The Robo v. Human Advisor Debate: Is it a Winner-Take-All Proposition?

by James Ferrare, Withum Wealth Management – May 29, 2019
The Robo v. Human Advisor Debate: Is it a Winner-Take-All Proposition?

Robo advisor. While this term might initially conjure up the image of a space-age consultant —  everything from Rosie the Robot in The Jetsons to R2D2 — it also generates the need for careful con­sideration when it comes to financial and wealth management.

By definition, robo advisors (robos) provide digital financial advice based on mathematical rules (algorithms) that are devoid of virtually any human intervention. As might be expected, these self-guided investment platforms are unequivocally cheaper than advice received from most financial advisors. The bullish case for robos is this: their algorithms, net of fees, will do a better job than human advisors in asset allocations and managing client assets.

However, the choice between a digital and human advisor is NOT a zero-sum game and NOT a winner-take-all proposition. There is no doubt that robos are helping fill a void that many asset management firms find unprofitable with regard to small account balances. Robos typically utilize low-cost index-based investments as a means of gain­ing market exposure. Non-robo advisors have an expanded investment universe from which to work, including traditional and non-traditional investments. Aside from an expanded investment universe, a non-robo advisor will always maintain one critical advantage — the ability to connect and communicate with their clients.

Emotionless Advice Versus Financial Integration 

Can a robo truly replace or replicate a dedicated, independently certified and/ or credentialed human advisor? While it’s true a robo advisor is void of emotion, since the software cannot be influenced by greed and fear, it does require a participant to have complete and total faith in the algorithm-based program. This unwavering confidence in a software program can be tested in times of heightened volatility. In contrast, a human advisor can be of tremendous assistance during market turbulence, especially when it comes to en­couraging clients to stay the course when their emotions are tempting them to do the exact opposite.

In addition, human advisors offer another strategic advantage over robos: the abili­ty to create total financial integration for their client. A properly credentialed and experienced advisor can assess variables that extend far beyond asset allocation and portfolio rebalancing. Pertinent examples include an upcoming change in the tax code, a pending business sale, a short-term defi­ciency in cash flow, a concentrated invest­ment, a change in employment or marital status, or the dovetailing of a 401(k) plan into an overall investment strategy. These scenarios, which are quite common over an investment cycle, tip the scales toward hav­ing a trusted go-to advisor or advisory team.

Competition is fierce among robo advisory firms. In addition to competing against traditional advisors, they also are vying for clientele alongside other robo advisors. Each distinguishes itself based on different algorithms, asset class choic­es, requirements and unique features. Adding to the competition are “hybrid” robos which offer some limited level of human interaction. Financial and wealth management professionals and their clien­tele can find some comfort in the fact that all robos should be registered investment advisors. As such, they are subject to the jurisdiction of the Securities and Ex­change Commission and the substantive and fiduciary obligations of the invest­ment Advisors Act of 1940.

When considering a robo, price should not be the only key variable for choosing the right advisor. Asset levels, complexity and the need for human interaction are also strong considerations. Of course, robo and human advisors are not necessarily mutually exclusive. In some cases, each may represent the smarter choice for the greatest gains.

Case-Study: The Power of a Robo/Personal Advisor Collaboration 

An investor would like to contribute a modest monthly amount into a diversified, age- and risk-appropriate portfolio. The contributed capital amount is expected to tally $250,000 over the next three years. The investor would like the account to be periodically rebalanced and have losses harvested to minimize capital gains at the end of each year. A broker quotes an all-in cost of 1.50 percent per year. The pricing represents their typical “outsourced” approach and low associated asset balance. A robo advisor in this case can make sense.

The same investor receives sudden wealth of several million dollars and is uncomfortable with having a digital relationship for these funds. As the result of being discouraged in a previous broker search, the investor identifies a registered investment advisor held to a fiduciary standard just like their robo advisor. Their independent personal advisor becomes a cost-effective, intelligent choice for creating an integrated investment strategy. 

James Ferrare

James Ferrare is managing principal of Withum Wealth Management and principal of Withum's sub-investment advisor Pinnacle Associates Ltd. He advises clients in investment management matters as they navigate each new stage of life. Jim is a member of the New York Society of Security Analysts and CPA Institute.

This article appeared in the May/June 2019 issue of New Jersey CPA magazine. Read the full issue.