There is a war going on in the financial markets. It is a David versus Goliath story where the big bad investment industry is coming up against a newcomer in the form of technology that is threatening its way of life. This is the story of robo advisors versus financial advisors; the robots versus the humans!
Robo advisors have been gaining a lot of traction in the past few years. Firms like Wealthfront, Betterment, and Scalable.Captial are starting to gain real traction, stealing customers from human financial advisors every day.
Rather than investing using traditional brick and mortar storefronts, with human advisors helping clients invest their money, robo advisor use technology and mathematical algorithms to automatically select an efficient portfolio based on the clients needs.
Clients sign up for a robo advisor account entirely online, complete a detailed questionnaire to determine their risk tolerance, investment goals, and time horizon, and then the “robots” do the rest. The client’s money automatically gets invested in a well diversified portfolio of exchange traded funds with the right mix of stocks, bonds, real estate, and maybe even natural resources, and then is rebalanced periodically to make sure the asset allocation remains locked in.
All of this was traditionally done by human advisors, for what was typically a lot more in fees. However, there are a few differences between robo advisors and human advisors. Let’s pit the two against each other in this robo advisors vs financial advisors matchup to see who comes out on top.
One of the biggest impacts to a portfolio’s long-term value, if not the biggest, is how much in fees an investor has to pay to manage their investment portfolio. In fact, the amount an investor pays over the lifetime can make the difference between retiring on time, or having to delay retirement in order to contribute more to the retirement account.
Consider the chart below, which was put together by the Securities and Exchange Commission to show the impact that fees can have on even a modest portfolio.
A savings of only 0.75% in fees paid, can increase a portfolio value by over $30,000 on a $10,000 original investment.
Let’s look at this in another way. Consider the following graphics, which was prepared by Betterment.
When compared to a traditional human investment advisor, the fees difference with a robo advisor can add up to over $555,486 of potential savings. On a $1,000,000 portfolio, the robo advisor client pays $8,500 less in fees.
Getting into specific numbers, the typical human advisor will charge an annual fee of between 1.0% and 2.0% of assets under management. When compared to a robo advisor, the annual fees run anywhere between 0.25% to 0.50%. As we have seen, that can end up being worth tens of thousands of dollars more in your pocket.
Winner: Robo Advisors
People are only getting busier it seems. With the ever-increasing demands of work, family obligations like sports or arts, and extracurricular activities there is little extra time to devote to managing an investment portfolio.
When comparing robo advisors vs financial advisors, the accessibility factor is easy to see. Human advisors work regular schedules, and are usually only available during regular business hours. Those are the hours that clients may not be available due to their own business schedules.
Robo advisors on the other hand, are always available 24-hours a day. Because they are online, clients can check in on their investments at any time. Whether it is on the bus or train during the daily commute to and from work, or after the kids go to bed at night, the robo advisor is always available. And with the proliferation of online tools that are available to help get answers to clients questions, there is not as much need to even discuss the investment plan with a financial advisor.
Winner: Robo Advisors
Robots are not known for being very personal. Unless they are programmed to show empathy or to read human emotion, then they only deal with the facts and programmatically deal with situations that come up.
Robo advisors are not very personal, and don’t provide a great deal of personal service. They are designed to algorithmically provide an investor with the right portfolio for them, and will coldly manage that portfolio with little regard to exactly what the client wants. This is not necessarily a bad thing, however some clients want to be catered to and feel their situations are unique which may require more one-one-one support. Human financial advisors are obviously better at doing this and that is why they have the edge in this category.
Winner: Human Financial Advisors
Investment goals and plans can change over time. What is required when an investor is 20 years old can be very different than when an investor is 50. A good investment advisor – whether robo or human – must be able to adapt the portfolio based on the clients changing needs.
That said, investment portfolios should not change very often. Other than adjusting for less risk tolerance as the investor gets older, portfolios should remain relatively stable and without a lot of activity reacting to market gyrations or investor sentiments.
Robo advisors on the one hand, will rebalance the portfolio as different parts of the markets perform better than others. Human investment advisors will do this as well. Robo advisors will make decisions that benefit the investor from a tax standpoint. So will human investment advisors. Robo investors allow clients to adjust their investment goals, risk tolerance, and time horizon when required, and some even do that automatically. Human investment advisors also do that, only they do it more manually and using their experience rather than computer algorithms.
Anyway you look at it, in the robo advisors vs financial advisors battle, both can be quite adaptable when it comes to meeting the needs of their clients.
