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In these days of ‘robo-advisors,’ a person is still a superior machine

by Joseph Arroyo | Contributor
Jan 7, 2022

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We live in a digital world, and we’re getting more digital by the day. It’s no surprise, then, that technology has crept into the world of investing. The concept of robo-advisors – artificially intelligent financial tools – promises to save you money and help you achieve your investment goals. These may in fact be useful tools for beginning savers. However, as your nest egg grows in size alongside the complexities of your financial plan, a human may offer you a better chance at success.

What are robo-advisors?

Robo-advisors are a fairly new invention, having come on the scene in the 2000s. They have really taken off in popularity since the widespread adoption of smartphones, which came into the mainstream in the 2010s, and the advent of artificially intelligence.

As the name implies, these services are “advisors” that aren’t human. They are an attempt to replace, or at least offer an alternative to, human financial professionals. These automated investment services came about in response to the somewhat speckled history of the investment and financial services industry.

Historically, investment advising was predominantly geared toward the affluent. Fees were high, and access was restricted. Commissions were fixed and astoundingly high compared to today’s rates. Beyond this, people generally needed to have high balances in order to even open accounts with financial services companies and advisors. Annual, maintenance and sales charges were high, too. In short, there were a ton of fees eating into people’s nest eggs. Often, investment returns lagged behind the market just because of high fees.

Robo-advisors look to avoid these negatives and allow more people of all income and asset levels to benefit from investment advising. In short, robo-advisors attempt to offer a better service for more people.

How do robo-advisors work?

Robo-advisors are designed with the goal of replacing the services of a human. Not only are they designed to be more affordable to people, in some ways they hope to be “smarter” than humans, too. These automated investing tools work by establishing a profile for you. Your profile will be based on your answers to a variety of questions, like:

  • Your current age
  • Your income level
  • Your risk tolerance
  • Your savings and investment goals
  • Your current asset balances

These are the kinds of questions that a flesh-and-blood financial professional would ask you. The basic idea is to determine a baseline of your current circumstances. You also have certain goals and risk tolerances. The robo-advisor then calculates a savings and investment plan based on your savings and risk profile.

Robo-advisors also monitor your investment performance, market performance and the number of years you have until retirement age. A robo-advisor will make changes to your investments in response to changes in market performance and personal circumstances. For instance, as you age robo-advisors would reduce your exposure to the stock market in favor of “safer” investments. A key feature of robo-advisors is that these changes and updates can be made automatically based on mathematical algorithms.

This is the basic idea behind robo-advisors. However, robo-advisors have branched out beyond simply managing your market-based investments. Robo-advisors are also available to help you determine how much and which kinds of insurance you should carry.

The overriding goal and method here is that robo-advisors aim to use automation, data analytics and algorithms to meet or exceed the performance of humans. And, they aim to do it for lower fees.

What are the cons of robo-advisors?

Robo-advisors may well fill a useful role for some people. Their main fault, though, lies in the fact that they aren’t human. Essentially, robo-advisors do what their programs tell them to, regardless of other relevant circumstances. They lack “emotional intelligence.” In other words, robo-advisors are unable to understand and process nuance.

For one example, a robo-advisor utilizing a value investing strategy might recognize high price to earnings (PE) ratios and rebalance your portfolio to reduce your exposure to the stock market. However, a human might recognize that due to the ongoing coronavirus pandemic, the Federal Reserve and state, local and federal governments have been pursuing policies of monetary stimulus. These policies drive money into the stock market. This incoming flood of money is likely to push PE ratios higher for the foreseeable future. Given these circumstances, it might be unwise to reduce stock market exposure.

A picture of six robots standing in front of a stack of coins.

Or, maybe it’s still the right call to reduce stock market exposure. The problem is that a robo-advisor doesn’t necessarily look at circumstances from multiple viewpoints. When certain conditions are met, the robo-advisor performs pre-determined moves. This kind of premeditated buying and selling helped make the 1987 stock market crash worse than it otherwise would have been. Automated portfolio instructions caused more and more institutional investors to sell, which pushed prices down. Rapidly falling prices caused more automated selling. And so on, and on. The bottom line here is that “automated” isn’t always “smarter.”

One other example of robo-advisors not having emotional intelligence would be in moving you to “safer” investments like bonds as you get closer to retirement age. Now, this is usually a sound strategy, but due to the historic intervention by the Federal Reserve, interest rates have been very low. While this is the “right” strategy based solely on your age and past market performance, it could be a terrible idea because you’d be locking in very low rates that will not pay you a livable income. There are other products that are better able to generate income in retirement, but these insurance-based products are much better used with a real-life financial professional (we’ll cover these income-generating assets in a little bit).

