Collectively, Tony and I have more than 60 years experience in the markets and with clients, who have ranged from individuals to large institutions. So, you will forgive us if we are somewhat cynical about the newest cure-all for providing foolproof investment advice: so-called “robo-advisors.”
The move to this technology seems to us to be just the latest grand idea to cure the ailments that have been dogging investors of all types for generations. If we ourselves were to believe in this latest investing solution—which attempts to automate the thinking behind strategy and implementation—we would be agreeing with the notion that technology will indeed supersede human nature.
In short, robo-advisors use artificial intelligence to make the calls; and because individuals of virtually every generation embrace these disruptive AI technologies in other aspects of their lives, they are now apparently willing to do the same with their money. “It’s different this time,” they say.
Tony and I disagree. Early in our careers, the financial advisory profession was evolving from a transactional to a consultative approach, with active managers and passive index funds taking the place of the long-time stock-picking, commission-compensated stock broker/advisor.
At that time, back in the late 1980s, firms rolled out advisory-managed account wrap-fee programs, and the foolproof method was to use questionnaires to determine clients’ risk tolerance and long-term investment goals and objectives.
The survey result would be inputted into an optimizer, then run through thousands of Monte Carlo simulations, providing the advisor the best allocation of managers from various “style boxes,” to populate the client’s investment strategy. This survey solution projected returns and volatility over the long term that would meet the investor’s objective for both return and risk.
There’s no substitute for having a (human) voice of reason to speak with when your gut reaction is to do the wrong thing at the wrong time.
So, what came of that ultimate solution? Despite the best intentions, after a short while, many clients reviewed the performance of their roster of managers and fired the underperformers, then allocated the assets to the top performers. As we went through market corrections and even bear markets, the idea of a long-term commitment to a strategic asset allocation to stocks went “out the window.”
In the end, as had happened in previous cycles, money chased into the hot strategies immediately after they had performed well; that same money simultaneously abandoned the underperformers and left the markets outright when the loss-adverse nature of its investors took hold.
So, will things be different this time around with robo-advisors? It’s not guaranteed that those willing to trust a machine with investment decisions will lose their discipline in the face of mounting losses in bear markets, or act in ways not seen before. Yet, with machines in charge, will real investors truly be willing to buy the weakness and sell the strength implied by any discipline that uses active rebalancing as a critical part of its investment strategy?
Let’s say that we have our doubts about how this will work when it’s put through a stress test or when the FOMO (fear of missing out) sentiment takes hold. After so many years working closely with clients and actually helping guide their investments through many market cycles, we are confident that investors still want and need good advice that recognizes that we are human (after all) and that emotion drives much of our decision-making, especially in times of stress.
Our take, then, is that it is not different this time around, regardless of how abnormal the markets and the political backdrop seem these days. And, there is no substitute for having a (human) “voice of reason” to speak with when your gut reaction is to do the wrong thing at the wrong time.
Tony Maddalena is a wealth advisor with the Wealth Management division of Morgan Stanley in Purchase, NY. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, member, SIPC, www.sipc.org. Morgan Stanley financial advisors engage Worth to feature this article. Maddalena may transact business only in states where he is registered or excluded or exempted from registration, http://fa.morganstanley.com/themaddalenagroup. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Maddalena is not registered or excluded or exempt from registration. The strategies and/or investments referenced may not be suitable for all investors. CRC1821329 06/17.