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Is it time to rage against the machine?
If you are a financial adviser and the Royal Bank of Scotland (NYSE: RBS) was your employer, it just might be time. The Edinburgh-based bank recently announced it had fired 220 of its human advisers and replaced them with “robo-advisers.”
Financial advisers at other banks could also find themselves similarly unemployed. Consulting firm A.T. Kearney expects assets managed by robo-advisers to grow 68% annually and hit $2.2 trillion by 2020.
So, who or what are these asset-gobbling, job-destroying robo-advisers?
A robo-adviser is an automated online investing service that uses computer algorithms to allocate, deploy and rebalance investment portfolios. Portfolio composition is guided by answers to a series of questions that focus on investment strategy, goals, time requirement, amount invested and risk tolerance. Stocks, bonds, mutual funds, ETFs, options, futures, real estate, commodities – they’re all on the table (depending on the provider). Once the client is on board, the algorithm takes over the decision-making process.
It all sounds so scientific, and science is what we’re told we want. Let the computers allocate the investment portfolio and make all the subsequent buy-sell decisions. Pesky human emotions are removed from the equation. No more selling at the bottom and buying at the top.
Unfortunately, it’s quite less HAL-ish than that. I refer to the sentient, thinking computer HAL 9000 in Arthur C. Clarke’s “2001: A Space Odyssey.” Behind every robo-adviser is a very real human actor. After all, someone has to perform the research that supports the algorithms, and only humans can do that. No HALs have yet been produced.
That said, degrees of sophistication exist. Robo-advisers run from the straightforward to the complex. Some, such as AssetBuilder, construct portfolios using mutual funds cobbled together based on established modern portfolio theory. Others, such as WealthFront, employ a host of PhD.-credentialed quantitative scientist and market researchers.
Is one approach better than the other?
I can’t say. The robo-adviser concept is new and hasn’t been seriously stress tested. But don’t assume that smart complexity is necessarily better. (After all, mega-fortunes are often products of the simplest insights few seem to grasp.)
No investment firm was better endowed with mental horsepower than Long-Term Investment Capital in the 1990s. Using the most sophisticated quantitative models and a lot of leverage, LTIC sought to exploit arbitrage fixed-income opportunities, which it did with great success for the first four years of its existence. It all went bust in 1998, thanks to the Russian debt crisis, an outlier event that hadn’t been (and couldn’t have been) accounted for in the sophisticated algorithms.
Distribution is what really separates the robots from the humans. Investors who would go through a human to get portfolio management services can go through a robo-adviser for the same services.
Robo-advisers are particularly beneficial to unsophisticated, lesser-endowed investors. Betterment.com, an ETF-centered robo-adviser, will let you in for nothing. It demands no minimum deposit. Betterment.com fees range from 0.15% to 0.35% of assets under management. But you get what you pay for. Investment choices are limited to ETFs.
If you want more from your robo-adviser, you have to pay more. Rebalance IRA demands a $100,000 minimum initial deposit. It charges a $250 setup fee, plus 0.50% of assets under management. Investors are also on the hook for any trading fees. But the Rebalance IRA’s robo-adviser comes with a human assistant and wider array of investment choices.
The more things change, the more they remain the same. The bromide applies to robo-advisers. Because robo-advisers are backed by humans, nothing really changes in terms of investment strategy, risk control or financial theory. That is, nothing really changes except the marketing of the same old service.
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