Can Robo-Advisors Replace Human Financial Advisors?
When Back to the Future 2 was first released, many people doubted that there would be flying cars, hover boards, or self-strapping Nike shoes in the year 2015. But the ever-progressing field of technology actually managed to come pretty close to proving the doubters wrong. The shoes became available to the public in 2016 — although it never became very popular, hover-boards were built — although not available for commercial use, and flying cars… well, I guess we are not quite there yet.
When movies like Steven Spielberg’s A.I. Artificial Intelligence, I, Robot, or even The Terminator series were first released, many people doubted that robots could attain high levels of intelligence, replace human jobs, or attempt to destroy the world as we know it.
Sure enough, technology is again racing rapidly to prove us wrong…
While technology has not quite reached the last level yet — and let’s hope it is far from it, robots can outsmart humans — Google DeepMind’s AlphaGo beat Go world champion Lee Sedol 4–1 in a five-game match, and are increasing their sphere of influence in many aspects of our society. In particular, robots are fast approaching the world of finance.
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Industry Overview
Robo-Advisors have gradually been growing as formidable industry disruptors to the traditional money management scene. Now boasting over $200 billion in Assets Under Management (AUM), the robo-advisory industry seeks to exceed $5 trillion by 2020.
Although Robo-Advisors are usually developed by talented tech startups, many large global firms are starting to incorporate them into their own platforms in order to reduce operating expenses and improve decision-making.
According to Gartner, around 14% of the firms they surveyed are currently using Artificial Intelligence in wealth management (more widely used in the retail and commercial banking space), and 37% of the wealth management firms have no intention of using AI in the next two years, which means 63% plan on using AI. The extent to which AI is currently being used is experimental at best, such as simple, voice-response products like Amazon’s Alexa; however, this could be indicative of the use of more advanced AI technology, like Robo-Advisors, in the near future.
The Advantages
So why do investors choose robots over humans? One of the biggest reasons is that Robo-Advisors are not swayed by emotions. By strictly adhering to the algorithms that they programmed with, they can make the right decisions without riding the emotional waves of the market trends. It is important to understand that the stock market, or any equity capital market for that matter, is not some mysterious sorcery controlled by some higher being; rather, it is a complex representation of people’s psychological interpretations of how different market forces will react to one another. So while it is easy to follow trends, it is hard to be sure that it is the right decision.
There are few market-savvy investors out there who can navigate such stormy waters successfully, which is why for the average investor, it may be best to rely on the historical data of how people have reacted in the past. This is exactly what Robo-Advisors do, and they do this much faster and more effectively than human advisors can. Instead of relying on arbitrary predictions and analyses of how people will respond, Robo-Advisors possess the ability to analyze years of data and provide investors with recommendations of how they should respond.
And sure enough, the effects have shown. According to Betterment, any portfolio with 20% or more equity has outperformed the average private client investor with equivalent equity proportions.
This isn’t the only way Robo-Advisors make successful investing more accessible to the average investor. While the traditional financial advisor charges around 1% of a client’s portfolio on average, Robo-Advisors such as Betterment and Charles Schwab’s Intelligent Portfolios charge as little as 0 to 0.25% of a client’s portfolio.
The Disadvantages
At this point, it seems that we might as well shut down Wall Street, invest everything we have in the stock market and have cyborg replicas of Arnold do our taxes. But surely, there must be reasons why the financial world has not completely embraced Robo-Advisors.
Ironically, the biggest one seems to coincide with that of why the financial world has started to embrace Robo-Advisors: lack of emotions. For the individual investor, investing is more than just crunching numbers. Losses can take a huge toll on one’s emotional health, while gains can inflate one’s ego to an unhealthy size. When going through this emotional rollercoaster, it may be beneficial for the investor to have someone they can talk to and express feelings with. Sure, Tom Hanks got along fine with Wilson in Castaway, but wouldn’t he have been much better off with a fellow human being?
While Robo-Advisors are personalized and customizable in regards to the investor’s financial goals and risk preferences, they do not, at least for the time being, harness the empathy, support, and most importantly, the humanity that human advisors do.
Half-Man, Half-Robot
Perhaps that is the reason why the idea of “bionic advisory” is gaining traction. Bionic advisory seeks to bring together the best of both worlds of robo and human advisory. According to Prive Financial, which is a financial services company that offers bionic advisory, a combination of human and artificial intelligence “highlights human intelligence and customer preference while leveraging the robo engine and optimizes investments in a truly customized approach.” The human element comes in identifying the clients’ emotions, risk tolerance, and other variables. Initially, when Robo-Advisors became a relevant topic, many financial advisors feared they would end up on the streets. However, the goal of bionic advisors is not to overthrow the traditional financial services industry — it’s to aid it by eliminating the mundane, tedious tasks that waste time and efficiency with technology.
The Verdict
Can Robo-Advisors replace human financial advisors?
From a technical point, yes, they probably could. As far as numbers are concerned, Robo-Advisors can outperform human advisors almost every time. With award-winning algorithms that can analyze years of market data in minutes and immunity to emotional swings, it is probably safe to say that our mechanized counterparts are much better suited to make the right investment decisions. However, considering the fact that investing is much more than a numbers game, the human element will remain relevant as long as the financial markets exist. The innate abilities to empathize, understand, and relate are qualities that are essential to an investor, and not to mention, uniquely human.
And once robots are able to imitate those characteristics, we might have a bigger problem on our hands than whether to short Apple or not.
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