So, you’ve met the perfect robo-adviser and it’s everything that your human financial adviser isn’t. On call 24/7? Check. Available on any device or computer? Check. Totally into you? Check, check and check … or so it seems from all the promises made on the home page.
But before you go jumping into a relationship with that robo-adviser, think twice and do something more. It may only want the financial advice equivalent of a one-night stand.
Look inside its heart
Robo-advice is simply an automated financial advice process, most commonly leading to a recommended investment. Instead of a person asking questions, you respond on a computer. Then the computer reviews your answers and makes a recommendation, rather than a person making a judgement about your situation.
This can be good or bad. When it’s good, it makes advice available to a lot more people who might have missed out on seeing a human. But when it’s bad, these people can end up receiving advice that might not be suitable for them, and then the relationship does not last.
To find out if a robo is good or bad, find out what makes it tick.
Will it ‘ghost’ you?
Online dating has introduced the concept of ‘ghosting’, where someone in a relationship simply vanishes. A partner suddenly cuts communication with the person they have been seeing, and the person realises the partner has lost interest.
Many robos are ghosts-in-waiting.
Investors became excited about robo-advisers ‘doing an Uber’ on financial advice, so a lot of Silicon Valley types pour money into developing ‘entrepreneurial’ robo platforms. But many have already vanished and many others soon will because they could not attract enough investment to make any money. Betterment, based in the US, is the world’s most successful entrepreneurial robo but it has never made a profit and relies on raising new equity to survive.
Robo offerings from well-known banks, super fund and financial institutions are different. Their job is not to go out and win new money. It is to advise the existing customers more quickly, cheaply and consistently than a human (or many humans) could do. They are far more likely to be there for you tomorrow.
Is it really a ‘keeper’?
Even among financial institutions not every robo is a ‘keeper’. Robos are only as good as the computer programmes that drive them, called ‘algorithms’. These sound super-smart, but are not. An algorithm is simply a formulaic way of responding to an input, like:
- It is cloudy, I will take my umbrella
- It is sunny, I will not take my umbrella
However, what if it is cloudy, but we will be parking underground? What if then we decide to briefly walk outside to go to a restaurant? Should we still take an umbrella? What if it’s sunny when we get when we are going – where do we put the umbrella then?
Financial planning questions tend to be like that. Things can quickly become complicated. Robos are evolving and some are beginning to contemplate those highly complex issues, like aged care and estate planning. But writing complex algorithms to take account of many different variables is mind-numbingly hard and expensive, so most people don’t do it.
Instead, they’ve given most robos limited abilities and scope. Mostly, they are confined to recommending an investment from a range of ‘off-the-shelf’ options which is matched to you through your answers to online questions.
Investing is a big, risky deal. To make investment recommendations, the robo must be asking a LOT of questions – right? Unfortunately – wrong. Some barely want to know anything before urging you to invest with them.
It’s all about you (or should be)
In the United States, ‘Target date funds’ only want to know one thing about you: your birthdate. The fund then allocates your assets and automatically converts equities into cash as you age. Personal circumstances, tax considerations and other investments simply don’t come into the mix. There is no ‘right’ number of questions to look for, but one question is probably not enough.
Ideally, before making an investment recommendation, a robo-adviser should ask you questions about at least three things:
1. Risk tolerance: At the bare minimum it should determine your risk tolerance – that is, the amount of investment risk you will feel comfortable with should markets fluctuate.
2. Risk capacity: Ideally, it would then inquire about your risk capacity – that is, if this investment went badly, could you still achieve your goals?
3. Risk required: A good robo will also talk about ‘risk required’ – that is, how much risk you need to take on to reach your goal given your starting point.
But there is a trade-off. Some people get bored answering questions, so many robos have quite deliberately kept their questioning brief, although this makes their recommendation less precise.
‘Swipe left’ on the losers
Robo-advisers must meet the same regulatory and ethical requirements that human advisers are required to meet. Don’t put up with automated advice that is self-centred or uninterested in finding out about you. Like a judgement on Tinder, swipe them left out of your life.
Paul Resnik is Co-Founder and Director of Finametrica, a risk profiling system that guides ‘best-fit’ investment decisions.