Only when the tide goes out do you discover who’s been swimming naked.
This weekend I saw yet another story on the predicted end of the human investment advisors and the takeover of the robo-advisors. Whenever I see such stories, I just shake my head. I guess that as an attorney and someone who has been in the investment advisory business arena since 1995, I just see a different picture than a lot of other people.
Yes, robo-advisors can offer beneficial economies of scale in the provision of personal investment advice, but the quality of the services provided by robo-advisors has yet to be really tested by a significant downturn in the stock market. And there are many who believe that when “the tide does go out,” and the market does experience a significant downturn, a number of suspected issues involving robo-advisors will be exposed, resulting in a wave of litigation.
People who know me know that I like to tell the story about the computerized asset allocation proposal that was prepared for a recently widowed wife. Her husband had carefully created an investment portfolio that provided significant income through interest and dividend payments, more than enough for them to live comfortably for the rest of their lives.
An investment advisor asked her to fill out a risk tolerance questionnaire so that he could prepare a financial plan for her, including an asset allocation proposal. One of the questions on the risk tolerance questionnaire asked her if she had any needs for income. Naturally, she answered “no,” as her current investment portfolio provided more than a sufficient amount of income.
However, the computer program did not, and could not, realize that her answer was based on the income produced by her portfolio. As a result, the asset allocation software program recommended a re-allocation that was totally unsuitable, replacing most of the income-oriented investments with equity-based products, some of which were grossly unsuitable.
Worse yet, the advisor actually presented the proposal to the widow. Fortunately, she did not implement the proposed re-allocation, as she sought the advice of her counsel and her children before making any changes in her portfolio.
As we all know, any computer based financial planning/investment program is subject the to the familiar “garbage in/garbage out” trap. In the case of the widow, her answer was totally accurate, but the inherent limitations of any computer program needed to be recognized and addressed.
I have read that at least one of the major robo-advisor firms has now partnered with an investment advisory firm to add the human element to their services, apparently in recognition of the potential legal issues that may result from a totally computer-based program.
I still am unclear on exactly what services the human advisors provide in this new program, but hopefully it will include the ability to reduce potential legal liability by offering proactive wealth management services beyond the simple re-balancing services which most robo-advisors offer. Re-balancing alone simply does not provide the downside protection contemplated and endorsed by the Prudent Investor Rule, as set out in Section 90 the Restatement (Third) of Trusts.
Asset allocation decisions are a fundamental aspect of an investment strategy and a starting point in formulating a plan of diversification….These decisions are subject to adjustment from time to time as changes occur in economic conditions or expectations or in the needs or the investment objectives of the trust.
I believe that while some litigation will be based on basic unsuitability claims based on the investments within some investment portfolios, the major litigation claims will be based on the positions set forth in the Restatement, including the Prudent Investor Rule. I always advise new clients to take a weekend and visit a local law school library and read the entire volume on the Prudent Investor Rule, as the courts and the regulators routinely rely on the Restatement in deciding investment and fiduciary related cases.
Another reason that I believe that the human element will always be needed in the financial planning and investment advisory businesses is that clients will always need additional wealth management services that can only properly be provided by human advisors. For instance, recent studies are consistently showing that high net worth clients are inquiring more about asset protection and wealth preservation strategies.
In the legal community, this concept of “integrated estate planning” is growing, especially since the new higher estate tax exemptions and the new portability laws are reducing the need for many of the more traditional estate planning techniques. Integrated estate planning actually offers a good opportunity for investment advisors to form new collaborative relationships with attorneys.
Investment advisors can obviously seize on this concept of collateral services by developing other services that the public often seeks , such as college tuition planning, divorce planning, and retirement income/retirement distribution planning. In most cases there are programs, in most cases conferring designations. to help an advisor acquire the knowledge necessary to properly provide such services.
Just as Mark Twain noted that reports of his death had been greatly exaggerated, I believe that there will always be a need for the human element in the investment advisory and financial planning businesses.