In a previous article, we opined that the truth behind robo advisors is that they simply take the same private wealth management tools that a human financial advisor would always use and then automate them, simplify them, and externalize them. We tried to prove this by comparing robo advisor Betterment with Motif Investing and pointed out that in fact you can accomplish the same thing as a robo advisor with tools that exists on the marketplace today. This begs the question, why do we need a human financial advisor in the first place? Let’s play with that thought a bit.
People love to talk about “banking” and “big banks” and “bankers” and yet few people understand all the components that make up a traditional investment bank. Each division in a bank attracts a certain type of individual who will excel in that domain. Sales and Trading usually attracts alpha males, the big swinging dicks (BSDs) of the world, as it was once coined in the legendary book “Liar’s Poker”.
Mergers and acquisitions (M&A) attracts those who are good at building financial models of a company’s cash flows, and are good at hypothesizing and attempting to prove possible synergies for an acquisition. And private wealth management (PWM) attracts those individuals who are “good with people”. Usually roles that call for “being good with people” equate to roles where “not a lot of technical skills are required”. Oh sure, as a financial advisor you need to pick up the Wall Street Journal every day so you can address what’s on your clients’ minds but do you really need to know that much about wealth management or are you simply just going to follow the predefined scripts that were given to you the first day on the job? Maybe it will help to examine this from the other side.
Let’s take a gentleman called David who works in financial services as a successful C-level executive. He has a great deal of money tied up in executive compensation (i.e. company shares and options) so he’s looking to diversify his wealth. His colleague recommended that he try out a private wealth management firm called Golden Slacks. He has his secretary setup an appointment and he arrives in the lobby of Golden Slacks Private Wealth Management:
The first thing you have to be thinking if you’re David is “just who the hell picked those colors”. The second thing you have to be thinking is “who the hell paid for this extravagant décor”? David is then led to an office by an overly attractive female who then introduces David to an even more attractive financial advisor named Alastair who just exudes charm and confidence. Small talk is exchanged and they get on to talking about David’s “risk profile”. A series of questions are asked (informally, of course) and when David leaves, Alastair plugs in all the answers into an internal system which acts as a robo-advisor for Alastair. The question you have to be asking is, why do we need Alastair as a middle man? The answer is, we don’t. All of this could take place online without the need for a posh office or a posh bloke named Alistair. So why isn’t it?
Most people who have a personal net worth in excess of say, $10 million, are not that comfortable at all with just moving their money around and making investments with it. They need to be reassured. They need to see that the place they are investing their money with is real. They need to be assured by seeing Alistair’s sophistication, his Rolex, his Ferragamo tie:
Never mind the fact that Alistair took the subway into work because he’s just getting his feet on the ground while David drove up to the meeting in a Rolls Royce. Somehow this is all backwards. Shouldn’t the people who are successful be the ones giving advice? If Alistair really knew how to generate alpha so predictably, would he even need to have that private wealth management job? Shouldn’t he be the one driving the Rolls Royce?
We’re now embarking upon a new era of financial technology innovation that has brought with it all kinds of tools, like the ability to create your own ETFs with Motif Investing, or the ability to use the same sort of tools that private wealth managers use. At what point will we no longer need the middle man financial advisor to exchange pleasantries with and to provide us with reassurance, someone who gives us a shoulder to cry on when the markets are tanking? A robo advisory firm like Betterment charges ridiculously low rates and they are also smart enough to only use the lowest fee ETFs in the industry to avoid getting “taxed twice”:
Right now the “big banks” are scooping up robo advisors in an attempt to combat the externalization of their secret tools. People now know about “the man behind the curtain”. We’re now seeing companies getting funded like AdvisorEngine which is a robo advisor for investment advisors. At some point can we just get rid of the whole “human advisor” thing because it’s already been proven that 80% of active managers can’t beat their benchmarks? Although it may make my heart flutter a bit, I don’t need Alistair to hold my hand while a “robot” makes decisions for me.
A few days ago, Bloomberg ran a piece titled “Cheer Up, America: 1,700 Millionaires Are Minted Every Day” and perhaps what was most interesting about that article was seeing just how many people are in the $1M to $5M bracket:
If you’re in that $1M to $5M bracket, don’t go subsidize Alastair’s lifestyle. If you have even the slightest bit of interest in doing it yourself, there are enough tools available today for you to do this. If not, spread it around with a few different robo advisors to avoid systemic risk and you’re all set. Here’s a look at the savings you can expect to realize when you use a robo advisor firm like Betterment vs. a typical private wealth management firm:
You can be pretty much guaranteed that the fees you’ll pay a robo advisor will be less than what you’ll pay a financial advisor and his firm for an hour of face time every few months. And remember that you’re paying those fees no matter what happens in the market. That’s why Alistair’s decisions are pretty much scripted and all that money you’re handing over is going into Golden Slacks investment products which you’re going to be paying fees on as well. That’s why no matter how bad the market is, Golden Slacks is always going to be enjoying that lobby.