The “promise” of digital advice
As financial services experts, we know that investors who do not use advisers, underperform when compared to the annual average returns to the market. We also know that studies have also shown that poor investment results are often a direct result of the investor’s behaviour, rather than the performance of the portfolio or its underlying assets.
It should be obvious that automating some decision-making processes will help investors make better investment decisions and achieve better outcomes.
So how do we explain the industry’s hesitation to embrace digital advice?
Most individual investors are not knowledgeable about investing
Regulatory uncertainty isn’t the reason for advisers' hesitation. The Australian Securities and Investment Commission (ASIC) support the development of a healthy and robust digital advice market in Australia. They predict that there will be a growth of the number of service providers who adopt digital advice platforms.
Remember that, according to ASIC, only about 20% of adult Australians use a personal adviser. While the causes and consequences of this low level of engagement are debatable, ASIC recognise that digital advice models have the potential to provide convenient low-cost services for many Australians.
This is good news overall because research shows that most individual investors are not knowledgeable about investing and are on average performing far worse than standard indices.
Dalbar's 2015 QAIB study, showed that for 2014, the average equity mutual fund investor (5.50%) underperformed the S&P 500 return by a wide margin of 8.19%. The gap is even wider when compared to the broader market that earned 13.69%.
The performance gap suggests the pressing need for professional advice. Unfortunately, Australian studies show that investors, for a variety of reasons, are choosing not to avail themselves of professional advice. A recent ASX Study found that of the 6.48 million people who invest on the share market in Australia, only 31% traded through a full-service broker.
58% of ASX direct investors trade through an online broker but, alarmingly, 76% of the investors surveyed claimed that they were not knowledgeable about investing.
Why do so many investors choose not to use an adviser?
The ASX study also shows that most people who choose not to use a broker, do so because of:
- Reputational issues
- They believe that brokers are too expensive
- They believe that they are too small to justify the full attention of the broker
- They were not sure what value the broker added beyond the transactional level of making the investment
- They do not think brokers are independent enough in their investment recommendations
- They find brokers a bit intimidating
The ASX Survey results echo common consumer feedback about financial planners. Cost, conflicts, complexity, inconvenience, disinterest and the impact of sustained media focus are all reasons for the low levels of consumption of financial planning services.
Not every investor has, or wants, an adviser. Coredata’a presentation (“The Seeds of Greatness”) identified that 42.9% of their surveyed respondents did not currently have an adviser or accountant. Interestingly, 22.3% of that sample did not want an adviser or accountant at all.
Digital advice may be an immature solution, but it would be unwise to dismiss its future potential on the basis of its current limitations. The opportunity for digital advice is real. ASIC’s report on ongoing advice fees (“Financial Advice: Fees for no service”) presents a compelling argument for digital advice, if only to provide the ongoing advice for which some consumers are paying but seldom receiving.
Digital Advice has the potential to change consumer behaviour as dramatically, and profoundly, as the introduction of ATM and on-line banking changed the local bank branch.
Until digital advice solutions are able to address superannuation and insurance, their appeal may be limited. Nevertheless, while digital solutions are unlikely to dominate in the short term, it would be foolish to underestimate their appeal to consumers.
Dismissing digital advice as sub-optimal or immature fails to properly acknowledge consumer hesitation to embrace financial advice more generally. While historical responses to low consumption rates and consumer apprehension has been to focus on the value of advice, perhaps a better solution is to focus on the dangers of “no advice”.
The pitfalls of managing your own investments
The fact is that, for most investors, selecting and managing investments by themselves is inefficient, time consuming and far too difficult.
Investors need adequate time to monitor their portfolio and strong discipline to adjust to different market conditions. They also have to keep their emotions in check when the markets are volatile and that's a particularly hard thing to do when it’s your money.
An article of faith for most amateur investors is that “getting in at the right time” is the foundation of success. The reality could not be more different.
Research shows that the underperformance gap is not attributable to simply buying or selling at the wrong time; it’s primarily caused by the investor’s inability to manage their emotions and their failure to recognise that their often irrational investment decisions are influenced by psychological traps, biases, triggers and misconceptions.
A robo-adviser can mitigate irrationality and assist investors to develop consistent, and consistently followed, investment habits. The sophistication of the specific solution aside, digital advisers are simply automatic investment services that apply, more consistently, the rules and strategies used by human advisers. These on-line systems utilise algorithms to manage investors' portfolios and provide structured financial advice. There is minimal human intervention and a greater emphasis on consistency than creativity.
If it comes down to using digital advice or using no adviser at all, then the choice is definitely digital advice. But human advisers shouldn't simply dismiss digital advice as a sub-optimal competitor servicing low value clients. Investors who can’t afford traditional advice or have trust issues concerning advisers, will find that digital advice platforms offer them an attractive alternative.
The argument for traditional advice
Digital Advice might be better than no advice, but automation and algorithms can’t currently replace a competent, capable and caring adviser. Nor can algorithms replace human oversight and creative skills. The investment market may be dominated by highly-skilled and trained brokers but retail advice requires more than a focus on returns.
Consumers that have engaged a financial adviser appreciate that advice is about more than just managing their investments. Advice professionals, unlike financial product salespeople, demonstrate a genuine interest in their clients, a personal disinterest in the products recommended and an understanding of their clients’ ongoing need for reassurance and support.
The absence of empathy aside, digital advice solutions have other limitations that need to be recognised. They can’t answer complex questions like ‘what is the most tax effective way to structure my pension?’ or ‘how should I structure my binding nomination’.
An advice professional, on the other hand, can review the investors’ plans with them and advise if they are on track and also look at other investment options.
The Hybrid Model: Complementary Advice
Even with their obvious limitations, digital advice services are good news for consumers. More importantly, they’re also promising tools for current advice businesses.
Robo-advice is often presented as the alternative to, and successor of, traditional advice models. In reality, the real promise of digital advice is the way in which it can complement traditional models and liberate human advisers to focus on creative and considered tasks. Better still, those consumers attracted to the digital offer will develop into full service clients as trust builds and as their financial needs become more complex.
Some firms are already operating hybrid models where digital advice platforms are overseen by human advisors who monitor the performance of the system for optimal results. In these businesses, the automated advice solution:
- attends to the tedious, manual tasks which are often repetitive and subject to manual errors
- deals with high transaction volumes
- handles tasks at high speeds and from a QMS point of view, provide work at high speed with uniformity
- Operationalises and normalise new regulations free the financial adviser to do more high- value work
- Delivers significant cost benefits for users. Digital models can charge from 0.15% to 0.35% of assets compared to from 1% upwards fee charged by a broker.
A good example of a hybrid model is that created by wealthfront who, a couple of years ago, were at the forefront of developing autonomous investment advice systems. In Australia, Stockspot and Six Park are now leading the charge for digital advice models.
The popularity and appeal of Wealthfront and Betterment is that they provide investment services that were normally only available to high end clients. Technology, algorithms and automation, supplemented by human oversight, have allowed them to offer ordinary investors equivalent, but more affordable, services than those available from human advisers.
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