Rise of the Robo Advisors

Historically, savers have had two options for their investment strategy. Savvy investors with a knack for numbers can pick and choose their own investments while those who lack the time or will to manage their finances can delegate the responsibility to professional financial advisors.

Now it seems there’s a third option. Advances in artificial intelligence technology have allowed some developers to create computer software that can automate many of the more mundane aspects of personal financial management. So-called “robo advisors” are based on algorithms that can determine a person’s risk tolerance, risk-bearing capacity, and time horizon. The robo advisor can then allocate capital to different asset classes, periodically rebalance the portfolio, and even harvest tax-losses without human intervention (NERDWALLET, Jan. 25, 2019).  

Robo advisors offer a number of advantages. For one, they’re tightly bound by the parameters and rules baked into their algorithm, which can help infuse discipline into a long-term financial plan. By automating many of the routine tasks of a traditional financial advisor, the technology can help eliminate inefficiencies in the asset management process and substantially reduce the costs of these services.

The promise of better financial management at lower costs is so alluring that a number of multinational asset management companies, including Charles Schwab and Vanguard, have launched their own robo advisory services (Steve Garmhausen, Barron’s, Dec 4th, 2018).

The market for AI-powered advisory services is growing so rapidly that experts estimate that these robo advisors could be managing assets worth over $16 trillion by 2025 (Barbara Friedberg, US News, June 27, 2018). Vanguard’s robo advisor already has over $101 billion in assets under management.

However, these sophisticated algorithms haven’t made human advisors redundant just yet. Robo advisors offer a cookie-cutter solution for investors with simple portfolios and straightforward financial goals. AI-based tools can’t help investors with their tax planning, compliance issues, estate planning, or alternative investments. Since these software solutions are intended for mass commercial use, customisation or personalisation isn’t really an option.

Another weakness of these robo advisory platforms is their lack of soft skills. Algorithms can’t explain complex financial concepts to the average saver. The software package can’t express empathy with a user anxious about losing their job, debate the government’s tax policies, or assist a veteran entrepreneur with succession at her family business. The personal and intangible aspects of the advisory relationship may never be automated away.

With this in mind, a combined service may be the best solution for most investors. Combining the experience and soft skills of a professional human advisor with the precision and efficiency of robo advisory services could help more people achieve their long-term financial ambitions faster.      

The value of investments and income from them may go down as well as up and you may not get back the original amount invested.