The advancement of technology and emergence of robo-advisors have ignited discussion about the future of human financial advisors. Advisors are divided: some see robo-advisors as a threat to their livelihood, while others welcome the technology with open arms. The wide range of views can be attributed to the broad definition of financial advice.
Financial advice and advisors are traditionally associated with investing and investment advice. While investing is a key component in personal financial planning, financial advice is so much more than investment selection and implementation. And those advisors (and consumers) who place greater value on the other aspects of financial advice may be the ones who embrace this new technology the most.
Even when refuting the notion that robo-advisors can or will replace human advisors, many of the arguments are still centered around the value a human can bring to investment advice. But looking past the investment advice may be a better way to distinguish the roles of human and robo-advisors.
Investing decisions are the result of a culmination of mostly non-investing activities. For example: advice about income and spending, prioritizing and funding non-retirement goals, consumerism, debt management, identifying and managing risks, and making financial decisions.
Just like a mountain, most of the substance of personal finance exists below the peak.
Most of the value generated by financial advice relates to the activities leading to the investment advice rather than actual investment advice. The key tenets of investing (diversification, asset allocation, low expenses) are not secret. Advisors can still add value to those tenants, provide education, and help keep clients from making mistakes driven by fear or greed. Avoiding mistakes can be an enormous value-adding function of advice, but the critical effects that stem from mistakes extend well beyond buying or selling securities.
Before advising a client on asset allocation, investment selection, or account location, an advisor needs to know how much should be invested. Before that can be determined, advisors have to know how much can be committed to long-term investments. In other words how much is available after accounting for all the other needs that don’t involve investing in securities. Those needs must be carefully evaluated so as to not interfere with or invalidate the investment planning decisions being made.
Financial to-dos such as evaluating how much cash is needed for living expenses and financial emergencies, paying down debt, planning the initial purchase of non-investment assets, maintaining or replacing non-investment assets, or funding near-term goals are not easy or intuitive tasks. But these to-dos all part of the balanced equation that includes investing for retirement. And each part of the equation competes for a resource that is limited. Therefore, mistakes can be costly.
Even if a client accurately estimates their ability to save, it will become problematic if the portion intended for and being applied to retirement is overestimated because other savings needs were underestimated.
Each time retirement savings is interrupted because a client had to put a new roof on their home, buy a new car, or some other occasional lifestyle related expense rolls around, their entire financial picture is affected. And if they have to borrowing now to pay for those expenses, that just leads to lower savings later. New advice can be generated in reaction to this new information, but what about the root cause: counting assets saved for things other than retirement as retirement assets?
Let’s go back to the core variables that go into financial planning:
- Investment assets (starting balance)
- Amounts saved for retirement (additions)
- Retirement age (when additions stop)
- Amounts spent in retirement (net distributions)
- Longevity (when the distributions stop)
- Investment asset allocation (rate of growth)
Some of these variables are within a client’s control and some are not. And outside factors such a cash flow and taxes impact them with varying degrees of control.
While robo-advisors can recommend and implement investment portfolios based on these variables and even solve for some of them given the rest, if the provided variables are wrong, the advice will be wrong. That means the variables themselves pose a significant amount of value.
The value may not be in the more sexy investment-related variables, which the client may also exercise with the least amount of control. Longevity and retirement age may be a close second and third, respectively. Even with uncertainty of future income, clients have much more control over spending and saving. Spending plans can bring much needed clarity to the available investment balance to which all of these other variables will be applied.
There is significant value in advice that minimizes over-planning and under-planning in the many non-investment related decisions clients make. Why? Because over-planning or under-planning cash needs can have as much (or possibly more) impact than many investing decisions. Advisors talk about the impact of investment fees over time, but what about the erosion of purchasing power to cash held in bank accounts over decades? What about the cost of not planning for enough cash and having to divert resources in the future?
Given all of these variables and important questions, some advisors might consider the spending plan to be the cornerstone of any financial advice, up to and including investment advice. That’s a significant onus on a set of present-day decisions.
If technology (like robo-advisors) can absorb some of the burden further down the process – allowing human advisors to give more attention to these impactful decisions – then human advisors who value the impact of spending may be able to use this technology to deliver more value to their clients.
Image Credit: Jeremy Thomas