Technology has made everything better, faster, and cheaper over the years, and investing is no exception. Indeed, many robo-advisory firms have launched in the last five years touting the benefits of algorithmic investing rather than human selection. But in a world where convenience sometimes seems to trump involvement, can we really rely on the marvels of our modern age to their fullest. Driverless cars may soon be ready for prime time, but are we ready for humanless portfolios?
Artificial intelligence based on historical pattern recognition is already pervasive throughout our society. Take Waze or Google Maps; most of the time we need only type three or four letters and the system knows exactly where we want to go. Likewise, computers are great at processing rules-based algorithms. But there are still some things that require the kind of vision, sensibility, and insight that only a human being can offer.
For example, during the Flash Crash of May 6, 2010, at 2:32pm the stock markets without warning tumbled nearly 1000 points or 9%. The whole debacle lasted 36 minutes as the stock market dropped and then quickly rebounded. Program Traders that had automatic stop loss orders lost millions as the selling triggered computer programs to initiate even more selling. The computer programs were simply acting out the instructions set out by their algorithms, namely: “In a significant down market, take losses and sell no matter what”.
The programs were not wise enough to evaluate the different possibilities for the market drop including the possibility of a malfunction in the system. Like good soldiers, these programs carried out their duties exactly as described. There was no chance of the ‘programs’ veering off the path or taking pause for reflection.
This is where human wisdom outperforms even the most sophisticated artificial intelligence. Not only are humans flexible by nature but our gut instinct gives us an uncanny ability to evaluate all forms of information including the absence of information.
Ever seen a magician pull off the ‘disappearing in the box’ trick or ‘catch a bullet in the mouth’. Although the trick has every bit the appearance of realism and even though we cannot explain how the trick is done, we know that we are victims of an illusion. The magician is toying with us. The ‘how’ is not known but for certain the magician did not vanish nor take a live bullet in the mouth.
Human insight and innovation pick up where automated rules-based tools leave off. We humans still do a better job of picking out the friends, mates, and careers that will give us a fulfilling future than a computer can. A GPS device can help us work our way through a maze of hiking trails, but it can’t necessarily plan the sights we want to enjoy along the way.
The situation of every client is unique and dynamic. An experienced advisor is able to leverage an individual connection into a personalized recommendation that transcends a simple algorithm that looks straight ahead, even as your life and career follow many winding turns.
In contrast, pure robo advisors generally rely on a 10-point questionnaire to summarize their client’s situation. For millennials at the beginning of their wealth accumulation years, the lack of a human element in the investment decision-making process is acceptable. Accounts are small, usually in the tens of thousands. In a small portfolio, higher fees from an active human advisor are likely to neutralize any benefit.
But once these same millenials have accumulated a little more wealth, they will need to direct it toward varied and specific goals – like buying a home or business, putting the kids through college, retirement, estate planning, and a multitude of other wealth management issues that will add value, security, and ease to their lives.
These things require wise and evolving asset allocation, tax efficiency planning, and some quick turns to keep up with the surprises of life… like babies, new jobs, new careers, and unexpected moves or expenses. Unless your robo-algorithm follows you on Facebook, it is unlikely to be able to respond properly to the dynamism, uncertainty, and robustness of your life.
Clients that are likely to benefit most from a robo-human hybrid approach are professionals, corporate executives, and budding entrepreneurs. These investors are likely to embrace the technological aspect of a robo-advisor, while their professional status calls for an investment expert to guide their asset allocation, tax planning, and so forth. The more wealth, the more opportunities for cracks to form and seepage to occur.
Remember Robocop? The 100% robotic cop had no human sense or instincts – only robotic hardware and algorithms. But the cybernetic-human robot with a real human mind had all the strength and technology of the robot plus a real human intellect to guide it. That worked out a lot better. A cybernetic organism (or “cyborg”) offers the best of both worlds.
Your short-term losses now may help your robo-firm to tweak their algorithm to make it better next time, but your friendly advisor already has the experience to see some market events and personal events coming. Other times, a good advisor will know what risk measures should be in place to help deal with possible unforeseen events or unknown outcomes.
Brexit is an excellent example of an outcome that was difficult to predict and actually proved the pollsters wrong. Layering on some hedges via put protection to temporarily protect the portfolio was not only prudent a week before the vote but made a lot of financial sense as well. Knowing how far out to hedge, the strike price of the puts, and ultimately when to pull the hedges is a decision much more complicated than several ‘if-then’ code line items.
Likewise, it is beneficial to have an advisor who knows the various members of your family who are being affected by the wealth management decisions being made. That knowledge is incredibly important, and may make the decisive difference in formulating a plan. Or the advisor may have had firsthand experience in helping other clients through similar life/investment events-and gleaned hard-won knowledge that he or she is happy to pass along.
Life is complicated. Technology can help us get the best results from the decisions we make, but it will never be able to make those decisions for us. Can a robo-advisor give thoughtful advice on the well-planned transfer of wealth to the next generation? Or on the tax efficiency of the sale of a business? Can a smartphone with a fancy app offer the best customized human options to an entrepreneur or corporate executive on how expansion will affect her cash flow over the next year? Uh… No.
Winning coaches need a Peyton Manning, and successful executives and entrepreneurs want that star financial quarterback with the savvy, experience, and instincts to handle their investment affairs too. When a robo-coach is good enough on its own to lead the Chicago Cubs to a World Series or the Toronto Maple Leafs to a Stanley Cup, we can start the de-crescendo of our reliance on human advisors. But until then, it helps to have a star financial quarterback to integrate technology to its fullest and to deal with ever changing situations.