The future of Robo Advisors and financial advice. [Part 3]

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Part 3: Goal Based Planning — Fiduciary “Smoke and Mirrors”

The hardest part of giving high quality and fiduciary investment advice is creating a way to map a client’s goals:

“what they want to achieve in their financial objectives”

combined with a deep understanding of their comprehensive financial situation today:

“what they have, i.e. savings, debt, investments”

and mapping this to an appropriate investment portfolio selection:

“how to get from where they are today, to where they want to be in the future”

To the extent that this sort of comprehensive advice is available today, it is only done by human advisors.

However, the quality of analysis done by human advisors runs the full spectrum from top quality to completely rudimentary or worse- there is very little quality control or transparency.

Old school software, which is what human advisors generally employ, works by identifying certain goals that individuals are trying to achieve in their investments- which seems like a good place to start, but much more information is needed to discern what is possible. A top quality human advisor will also combine this with other heuristic techniques, to find out:

a. Which questions to ask the individual client to really understand their situation?

b. What information does the advisor need beyond what is standard to evaluate their finances today and in the future?

c. How to tailor the overall plan to what the client uniquely needs

The challenge is that the communications with human advisors can sometimes be quite opaque. They may alternate between complicated sounding methodologies like “Monte Carlo simulations”- generally without adequate explanation, or over- simplify planning to basic but incomplete approaches like “Goal based Planning”. Clients need to have more transparency into the methods being used to generate advice.

Human advisors can also manipulate data inputs to their software that should be externally provided- like Inflation projections, or Tax rates, often with no standardization or control of these variables within a firm. This can skew results and diminish the validity of the recommendations.

The financial advising software used by humans is typically outdated and inadequate, in particular because it is unable to incorporate the interrelationships among the vast number of data points that describe any individual’s financial situation. In addition to a client’s spending and savings patterns, current assets and debt, there are the myriad economic and market variables relevant for the analysis. These shortcomings of the technological tools can sometimes be compensated for, to some extent, by a talented human advisor. However, human advisors are exceedingly expensive, and whether they are any good at supplementing the output of their computer models is highly dependent on the skill of the advisor and not easy for a new client to discern. Unfortunately, the reality is that you are likely to get 10 different answers from 10 different advisors regarding the best investment path for you, even If they are at the same firm. It is a very subjective process.

How do Robo advisors fare in providing financial advice? Ultimately, they are pushing the responsibility of planning back onto the user, with potentially disastrous effects. They may do any of the following:

a. Provides Goal Based Planning — which simplifies multi-dimensional planning to a single factor, and doesn’t capture the interconnectedness of financial decisions. Each goal, such as “buy a house”, “put your kids through college”, “retire”, etc., are all looked at and planned for independently in Goal Based Planning. The reality is that one goal deeply impacts the other- as any parent who is paying for their child’s college understands when thinking about buying a new house or considering retirement.

b. Disregards Savings — With Robo’s, advice on how best to save- whether through 401k, IRA, savings account, or direct market investments, must be determined by the user- the Robo doesn’t help with this. This is a very important decision- the first course of action for most people should not be investing in markets, but rather how best and how much to save- the statistics on inadequate nest eggs for most Americans are well known. Pushing people to invest leads to short term behavior and piecemeal decision making- and suboptimal financial results.

c. Provide an Army of Human Advisors on the phone– It is great to have a person available to answer your questions — but what if you don’t know what to ask? Who will provide the questions? Will the advisor accurately translate all the information you have? Who will monitor and review? When you call again will the same advisor answer your call? What business hours do they keep- your financial life evolves 24/7- are they available when you need them? Will you get a comprehensive financial plan- and will it be updated as your financial situation evolves? Is there a clear linkage between your plans and your investments? Are you taking too much risk, or too little to make your plans happen?

d. Provide discrete updates- A Robo advisor- with or without human advisor supplements, only update their analysis, and their advice, at discrete moments in time. But the many, many variables that describe an individual’s financial life — as well as markets, economic variables, and spending, encompassing millions of data points over a lifetime -are all changing dynamically. If the advisor, human or Robo, are unable to update and dynamically adjust the plan for relevant changes in these variables- and their interrelationships- the plan will be obsolete moments after it is delivered.

Goal Based Planning and humans at the end of a phone line are the ways in which Robos have attempted to convince clients and regulators that they are fiduciary. It takes far more to really understand a client’s financial situation and to look out for their best interest. Optics that look fiduciary are not the same as being fiduciary. Beware smoke and mirrors.

Jay Gopalakrishnan