Robots can play soccer, but they can’t know you—step one to delivering financial advice that’s best for you. Photo by Joe Saedle/Getty Images.
Robots are a marvelous bunch. They can vacuum our floors. Drive cars. Deliver beer. Play soccer with President Obama. But there is one thing they can’t do: Get to know you and deliver you-first financial advice.
I point this out because UK regulators seem to disagree—potentially to the detriment of investors. UK investors haven’t had an easy time accessing quality, honorable investment advice over the past year. A raft of mis-selling scandals has plagued the industry, resulting in 2.3 million enquiries with the Financial Ombudsman over the past year and harsh calls from BoE Governor Mark Carney to ratchet up ethical standards, pronto. An early 2013 regulatory change, Retail Distribution Review (RDR), tried to clean up the industry by banning brokers from receiving commission payments from any funds they sell and regulating how they charge clients for services. It was well-intended but costly to comply with, resulting in a mass exodus of Independent Financial Advisers (IFAs) from the industry. Many who remained stopped serving clients with smaller accounts, leaving tens of thousands of investors out in the cold.
Since then, the Financial Conduct Authority (FCA) has struggled to fix this “advice gap.” In a speech last Thursday, FCA Chief Martin Wheatley proposed his solution: Promoting “robo-advisers” as a cheap alternative. Online platforms that take your information and use a bunch of algorithms to spit out a financial plan.
It’s all a bit “Let them eat cake,” if you ask me. The obvious solution should involve identifying and tearing down whatever barriers prevent clients of any net worth from receiving advice from expert, ethical humans who can get to know them, develop a plan that matches their needs, and provide the ongoing advice and counsel they need to navigate the market’s ups and downs without making destructive emotional decisions along the way. If regulators created these barriers, they should be able to destroy them. Throwing up their hands, pretending folks’ needs aren’t so great and saying, “Let them have bots” is just a might out of touch.
It’s also ignorant and downright foolish. Yes, robo-advisers are cheap, but you get what you pay for. If you hire an investment adviser, chances are you want help developing a strategy to reach your long-term financial goals, and you want ongoing help in selecting the right investments. If the adviser does things right—if they’re doing what’s best for you—they take the time to get to know you. Online questionnaires can’t capture the nuance of this discussion. They’re a surface-level, cookie-cutter look at your age, planned retirement date, “risk tolerance,” objectives and the like. There is no back and forth, no deeper questioning.
They also rely on you to know what your goals are and have an accurate assessment of your investment time horizon. Problem is, most folks don’t. They know, roughly, what they need—cash flow through retirement, certain expenses they must meet, major life events they have to plan for, enough money to take care of their spouse and family. But for many, it’s hard to translate needs and wants into concrete investment objectives that match their financial goals.
Why? Doing so requires an understanding of the tradeoffs between risk and return—an understanding many folks don’t have. In a recent study of investor behavior, global financial firm Natixis reached an alarming conclusion: “Few have clearly defined goals or a plan to reach them, and they are torn between a desire for high, historically unrealistic, returns and insecurity about taking on risk.”
It gets worse. 58% admit they don’t have clear financial goals. 50% admit they don’t know what annual return their goals require. 54% want “steady returns through market cycles” but don’t know how to achieve them—understandable, since the laws of risk, return and volatility dictates no such investment exists. 70% are torn between primary goals of long-term growth and capital preservation, and 78% are inclined toward “safety.” Even though 65% believe they need anywhere from 5% to 15% annualized—after inflation—to meet their goals. Another 12% say they need more than 15% per year. 26% believe success means all gains, no loss, over any period.
There is more, but you get the drift. The majority of investors are conflicted. Confused about risk and return. Hoping for returns far beyond what equity markets have historically provided (roughly 10% annualized since 1926) but unwilling to take the risk to get even market-like returns over time.
As Natixis sums it up: “Wanting something and doing what is needed to meet that goal are two completely different things.”
A robot can’t talk you through this. They can’t tell you when your expectations are dangerously out of step with reality. They can't educate you on the tradeoff between the risk of short-term declines and the rewards of long-term growth. They can't explain capital preservation and growth are 100% conflicting goals. They can’t help steer you right and then recommend the strategy that matches. They can only take whatever information you give them and spit out whatever recommendation they’re programmed to.
That’s another problem. Robo-advisers are programmed by people. There is no guarantee they’re giving you expert recommendations, grounded in an understanding of capital markets. Their recommendations could very well be based on the same dumb mythology, groupthink and rules of thumb Wall Street has peddled for decades. Their ongoing advice and tactical recommendations are whatever the humans in control make them to be—it could be as simple and useless as “rebalance to target allocation every year,” with no regard for the market outlook. If they try to navigate market cycles, how do you know the human inputs are based on solid forward-looking analysis and not a herd-like interpretation of (and reaction to) the day’s news? Wheatley says computers are capable of “previously unimaginable and impossible feats of accuracy and forecasting.” Perhaps in some regards, that’s true. But this isn’t Deep Blue gaming Gary Kasparov’s next move. Can a computer game the downstream unintended consequences of one sentence in an 800-page regulatory proposal?
The list of drawbacks goes on. Robots can’t counsel you when times are tough. Computers can’t help you identify and beat bias and behavioral error. If you want to liquidate at the bottom of a bear market, an algorithm can’t help you see through the noise and panic and focus on your long-term goals. Adviserbot can’t discover changes to your goals and financial situation through the simple course of conversation.
From the assembly line to the Roomba, robotics and automation have brought amazing improvements to quality of life. But it stops at financial advice. There, the human element is irreplaceable. Go bot at your peril.
From the start, RDR was all about putting the client’s interests first. No more could IFAs advertise “free advice,” recommend expensive funds, then get a kickback from said expensive fund. No more could they advertise their advice as independent but recommend products they had a financial stake in. But like even the best-intended changes, it had unintended consequences. It left folks underserved, totally lacking the you-first advice regulators wanted them to have. So why is the solution a robot that can’t ever give them the advice they deserve?
I’m going out on a limb here, but I’m pretty sure Wheatley finds his own profession too nuanced for robots to take over. Let’s hope he and his colleagues realize the same about financial advice and fix whatever is keeping UK investors of all sizes from accessing the services they deserve, instead of relying on a robot copout.