Although robo-advisors can beat human financial advisors in certain ways, humans still outperform the machines in various skills.

A practical aspect

Opening a robo-advisor account is easy. Starting saving is smooth. But if you already have assets, it’s not always that smooth. While most robos will directly gain access and trade into your existing bank, savings and brokerage accounts, not all robo-advisors offer this service. Betterment, for instance, requires investors to transfer all their assets into Betterment’s integrated platform.

In other words, the investor needs to liquidate its holdings at his current custodians, transfer the cash, and let the robo-advisor re-invest the cash according to the program’s allocation.

Liquidating, transferring and re-investing isn’t harmless.

• There are trading costs (execution fees, market impact).
• There are delays, which translates into risks, as the investor may not benefit from a sudden market rise If he is not invested at that time.
• More importantly, there are tax considerations. Liquidating a tax-deferred account can generate penalties if the process is not completed according to the rules and guidelines.

Financial advisors would manage this for you without difficulty. By signing up with a robo-advisor, you sometimes take transfer costs and risks.

This shouldn’t prevent you from doing a transfer, but you should be careful with self-contained platforms.

The benefit of the human touch

There are many reasons for which a human contact is irreplaceable.

Robo asset management firms are technological firms. While some firms have reached a remarkable quality in communication, not all firm reaches the level of Betterment of Personal Capital’s dashboard. Anyway, humans still beat machines at explaining complex ideas and subtle nuances. Humans hold the communication advantage for complex issues.

Financial complexity increases with assets. A modest investor is well served with broad-based or target-date ETFs. The law actually prevents an advisor from suggesting investments which are beyond his/her understanding or financial strength. A financial advisor would commit a significant ‘suitability’ mistake if he was offering a hedge fund investment to a non-qualified investor.

As complexity rises, human experience becomes irreplaceable. A computer cannot assess the benefit/risk trade-offs of complex investments like forest land, farms or art. Besides understanding investments, understanding and serving your client’s interest also become challenging. Would you trust a computer to manage the transfer of your wealth to the next generation, or to decide and to execute your charity donations without human supervision?

People who have been burned when trading by themselves in the markets eventually ask a financial advisor to help them manage their assets. But they are not the easiest clients to guide, as they often resist advice. Financial advisors have more ‘bad traders’ than the average and have to make more efforts into explaining and implementing investment discipline.

We all know that wealthy individuals can take advantage of investment opportunities of higher complexity and value. The role of the advisor includes finding, verifying and suggesting such opportunities to his/her clients. Private equity, real estate, investment in under-developed countries all require experience for such analysis. Actually, many individuals will approach wealthy investors to suggest investments. The quality of those proposals is often dubious, at most, and the role of the financial advisor is often to identify and filter out a large proportion of inadequate ideas.

And sometimes, some investors simply prefer and trust their advisor.

Foresight, risks and crisis management

There are situations where a human is really valuable. As of writing this note, the markets recently crashed 30%. All asset classes were touched, to some very rare exceptions. When such a situation happens, calling for advice is the rational step to take. Your robo-advisor will not offer such a service, since it is entirely automated. Only a human at a traditional RIA will answer the phone and provide you with the reassurances or recommendations which match the situation.

Good financial advisors actually have enough experience and foresight to warn or to act against such market downturns. They also have invested enough to take ideas, confidence and exuberance with a pinch of salt. Every stock is a great trade, until it isn’t. Meanwhile, robo advisors will never answers to questions like:

• What could cause the next crisis?
• When could come the next crisis?
• What is your market exposure? Your true risk?
• What precautions should you take to protect your portfolio?
• Is the cost of this protection worth its benefits?

Robo-advisors are simply unable to correctly answer such complex questions. Their role is to invest money to maximize performance, not to foresee the future or prepare for it. Robo-advisors invest systematically, to optimize risk/profits according to modern portfolio theory and past data. They cannot foresee the future, and do not have the wisdom that experienced investors have.

Among the recommendations that financial advisors may offer and that a robo-advisor cannot offer, you will find also:

• Under investing to reduce exposure and have cash at hand
• Buying insurances like puts
• Select investments which tend to outperform in times of crisis or will handle an expected situation well. In its simplest form – buying gold can be an insurance against market crashes. Some fund managers are structurally designed to outperform in downturns – Taleb’s Black Swan fund.

Interestingly enough not all risk can be expressed mathematically. Standard deviation of returns, maximum drawdowns are metrics easily insertable into an optimizer. The fraud risk associated with the stellar performance of a Madoff or the operational risk associated with a derivatives fund like the SVXY are not well measured by simple metrics. As a reminder, the SVXY ETF, the New York Stock Exchange-listed VIX leveraged ETFs, lost 90% of its value on February 6^th, 2018. LJM, the institutional mutual fund lost 30% of its value on that same day. More recently, Malachite capital, an institutional $600 m fund investing in derivatives, was wiped out virtually overnight in the early days of March 2020.

It’s not that simple – not all products are possible

Some financial advisors do a great job with complicated situations. Here are some examples:

If you work in the oil & gas industry (say you are a drilling engineer), you are significantly exposed to the price of the oil barrel. Your employment will probably be gone if oil drops below the cost of extracting it. Your savings should therefore not be exposed to the main oil producers or retailers (Exxon, Chevron, ConocoPhillips…) or commodity prices in general. A robo-advisor will not be able to handle this fact, while a financial advisor can and will.