Robo-advisors also don’t understand the “why” of savings. You’re saving for a purpose: You want to live a particular lifestyle in retirement. The robo-advisor only sees numbers and math equations. It doesn’t see the quality time you envision while traveling or visiting family. Its decisions are heartless and unresponsive to the human element.

When to consider a human financial professional

There are some situations where a robo-advisor may be a good choice. This is especially true for people who are only just starting to save. Their needs are less complex, and the savings in fees and time (due to automations) may add up over decades of saving.

On the other hand, consider sticking with, or switching to, a human anytime your needs go beyond “basic.” Another way to think of this is to look for a financial professional when your needs are no longer one-dimensional (saving more) but have become multi-dimensional (generating income in retirement, structuring an estate plan to pass on the family business to your heirs and funding asset based long-term care insurance, for instance).

In some cases, these example goals might require different approaches to planning and saving. This could require differing investments or ownership structures. For instance, you may want your family trust to hold certain assets or portfolios. Based on your estate planning, you need accounts and beneficiary forms filled out with precision. Mistakes in these areas can undo a sound retirement or estate plan. A robo-advisor is not equipped to handle nuance like this. However, a person not only understands this, they also will have experience helping people execute complex strategies.

Another time to make sure you have a person is when you’re nearing retirement age – within five or even 10 years. In these cases, the human touch will come in handy. For instance, a person may be more familiar with your true risk tolerance (people are famous for thinking they’re more risk tolerant than they truly are) than a robo-advisor. A person who knows that you really don’t tolerate losses, or knows that you’re thinking of retiring a little earlier than planned, will reduce your market exposure earlier than a robo-advisor. This is simply because you have a conversation, and form a relationship, with a human in a way that you don’t with an algorithm.

A third reason to use a human is when you need more sophisticated investment assets. A robo-advisor may be great when you need a low-cost index fund to accumulate assets in. However, when converting those accumulated asset into monthly income, or protecting your heirs with insurance, a human is a better option. As you craft your retirement plan and especially as you add estate planning goals, you may need to use some or all of these tools:

  • Fixed annuities
  • Permanent and/or indexed life insurance
  • Trusts

These products all come with fees, costs and other intricate options. For example, index annuities and life insurance policies allow you to earn higher rates of interest based on choosing various investment indexes. However, many policies impose what are called “participation rates” and “rate caps.” These policy features have the effect of limiting how much you can earn in these policies. However, some reputable carriers are known to have more favorable participation rates and rate caps. A human financial professional knows which carriers and products will work best for you. This is especially true when it comes to insurance products because the entire insurance industry is based on the concept of agency – where the company relies on individual agents or brokers to work with individuals to find the right product fit. There is no “stock market” for annuities and life insurance where you can instantly get a price – each product is unique.

Another key feature of these insurance-based assets is their promise of protected income for life. With annuities, you can convert your account balance to a stream of income payments. The best part of this is that when you do that, the insurance company assumes the market risk. Their payments to you will continue for as long as you live, no matter how the stock market or the economy perform. Structuring these income streams takes wisdom and is another way in which a human is superior to a robo-advisor.

Fees are important, too, with these products. They all tend to have surrender charges that decrease over a period of time – generally 10 years. If you withdraw funds before this time, you’ll forfeit a part of your investment. For one thing, you want to try to minimize the fees or charges that you pay. So a financial professional can be a great help to you there. More importantly, though, you must completely understand the plan behind using these insurance products. You have to be committed to it for the long term. On the other hand, a human will be meeting with you face to face or over the phone. They’ll be able to make sure you understand the long-term nature of these products. They’ll help you stay the course and reap the benefits of indexed products with guaranteed income for life.

A multi-faceted plan is crucial

We’ve all heard the saying, “Failing to plan is planning to fail.” This saying is definitely true when it comes to retirement income planning. Planning for and executing a sound plan for the short- and long-term future is no accident. It takes strategic and tactical thinking. And, it’s deadly important. You don’t want to have to work all of your life, and in all likelihood, you won’t be able to in any case. Besides, you don’t want to just survive; you want to thrive during retirement.

A sound plan will take into account not just your plans for retirement, but also your desires for passing on part of your wealth to your heirs. How you build, grow and protect your assets over time will change. A person can help you though all stages of asset accumulation. The personal touch afforded by a live human being can make all the difference between sticking with your plan and going off the rails, so to speak. Working with a human financial professional can help you make your retirement and estate plans a success.

Alliance America can help

Alliance America is an insurance and financial services company dedicated to the art of personal financial planning. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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