David M Zolt writes in his article “Industry needs to rid itself of misleading labels” that “profound misrepresentation is just one of the many ways the financial services field misleads customers with language.” It is absolutely true. He explains:
Language matters. …
So when the advent of automated portfolio management came around, the label “robo-adviser” was coined. The fact that no “advising” is going on here didn’t faze a field that’s entirely too comfortable with false labels. Robo-investing is the correct term. Have we become so numb to the misuse of labels in financial planning that when this new service is dubbed with the highly misleading label of robo-adviser we don’t even notice it?
We have written elsewhere about the importance of receiving comprehensive financial advice. Obviously automatic investing and rebalancing tools don’t provide any advising services.
But even with such limited factors, there are significant problems with the help given by robo-investing that potential users may not realize.
We reviewed Schwab Intelligent Portfolios and found that they were not very intelligent. We also found that their rebalancing algorithm has more faults than virtues. We have programmed automated tools that assist our advisors in looking at the multiple factors involved in rebalancing (capital gains, tax brackets, charitable giving, keeping cash invested, special knowledge of the client, unlimited investment choices, etc.) and we believe that computers can do better than current capabilities of robo-investing. Competent advisors who know their clients and use computer technology can do even better.
Melanie L. Fein writing for Financial Planning Magazine in an article entitled “How Robos Fall Short of Fiduciary Law” has even harsher criticism:
Robo advisors do not provide personalized investment advice. Their advice is generated programmatically by computers based on client responses to online questionnaires, but the questionnaires do not elicit all relevant information and may ignore key facts, such as a user’s contribution and withdrawal schedule, dependents, other sources of wealth, monthly expenses, tax situation, and anticipated expenditures (such as college tuition). Robo advisor agreements provide that the client, not the robo advisor, is responsible for ensuring that the robo advisor’s recommendations are in the client’s best interest. Clients are left on their own to assess whether recommended investments are appropriate for their needs.
The claim that robo advisors are “free” or “low-cost” is misleading. Robo advisors do not offer their services without compensation. In addition to any fees from the customer, they receive fees and revenue sharing from affiliated and non-affiliated broker-dealers, custodians, and clearing firms that handle the customer’s securities transactions, the cost of which is embedded in the price of products sold to clients. They do not cost less than many mutual funds, particularly those that offer “C” shares.
The claim that robo advisors “minimize conflicts of interest” also is misleading. Robo advisors are affected with myriad conflicts of interest. They engage in self-dealing transactions, invest client assets in proprietary investment products, receive payments for order flow, use affiliated banks for cash sweeps, and use affiliated brokers, custodians, clearing firms or other firms. Clients must consent to these conflicts as a condition of use.
As Melanie L. Fein suggests, the Uniform Prudent Investors Act “requires a fiduciary to make investment decisions ‘not in isolation’ but in the context of the portfolio ‘as a whole’ and as a part of an overall investment strategy having risk and return objectives suited to the trust. Robo advisors do just the opposite.” She goes on to write:
In May the Securities and Exchange Commission and Financial Industry Regulatory Authority issued an investor alert cautioning that robo advisors may give advice based on incorrect assumptions, incomplete information, or circumstances not relevant to the user, and may use questionnaires that are ambiguous, misleading and programmed to generate preset options. The regulators warned that robo advisors may use economic assumptions that will not react to market shifts, and may be programmed to consider only limited investment options — such as only investments of an affiliate.
A program is only as good as its programmer. Robo-investing programs produced by commission-based brokerage firms will automatically make all the same mistakes the firms’ human agents do. They will not act in your best interest simply because they are executing a program.
Commission-based salespeople have long wanted to use the term “advisor” because it makes them sound like they’re on your side when their business model depends on them acting otherwise. If they don’t deserve the title “advisor”, their computers certainly don’t.
Photo used here under Flickr Creative Commons.