FAs Fear Robos Promote Bad Investment Behavior
In the past year, advisor Mark Balasa has been investigating how best to incorporate robo technologies into his practice. But despite early optimism that such automated portfolio tools could give him ways to economically serve more Millennials, he’s wary of jumping into the field too early.
“As it stands now, there’s still a glaring gap between today’s robo technology and the latest advances in modern portfolio theory,” says the partner at Balasa Dinverno Foltz in Itasca, Ill., which manages $3.2 billion.
Robos can generally only access a client’s holdings on an account-by-account basis, he points out. And that flies in the face of a fundamental principle of proper asset allocation, according to Balasa.
“You start with a top-down overview of everything you own, then divvy up your assets by account – not vice versa,” he says.
For example, Balasa recently met with a local executive whose brokerage portfolio was heavily invested in company stock. But after reviewing his new client’s total wealth picture, the FA discovered another $1.5 million of investments in several different tax-deferred accounts, real estate holdings and tangible assets.
The deeper dive by Balasa culminated in a recommendation to take a balanced approach tilted towards holding bonds in IRAs and other tax-advantaged accounts.
As part of his firm’s research into robos, the FA also compared how online allocators would’ve handled the family’s portfolio. His conclusion: A more “compartmentalized” approach could’ve easily led to overweighting bonds in the man’s brokerage accounts and devoting too much to stocks in his tax-deferred accounts.
“In many respects it’s irresponsible for these robo-advisors to take such an isolated and narrow view of someone’s true investment worth,” says Balasa.
Indeed the industry’s self-funded regulator, Finra, put out a 17-page report last week urging advisors to be aware of “those tools’ limitations.”
Sound advice “rests on robust understanding” of each individual situation, the alert notes.
It adds that those using robos need to scrutinize whether such a service provider “gathers sufficient information and asks sufficient questions to understand their needs” and “whether these factors are reflected in the advice they receive.”
But it’s not just a person’s full financial background that robos are missing, argues Brad Klontz, managing partner at Occidental Asset Management in Burlingame, Calif., with $250 million.
Besides working as an advisor, the former clinical psychologist teaches financial planning at Creighton University. Along with two academics at Kansas State University, Klontz has put together a new study looking at behavioral differences between ultra high net worth investors and the mass affluent.
His research found that the ultra high net worth crowd usually makes “significantly” fewer cognitive errors – that is, they’re less likely to show “self-destructive” tendencies such as selling low and buying high. A key reason why, Klontz observes, is that UHNW investors usually reach out for guidance from third-party experts like CPAs and lawyers.
“But as an advisor, I’ve seen for myself that it’s a myth to assume that people who’ve accumulated less wealth – and face fewer complicated tax and estate planning issues – can get by with less outside support from knowledgeable and objective professionals,” says Klontz.
In fact, he believes investors with smaller portfolios “are the ones who feel the impact of poor behavior the most – they’re the ones who can least afford to make major mistakes.”
As a result, many advisors who are already using robos say they’re not ready to hand over their complete investment processes to computers.
At Morristown, N.J.-based RegentAtlantic, which manages $3 billion, advisors use their firm’s own robo-like toolkits built in-house to handle one-off tasks such as reviewing asset allocations and looking for rebalancing opportunities.
“It makes the investment process – both for our portfolio managers and clients – so much more efficient and less time consuming,” says Chris Cordaro, who serves as the independent RIA’s chief investment officer.
At the same time, he makes a point of keeping client expectations in check about the feasibility of handing final allocation decisions totally over to robos.
“The current state of this technology will no doubt improve over time,” says Cordaro. “But as it stands now, there’s a real danger that robos will foster a greater sense of tunnel vision about investing.”
And that, he adds, might "obscure investors’ big picture objectives even more – no matter how simple or complex of a portfolio they hold.”