Winner: Split Decisions
Humans are complex machines. Decisions they make are depending on experiences they have had, what they have learned through school and hard-knocks, and cognitive biases that can often lead them to make poor financial decisions. In fact, research has shown that people, including financial advisors, identify patterns where none exist. That can lean to bad investment decisions which ultimately can hurt their client’s portfolio performance.
Robo advisors on the other hand, make decisions only based on the algorithm. If the portfolio is not aligned to the target asset allocation, then it is adjusted. Does the asset allocation still fit in with the client’s goals? If so, stay the course. If not, adjust as required. There is no second question, or intuition involves.
When it comes to investing, the process is often more important than the human input. Robo advisors rely on a strict process to make sure a client’s money is invested efficiently and with the right balance of risk and reward. Humans are emotional beings, and that is not always good when it comes to investment decisions. It is this lack of emotion that makes robo advisors better advisors.
Winner: Robo Advisors
Investing can be either active or passive. Active investing is uses various strategies to attempt to beat the market. This often includes actively trying to time the market (getting in and out of the market depending on market conditions) and / or researching stocks and bonds to identify the best ones.
Passive investing on the other hand, simply tries to get the market returns, no more no less. It is a very efficient way to invest as it is usually cheaper and in many cases, performs better.
Consider the SPIVA® U.S. Scorecard’s findings:
During the five-year period ending Dec. 31, 2016, 88.3% of large-cap managers, 89.95% of midcap managers, and 96.57% of small-cap managers underperformed their respective benchmarks.
Most active managers failed to beat the market. In fact, they actually underperform the market and gave their clients a lower return than they could have got by just buying exchange traded index funds that invested in the benchmarks (i.e. the FTSE 100).
Robo advisors invest in a completely passive style, and as such will more than likely outperform active advisors. Most human financial advisors – most but not all – will invest using an active style of management that is intended to get their clients a better return than the market. The data suggest that this does not work, and is why robo advisors have the edge when it comes down to performance.
Winner: Robo Advisors
Sometimes investment clients need help. For example, in the 2008 stock market crash, many investors bailed from their investment plans and sold everything. The trouble is, if you did that and stayed out of the market since then, then you have missed out on one of the best bull runs in recent history.
Take a look at the following chart of the S&P 500. If you look around 2008, you can see that big drop in the market. However, look at where the share price is today. If investors just held on and didn’t sell during that time, they would have been much better off.
The best investment advisors were able to coach their clients to stay the course, and not react based on emotions. Robo advisors without human intervention is not able to provide this coaching. Without that coaching, it is hard to say what clients will do. A good coach will be able to address the challenges clients face along the way—from market crashes to needing cash to pay down debt—to ensure that issues come up do not jeopardize the long-term growth potential of the portfolio. Only human advisors can do that, and this why the edge is given to human financial advisors in this category.
Winner: Human Financial Advisors
The final comparison in the robo advisors vs financial advisors analysis is account minimums.
Due to the higher costs of offering traditional investment management, financial advisors typically can not take in clients with less that £50,000 in investable assets. Some refuse to take clients unless they have more than £500,000 in investable assets. The reason for this is that the fees they generate on anything less that £50,000 does not cover their costs of doing business. Even as a client’s assets grow and fees scale down, the costs of using a traditional investment manager remains high, making their services inhibitive for smaller investors.
Alternatively, some robo advisors have no minimums required to open an account, and some only require as low as £500 to open an account. In addition, because of the much lower infrastructure requirements of running a robo investing business, the fees are much lower.
Clearly robo advisors win this round.
Winner: Robo Advisors
Here is how the robo advisors vs financial advisors scored, out of eight categories:
Robo Advisors: 5 out of 8
Human Financial Advisors: 2 out of 8
Tie: 1 out 8
Clearly robo advisors came out ahead in most categories. They are doing a good job of meeting the needs of a lot of investors, and can be a good choice if you don’t need a lot of hand holding. Even if you do, there is a lot of help through the process via online help, chat, as well as customer service agents who can help with the signup process.
Even with that in mind, it doesn’t need to be decision of going strictly robo advisor or strictly human financial advisor. Many robo advisors are starting to offer a level of human financial advice intertwined with their robo advisor portfolio management services. You can call and get connected to a registered investment manager, who can guide you in the decisions that are unique to your financial situation. For example, if you have specific tax requirements then there are advisors at the robo advisor firms who can help you navigate that.
Companies like Moneyfarm and MarketRiders are both starting to introduce human advisors to complement their robo services. If you want the best of both worlds, then considering these firms are a real viable option.