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Will Robo-Advisors Replace Traditional Financial Planners?
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Will Robo-Advisors Replace Traditional Financial Planners?

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Will Robo-Advisors Replace Traditional Financial Planners?

The past decade has seen the rise of numerous automated investment management platforms -- "robo advisors" -- that are said to threaten the very existence of the human advice industry. While these services provide core offerings that can and do act as portfolio centerpieces, automated investment managers come with a number of drawbacks that may have a significant impact on their ability to grow into the future. A holistic exploration of the advantages and disadvantages of robo-advisors, especially in comparison to human-delivered advice, is warranted.

Lets look at two advantages first:

1. Inexpensive, Innovative, and Effective

Robo-advisors are elegant tools that do their best to minimize investing costs and streamline their clients' financial lives. FinTech firms like Betterment and Wealthfront have developed easy-to-use interfaces that allow clients to become fully invested after answering a simple questionnaire. Once invested -- usually in a low-cost portfolio of ETFs -- clients are able to go back to their everyday lives without thinking about their investments again, other than to add more money to their portfolio or open a new account.

This is done on a basic level for an expense fee of only 0.25% of assets annually, which is a far cry from the 1% (or more!) most traditional advisors will demand. The 0.75% cost difference alone is one reason to reconsider the choice to enlist a human advisor, but given that robo-advisors also offer powerful algorithms to optimize investment allocations, it's hard to ignore the inevitable impact that autonomous advisors will have on the wealth management landscape.

Image source: Getty Images.

2. Tax Awareness and Efficiency

Many robo-advisors offer automatic tax-loss harvesting, which refers to the realization of investment losses to offset investment gains -- thereby reducing an investor's tax bill. A traditional financial planner may perform these calculations manually, but the task can be time consuming and complicated if the client has multiple taxable accounts.

Further, by automating asset location, or placing tax-inefficient investments in tax-advantaged accounts, robo-advisors truly maximize after-tax portfolio return. For example, if an investor has both stock and bond holdings, it is generally preferred to place the bonds -- which derive most of their return from income -- in tax advantaged accounts like an IRA or 401(k). Given that tax rates are dynamic and personal financial circumstances tend to change rapidly, an automated service that accounts for all fluctuating variables is a very valuable tool.

The drawbacks of utilizing these investment managers are few in number, but important to mention:

1. Loss of Control and Limited Options

Robo-advisors tend to offer ETF or low-cost index mutual fund portfolios -- however, many people want to be able to trade individual stocks at will or invest in alternatives. High-net-worth individuals, specifically, may have a piece of their portfolio allocated to broad-based index funds, but also seek uncorrelated returns through hedge funds, private equity funds, or other private placements.

While robo advice is extremely appealing to much of the middle market and to those just getting started with investing, the offering has its downsides for those who seek more control over the day-to-day management of their investments and those who require more esoteric products. The upside to limited control, from the other end, is that emotions are less prominent in portfolio decision-making. As research has repeatedly shown, a frequently traded portfolio, as well as an overly complex one, will more than likely lead to subpar returns.

2. Robots are not Humans

There is a reason we all vigorously press "0" when we dial a customer service number. There is something reassuring about receiving human-guided advice, and it can be comforting to call a human planner with questions specific to your financial situation. There are many qualified and credentialed experts that stand ready to answer questions when called upon -- and the demand for them is undeniable.

As a result, several robo-advisory firms (Vanguard's Personal Advisor Service, to name one) have begun offering a hybrid product, combining the expertise of a human Certified Financial Planner(CFP) with streamlined robotic investment offerings. This limits the amount of manual trading done in the portfolio, but does allow a client or prospective client to discuss their questions or concerns with a highly competent individual. Ideally, the human in this scenario will be able to manage the relationship and break down complex financial concepts for the client.

This debate will continue to be a focal point within the wealth management industry for the next decade. It's increasingly clear, though, that automated investing is here to stay and is probably most effective when combined with human oversight. For those with a simple financial picture, however, robots are exceptionally formidable investment managers.

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