A future where robo advisors completely replace human financial advisors has major limitations: robots can’t appeal to investors emotionally and they also can’t interpret information intuitively when the need arises.

No matter what they suggest, robo advisors are not adept at quelling the nerves of investors during moments of panic — the type of panic that sets in during a major economic event like Brexit. They have yet to be tested extensively during an economic downturn and there are no rules to dictate the actions they can and should take to protect investors, leaving it to human financial advisors to step in and make decisions in investors’ best interests.

While many robo firms tout volatility-proof algorithms, the reality is that most investors still believe that human financial advisors are better at helping people understand their investments and making them feel confident about their decisions in good times and, especially, in bad times.

So, when the economy goes awry, who should the wealth management industry turn to — man or machine?

MARKET THRESHOLDS
When setting up a robo advisor, it’s common to create an algorithm clause that dictates market thresholds, high and low, to trigger a specific action, such as moving money out of the market. Since most robos tend to govern longer-term investments, such as saving for retirement, they are trained to tolerate typical market fluctuation. But if an extreme event occurs, it can trigger a response to algorithmic thresholds and initiate unnecessary sell-offs.

If an extreme event occurs, it can trigger a response to algorithmic thresholds and initiate unnecessary sell-offs.

Because most thresholds are fairly similar, hundreds of thousands of similar actions are triggered at once, and together, they create the appearance of a major market event.

Alternately, human advisors can interpret the information more intuitively, explain to investors why the market is shifting, and prevent them from making unnecessary selling decisions.

To solve this dilemma, human advisors can work with investors at the beginning of the robo advisory relationship to help them customize parameters for their accounts and explain what a realistic volatility band should look like for them. By explaining normal market dynamics, they can work to set parameters that only trigger sell-offs when actually required.

PROVIDING COUNSEL
In moments where communicating with investors is key, robos typically provide insight through emails or automated recordings over the phone. While this type of ongoing education is helpful during stable times in the market, insight delivered in this fashion can come across as short-sided and lacking the context necessary to guide an investor through a frightening economic event.

Alternatively, human advisors can pick up the phone or meet in person with an investor to provide broader perspective on how a rapidly unfolding political event is influencing the market, and how to diversify given this event, for example. Further, robos cannot answer the call at night about monetary policy, interest rates or politics.

Again, a combination of robot and human advice offers the best solution. Robos can supplement human advisors with ongoing counsel while the latter can also take over during moments of panic when the investor needs reassurance.

VALUE IN STRIFE
Despite some of the emotional and intuition-based shortcomings of robo advisors, they do add value in moments of economic strife.

They are able to look at all of the data available to them and show how similar situations have unfolded in the past. As they begin to gain intelligence through analysis of this data, they will gain predicative capabilities that might help to warn investors in advance about how to deal with rapidly changing markets. Armed with this information, investors are better equipped when crisis hits to deal with the situation at hand logically, perhaps without the constant help of a human advisor.

Robos can move beyond their current limitations by leveraging predictive simulations into the data they already leverage to generate advice. They can then preemptively inform investors what their exposure is depending on the outcome of an event, therefore educating and alerting them so they are aware and prepared when their portfolios might take a hit. However, it will take time, data and intelligence to get robos to that point.

Today, robo advisors and human advisors depend on each other in moments of crisis to ensure that investors are made aware of changes in the market, prepared for potential impact on their portfolios and protected from overreactions to market events.

Over time, robos can learn from responses to economic strife — what worked and what didn’t work — and modify their approach to amplify the success of the human advisors’ efforts.

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John Bird

John Bird

John Bird is vice president, product marketing and alliances, at Envestnet | Yodlee.