodak, which invented the digital camera in 1975. The company ignored its discovery and clung to the legacy film business. Kodak went bankrupt in 2012.
Financial Advice is Not a Product
But this example is way too simple and much too stark. Dire predictions about such industrial disruption belong chiefly to physical products. Financial advice is a service, encompassing both art and science. There is a limit on how much automated advances can turn services into dinosaurs. Answer this: How do you digitize a haircut?
Investment Performance of the Robos
Backend Benchmarking has done a lot to shed light on the Robos. Here is their mission statement:
“The mission of The Robo Report and The Robo Ranking is to bring transparency to the robo advice industry. We opened accounts at the largest providers and publish The Robo Report quarterly and The Robo Ranking semiannually to help investors make better choices with respect to their robo advisors.”
Backend created accounts and then tracked the performance at each firm relative to a Normalized Benchmark. They now have 3-year returns for 11 Robos, 2-year returns for 19 and 1-year returns for 34.
Through the third-quarter of 2019, Backend found the following:
- Only 2 of the 11 firms with a 3-year track record outpaced the normalized benchmark
- Only 2 of the 19 firms with a 2-year track record outpaced the normalized benchmark
- 17 of the 34 firms with a 1-year track record outpaced the normalized benchmark
The Theoretical Appeal of Robos
Robos, who chiefly focus on younger folks, charge very little because the 20-something set does not yet need the extensive plans that their mortgage-laden, family-supporting, college cost-obsessed, retirement-worrying elders do.
As the years go by, the millennials will have more assets and more complex demands, thus driving them to graduate to a more traditional financial planner.
And despite the Robos’ price advantage, don’t assume that Gen Y will always favor their approach versus the old-time sit-down model, where a real person gets to know them, their specific needs and their families. That’s why time will erode the appeal of a bare-bones, cheap-o model.
The biggest weakness of Robos is that they do not know their clients, or at least not very well.
Robos Are Not Personal
What’s missing most with robo-advisors is the personal touch. Some of these companies offer 800 numbers so you can talk to a person, which usually amounts to someone different every time, someone who doesn’t know you.
If a baby is on the way, no cookie-cutter algorithm can tell you the myriad things you need to do to prepare for the enormous change in your life, and how to plan for your young one’s future. If your spouse dies – the life partner who handled all financial matters – a computer screen or a stranger’s voice on an 800 line can’t replace a trusted advisor who lives nearby and can rush right over. That advisor knows you and your family. The robo-advisor does not.
Most importantly, the next time the stock market takes a dive, no automatic planning service will be there to hold your hand and prevent you from panicking, such as by selling all your shares, a decision you will rue once the market rebounds.
Many people don’t know what they don’t know. They don’t know what questions to ask and wealth management is not their area. A robo-advisor is next to no help to them.
Thus, the Robos aren’t bringing creative destruction to financial advisors. They are ushering in creative rejuvenation.
See /www.backendbenchmarking.com/the-robo-report/normalized-benchmarking for a methodology explanation.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Securities and advisory services offered through LPL Financial, a registered investment advisor, member FINRA/SIPC.
GENESIS Wealth Management, LLC is not an affilate company of LPL Financial.
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