How Robo-Advisors Will Sink Pretenders and Propel True Financial Advisors

Investing
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By Jack A. Kennedy

Learn more about Jack on NerdWallet’s Ask an Advisor

A new type of technology-based investment tool called the “robo-advisor” is supposedly threatening the existence of traditional financial advisors. These tools charge lower fees than advisors do and enable online customers to invest their money directly, often in exchange-traded funds.

Even big players in the field, such as Charles Schwab, are setting up their own robo-advisor arms, at the risk of cannibalizing a portion of their firms’ business and revenue.

The fearful, knee-jerk reaction from the industry is confusing. Could a computer program perform the same function in a client’s life as a trusted professional advisor? Of course not. Then why all the worry?

The answer requires some background about what has been happening in the financial advisory industry. In recent years it became apparent to the public that many financial brokers and brokerage firms were charging exorbitant commissions. These commissions were charged when these brokers sold financial products or placed trades and on overall account management, all to the detriment of client assets and growth.

The commissions had one person’s advancement in mind — the broker’s. At times, these commissions could add up to more than 3% of an investment portfolio’s total asset value.

Many brokers and advisors have been charging “advisory fees” as well, but in many cases in disguise. The most obvious example is the financial professional who splits up an account (IRA or brokerage) into two separate accounts. The first account is not fee-based, set up to generate commissionable sales. The second is fee-based, set up to generate recurring revenue based on assets under management.

I can’t tell you how many investment reviews I’ve performed over the past decade and thought to myself, “How can an investor not question this?” Worse, when I brought it to the investor’s attention, he or she seemed dumbfounded and shocked. Needless to say, when I reviewed these accounts, the investors became better educated and started to demand more.

Along came “fee-only” advisors, who in theory do not charge commissions or hidden fees, but rather a set fee based upon assets under management. In other words, their pricing model was fully transparent and fully accountable. My firm saw where the industry was heading years ago when it started the wheels turning to open our true “fee-only” RIA (Registered Investment Advisory) firm, to the hopeful advancement of client investment accounts.

However, many of the same brokers who once charged commissions are now the newest breed of fee-based advisors. Worse, the basic education and work ethic of those former brokers hasn’t improved. They allocate client assets to many of the same investments as before, only now in the fee-only wrapper. Many have shifted to using lower-cost ETF strategies that mimic indices and charge a fee on top — similar to, but to a lesser degree, what the robo-advisors are doing. Is that value or simply adding a level of fees?

The question I pose to advisors is this: If a robot or computer program can perform your role in an investor’s life, then do you have discernible value?

In my opinion, advisors should be continually educating themselves the way a computer cannot. Why do advisors shy away from individual stocks? Is there too much risk having a small portion of your portfolio in an individual company? Many investment professionals would say yes, but isn’t that what makes up those same indices the robo-advisors are buying and trading?

This aversion within the investment community to recommending individual stocks comes from many of these same traditional brokers and advisors, entirely based upon the fact that investing in individual stocks requires hard work, time and attention.

An advisor has to be able to perform fundamental analysis of a company’s financials, as well as perform technical analysis to know if it is a good time to buy, sell, update sell stops, etc.

Additionally, an advisor would have to monitor industry and company growth trends, company management, dividend announcements and so on. That amounts to a lot of time, work and research — time taken away from new sales.

This is the type of hard work and research investors would expect and welcome paying an advisor a fair amount for. It’s the old-fashioned investment management that advisors used to perform, before the industry became obsessed with earning commissions or falling prey to media-driven narratives about risk.

Advisors who research and work hard to find opportunities in individual stocks have an advantage over robo-advisors and nothing to fear from them. A computer will never be able to simulate the judgment of a CEO’s competency or gather fundamental and technical data to provide a sound conclusion on an individual stock as an investment. An educated human’s ability to analyze, process and make judgments on large swaths of data cannot and will not be replaced by a program. And computer buying and selling indices like the S&P 500 will never be able to offer the risk/reward that a true financial advisor who is performing old-fashioned investment management can.

What this industry trend will do, in my opinion, is educate the core base of financial advisors that are left standing. It will increase barriers to entry into the field and make it less of a commodity and more of a hard-earned and acquired skill.

I, for one, favor this trend, as it will promote the true financial professionals and provide a better result for hardworking Americans who deserve a true financial advisor.


This post originally appeared at Nasdaq.