Robo-Advisors and the Future of Investing

Are you prepared to send your children to university in 10 years or less?  Are you working in an industry that might experience lay-offs?  Is your estate invested in a way that measures market risk but also takes into consideration the tax liability you are leaving to your children and grandchildren?  When you ask such questions this gets to the heart of what you think a financial advisor is; is it someone who just sells you a product, or is it someone who understands your life’s situation related to your finances and bases advice on those criteria?  This brings me to the question if robo-advisors are the future of investing.

Technology gives us the ability to be efficient in ways we never thought possible, in some cases though the automation of jobs.  Everything from professional drivers, online marketers and even financial and sports reporters are jobs facing automation or being outright replaced by technology.  One of these professions that face the risk of disruption is financial advisors.

Currently the ranks of investors are rising and the number of financial advisors is shrinking.  The barriers for people to enter this profession are becoming more difficult and technology is picking up some of this slack.  Also, someone who enters the industry without the benefit of being hired by a team with existing clients have the odds stacked against them.  The average financial advisory team in Canada manages an average of $80 million over 159 households.  This means the average investor who has a financial advisor has approximately $503,000.  Investors who are what a bank or institution would consider "small" (generally less than $250,000) are being pushed away from advisors to the lower levels of advice in that firm, and increasingly to robo-advisors.  Understandably, some investors feel their only option is the use of technology for sophisticated advice.  Compared to their human counterparts, the average robo-advisor account is only $20,000 and currently manages approximately $20 billion of the $24 trillion in U.S. retirement assets.  It begs the question of just how sophisticated is that advice?

An issue with robo-advisors is that they primarily use ETFs and mutual funds.  When you have the potential of billions of dollars poured into only a few products, liquidity can become an issue.  This is very likely to happen as so many banks are reducing their advisor force in favour of the lower cost technology and will almost certainly use their own proprietary products.

Why this can be a concern for investors is illustrated in a story from the August 24, 2015 issue of the Wall Street Journal.  ETFs generally trade at prices that are close to their net asset values, or the price of their underlying securities.  Market makers and broker-dealers seek to provide liquidity to the market and try to offer a tight spread between an ETF’s buying and selling price.  In times of chaotic trading, they may have no idea what a fund’s holdings are really worth, and could be mispricing some ETFs:  "That seems to have happened on Monday morning.  While the holdings of value ETFs did decline, the prices of ETFs, in a number of instances, fell much further than their underlying holdings.  Guggenheim S&P 500 Equal Weight ETF simply holds equal weights of stocks in the S&P 500 index.  “It should have been down 6% on the open... it did, but it proceeded to print some trading down more than 40%."  Think of a room full of people trying to exit out of one door; this is fine if the crowd leaves in an orderly fashion but in the event of a fire (think of the 2008 Great Recession), good luck getting everyone out unscathed.

Aside from the specific investments, we need to ask what clients want and will ultimately need;
“…They [Clients] want advice.  Robo-advice is not advice,” says Josh Brown, CEO, Ritholtz Wealth Management and CNBC contributor. 

I agree.  Automation has many advantages, but an intuitive knowledge of clients and their situation is not one of them.  I don't believe an algorithm is qualified to make judgement calls for someone’s finances.

William Van Law, president of the Investment Advisors Division at Raymond James has stated publicly that you won’t see us starting a robo-platform.  Dennis Zank, Raymond James' COO has also stated the firm will be looking at integrating some of the new technology to enhance what advisors do.  I think this is an elegant solution to take advantage of technological innovation and still keep human intuition part of our financial decisions.

The question remains for investors is how to avoid being sent to a robo-advisor platform when you have been deemed "too small" by a bank.  My answer (admittedly somewhat self-serving) is for investors to interview financial advisors who work at independent firms like Raymond James.  Independent firms and the advisors who work there are often given the flexibility to help clients who find themselves without the advice they want and need.  It is unlikely anyone wants to take advice from HAL 9000.

Sources: BBC, CNBC, Fortune, Investment News, Pricemetrix.com,