Warning: The following contains adult situations and language and may not be suitable for those without The Right Stuff.
While the industry seems content to argue how many business models can dance on the head of a fiduciary, there is a demon that lives in the air. They say that whatever business models challenge this demon will die. Their pipelines will freeze up, their clients will be buffetted and their firms will disintegrate. The demon lives on the Internet, traveling 186,000 miles per second, where the electrons can no longer move out of the way. He lives behind an ether through which they say no man can ever pass. They call it … The Robo-Advisor.
Are robo-advisors the new target date funds? They both seem to have similar attributes. They are portrayed as easy, “one-stop” decisions. There’s an air of invincibility about them (thanks to the dispassionate grace of automation). And they’re hot! Hot! HOT!
Alas, the two products stand not as a testament to smart investing, but as a testament to smart marketing. Indeed, they offer validation to what Roger Ibbotson told me a couple weeks ago in an interview for FiduciaryNews.com: The industry has evolved from a focus on investing clients’ assets to a focus on selling clients’ products. In turn, much to the dismay of those who value the traditional investment advice business model, this progression threatens to commoditize the financial services industry.
Take heart, dear reader. I come not to bury the investment adviser, but to praise him (or her). For you see, I accidentally discovered the solution to the dilemma of the robo-advisor through a series of articles I wrote more than a month ago: Robo-advisors have an Achilles’ heel from which they are fated to succumb. It is as predictable as the movement of the hands on a clock. Nothing can change the inevitability of their demise. Indeed, the hidden gears that guide robo-advisors have, within them, a flaw so great, so fatal, that at least for those of us safely ensconced on the sidelines, it must ultimately lead to a new stream of entertaining “I-told-you-so” class action lawsuits.
The only way for purveyors of robo-advisors to avoid the realization of this legal liability is for human advisers to defeat them in the marketplace. That’s your job. (I am assuming only humans are reading this post.) It’s easy, but it might require you to suspend your disbelief in one of the most treasured myths of the modern investment advice era: asset allocation.
Now, before you stop reading, hear me out. Your continued livelihood might just depend on what I’m about to say.
A machine is nothing more than the sum of its parts. And the sum of a robo-advisor’s parts is a series of computer programs that spit out a recommended asset allocation. What are these formulae based on? And have they stood up to the scrutiny of scientific testing? If you are a human adviser the answers to these questions are obvious and heartening. The stochastic magic that produces these recommendations, now more than a half century old, has shown its age. It has suffered disrepute at the hands of behavioral finance researchers. And more importantly, when tested both on a short-term and a long-term basis, these asset allocation optimization models fail miserably.
To wit: In order to successfully defeat the robo-advisor in the marketplace, the human adviser must change the marketing paradigm. He (or she) must break the notion that investing is about products (the building blocks of asset allocation). He (or she) must prepare himself to go back to the fundamentals. This means returning to a time when providing investment advice meant focusing on goal-oriented targets. Assets can be allocated into specific goal-oriented targets, but not in the same formulaic way a robo-advisor does it. Indeed, broader investment strategies, customized for individual clients, never find success under a cookie-cutter regime. The provision of investment advice — at least before the ascendency of asset allocation model — required a type of intuitive approach only a human can master.
Until artificial intelligence programming advances to the levels of what today is science fiction, robo-advisors can offer nothing more than garbage out from the “garbage” in. They may be less expensive; but, then again, how many times have you heard that you get what you pay for?
Consider this interchange among America’s first astronauts (as captured in the 1983 film The Right Stuff):
Gus Grissom: You’ve got it all wrong … the issue here is monkey.
John Glenn: What?
Grissom: Us. We are the monkey.
Deke Slayton: What Gus is saying is that we’re missing the point. What Gus is saying is that we all heard the rumors that they want to send a monkey up first. Well, none of us wants to think that they’re gonna send a monkey up to do a man’s work. But what Gus is saying is that what they're trying to do to us is send a man up to do a monkey’s work. Us, a bunch of college-trained chimpanzees!
Grissom: F---in’ A, bubba.
Slayton: All right, so what Gus is saying is that we’ve got to change things around here. He’s saying that we are pilots. And we know more about what we need to fly this thing than anybody else. So what we have to do is to alter the experiment. And what that comes down to is who is gonna control this thing from here on out.
So, what are you? Monkey or Man? (And, like Neil Armstrong, I am referring to “man” as the species, not the sex, so that includes both men and women.) Are you robots or humans?
Now, channel your inner test pilot and take on those robo-advisors! Go out there and win one for the Grissom!
Author’s Note: If you’d like to better prepare yourself for this battle, you might want to read (or reread) the series of articles that caused me to experience this “Eureka!” moment. You can start with “7 Deadly Sins Every ERISA Fiduciary Must Avoid: The 5th Deadly Sin – Misapplied Asset Allocation.” From there you can access the rest of the series.