Generally speaking, robo-advisors cannot handle the originality and complexity of wealthier investors, while financial advisors can tailor a portfolio to the specificity of each of its investors.

Robos are providing good diversified portfolios, mostly made of ETFs and mutual funds. They are not able to handle a large swath of investment possible instruments :

• individual public (listed) equities,
• individual bonds (government, municipal, corporates, high yield or investment grade…),
• futures and options,
• structured products (in fixed income or in equities),
• life insurances,
• credit exposures,
• investments abroad,
• private equities,
• pink sheets (also called penny stocks),
• early investments (venture capital),
• real estate,
• alternative investments (hedge funds),
• bond private placements (Reg D),
• limited partnerships,
• master limited partnerships (MLPs are highly risky investments related to oil & gas prospection),
• …

Actually, some of these products cannot even be offered to most investors. Hedge fund shares, private placements, limited partnerships or private equities for instance are restricted to ‘qualified investors’ ( a ‘qualified investor’ is a professional of the financial industry, a financial institution or investment company or a director of such a firm, an individual with more than $2.1m of assets). And even if some of these instruments may legally be offered to a regular individual, they still may not be suitable for the individual. A retiree should not concentrate his savings in a few technological company (AMZN, GOOG, FB…) or a leveraged ETF (SVXY, XIV…), even if these shares are publicly traded on a large exchange. Robo-advisors avoid these suitability restrictions by offering only instruments which are acceptable to everybody (diversified ETFs and funds).

We have assumed in the paragraphs above that most of the products mentioned above were available for purchase in the United States. There are many assets, which are not available to US investors, even if they are as diversified as an ETF, like a European SICAV (the equivalent of a mutual fund) or a Luxembourg-listed index warrant. What can and cannot be offered to a US investor is regulated by the SEC (Securities Exchange Commission), which dictates which & how an instrument can be described, introduced and sold to US investors. The SEC eventually approves the instruments allowed for sale in the United States. That process is called the ‘SEC registration’. The SEC registration is never a recommendation for purchase, only a verification that the investment has passed the legal requirements.

Wealthy US individuals can purchase assets that are not registered with the SEC and cannot be distributed to US investors, provided that these individuals also meet appropriate qualification requirements.

Only a financial advisor can recommend such investments. Furthermore, there are other issues that have to betaken into account when assessing the suitability: riskiness, transparency, liquidity of the investments… Only  a human can and should recommend such instruments, as well as when to hold them or when to liquidate them. Even if you hold a stock (like AAPL), your advisor has to monitor the position and tell you when it becomes too risky for your investment profile.

It’s not that simple – not all vehicles are possible

In a similar fashion that robo-advisors cannot recommend all product to all investors, they cannot recommend all investment vehicles to all investors either.

Most robo-advisors will not handle funds domiciled outside of the United States. Even within the united states, robo-advisors may not serve all types of vehicles:

• Ally Invest does not manage 401(k), Coverdell, or 529 accounts(among others)
• Betterment and Wealthfront do not Simple IRAs accounts, on top of the above
• Ellevest and M1 Finance do not manage joint taxable accounts, on top of the above.
• Acorns only manages checking account and traditional IRAs.
• Almost all robo-advisors do not handle trust funds.

In a similar way that not all investment may be suitable or even possible for a given investor, some vehicles may not be possible legally, but not be suitable for investors either. A self-employed investor would probably be better served with a SEP (Simplified Employee Pension) IRA or a solo 401(k) rather than a regular 401(k).

When investment vehicles are domiciled outside of the United States, they are subjects to other laws, regulatory and tax regimes. They will have consequences on the individual himself. The mechanics and transfers of money or assets between such vehicles adds another layer of complexity.

As wealth and complexity increases, the investor may need bespoke investment funds. If your wealth is large enough, you may be paying more in management fees than the salary of your advisor, his support functions, the attorneys and the portfolio managers who directly manage the assets (through management fees) combined. In this case, you are better off hiring these individuals and having them work on your payrolls in your own specific investment company.

Such dedicated investment management vehicles are called ‘family offices’. Wealthy individuals sometimes pool their resources together to reduce the fixed and variable costs, into a structure called ‘multi-family offices’. The family and multi-family offices have seen a 10-fold growth over the last decade, now managing an estimated $4 trillion in wealth, or 6% of the asset management industry.

These structures offer additional benefits to the investors besides the cost reductions:

• More influence on the allocation and the investment strategies themselves,
• Consolidated analysis and reporting,
• Cyber security,
• Ethics,
• Transparency,
• Succession, which can become more than difficult at the second or third generation has lost contact and engagement with the original founders and activity,
• Talent selection, as well as ownership of the know-how and intellectual property,
• Confidentiality,
• …

Conclusion

While robo-advisors surely add value to some investors, they also fail to answer the need of many investors.

Financial planners will help their client save an average 29% by retirement age. Will robo-advisors match this indicated benchmark? Is the true alpha of financial advisors only financial, estate and college planning? Is their role that of managing the higher tranches of clients? Inter-generational wealth transitioning? Elder care? Charity giving? Tax and regulatory optimization?