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Robo-Advisors: What Service Are They REALLY Providing?

Robo-Advisors: What Service Are They REALLY Providing?

May 23, 2023

If you needed a ride and two friends each offered to give you a ride, how would you choose which offer you would accept? The best response would be that your decision would rest upon the dependability of your friends as drivers.

How would we determine how dependable our friends are at driving? Chances are good that we probably have experience in riding with them before, right? But there’s a first time for everything, so what is there to explain our decision to take a ride with them the first time? It’s not a complete gamble, is it?

While driving does require a certain level of knowledge and skill, it would seem that we don’t consider the necessary amounts of knowledge and skill for driving to be exclusive. In other words, as a general rule, anyone who is at least 16 years old can obtain a license, which represents the fact that the licensee possesses the necessary amounts of knowledge and skill. The way that is proven, though, is through testing. Do people give their friends driving tests prior to riding with them? Would you be offended if a friend asked you to take a driving test prior to riding with you?

Let’s change up the hypothetical a bit. Let’s say that you need surgery and the same two friends who offered to give you a ride have now stepped up and each has offered to perform your surgery. Important detail: neither is a surgeon, let alone a doctor. Which offer would you accept? Would you prefer they take a test first? Would you be offended if someone wanted you to take a test before you cut on them?

The point is that the weight of the decision increases substantially when the task at hand is surgery.

That’s because the knowledge and skill necessary to ensure that something doesn’t go wrong during the surgery, as opposed to driving, are of a more specialized and exclusive nature—i.e., the number of people who possess such knowledge and skill is far fewer than those who possess a driver’s license.

Now, let’s change up our hypothetical a little more. What if two of your friends each offered to be your financial advisor? (Important detail: neither one of them are a financial advisor.) Is the trust you have for them in other areas sufficient to trust their financial advice?

If that decision doesn’t feel as heavy as the surgery decision, that would be understandable, but it absolutely should feel heavier than the driving decision. While the potential consequences of something going wrong with a financial decision are not as dire as that of driving or surgery—you can’t lose life or limb—they are sufficiently dire to matter. Further, there are far fewer financial advisors than there are licensed drivers, which would seem to speak to the knowledge and skill required to be a financial advisor, and that would seem to contribute most to the weight of the decision presented here.

The reason why all of this matters is because Robo-Advisors exist. For the uninitiated, Robo-Advisors are “digital platform[s] that provide automated, algorithm-driven financial planning and investment services with little to no human supervision.” In essence, they are robots performing financial services, predominantly in the arena of investing.

If the decision to trust a friend as a financial advisor felt heavy, should the decision of whether to trust a Robo-Advisor not feel as heavy, if not heavier?

Some might respond by saying that there are some big-name firms offering such services. This is certainly true: there are a whole host of firms now offering Robo-Advisor investing services, including some larger players like Fidelity, Vanguard, and Morgan Stanley, among others.

What someone might be trying to imply by making such a point is that you can trust a big name, and if you can trust the name, then you can trust a service offered by that name. In reality, though, if all you do is rely on a name to establish whether you can trust a service, then you are essentially saying that the service doesn’t matter—i.e., any service offered by the name can be trusted.

Are we really comfortable with that idea?

In the next piece in this series, we’ll look at what a Robo-Advisor REALLY is. Is it truly a “robot”? Or is there someone behind it still pulling the strings?

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