The road from ancient Eleusis into the heart of Athens winds its way through a narrow pass in the mountains. Road-weary travelers on that route sometimes come into contact with the friendly innkeeper, Procrustes, who is quick to offer them a room to rest and a place at his table. They are informed by this golden-tongued, solicitous stranger that his iron bed will fit them perfectly.
What they are not told is how this could be.
Upon lying down, travelers who are too tall for the bed of Procrustes have the excess length of their appendages sawed off. Those unwitting guests who are too short for the iron bed are stretched with ropes or hammered out until they fit it just right. Procrustes then relieves their corpses of whatever wealth they’d been traveling with and heads back to the road to offer his bed to the next wayfarer.
This continues until someone clever comes along and questions how it could be that a bed could perfectly fit everyone. Plutarch tells us that none other than the heroic Theseus detects the ruse and gives Procrustes a turn of his own in the iron contraption.
There is a great deal of fear on Wall Street about job security. There are articles being written about the automation of stock picking, bond trading, back office functions and investment advice nearly every day. So-called robo-advisors are the subject of a new article pretty much hourly these days. What the media gets right is that they are important insofar as they’ve set the “market-clearing” rate for basic asset allocation. What the media misses is what the true impact will be on the wealth management industry.
Automated investing advice is a giant step forward for a large segment of the population. Middle class savers (with financial assets of between $50,000 and $100,000) and the mass affluent investor class (investable assets between $100,000 and $500,000) would otherwise have either little attention paid to them or the wrong kind of predatory services being offered. In comparison to the alternatives – apathy from wealth managers or treachery from conflicted salespeople – I believe that robo-advice and other software-based tools that enable investors are a grand slam.
However, the notion of a once-size-fits all solution to financial planning and asset allocation ignores the most critical aspect of investing – that it’s journey, not the destination, that counts. Software can show you the long-term projected performance of a portfolio on a computer screen. But it cannot make you feel, in advance, what you will feel along the road to reaching that destination.
Automated advice can do many things, but it cannot detect the subtle differences in emotional states, behavior and predisposition of each client. Knowing you have the right allocation mathematically, upon initially investing, is not the same as feeling you have the right allocation on an ongoing basis, nor is it as important. Surviving the journey is what pays off, anyone can plot the course in advance.
Backtests do not accurately reflect the experience of holding onto a portfolio through the trying times, even if, on a chart, things worked out okay in the end. Extrapolations are linear, while life is not. Projections are smooth, yet the terrain we must tread en route to fulfilling those projections is anything but.
While online risk tolerance questionnaires can quantify your attitudes about risk and reward, they cannot account for the fact that these attitudes are dynamic and highly dependent on the mood of the subject on the day during which they were completed. People who have recently been rewarded for the risks they’ve taken will largely feel better about how much risk they can bear.
On the other side, behavioral studies and real-world evidence have shown that people become significantly more risk averse and much less concerned about potential reward immediately following short-term losses in the market. This is when “preservation of capital” shoots up as an investment priority while hedging and risk management become the dominant behavior. Paradoxically, it is is precisely at these moments when investors should be taking more risk, but the human psyche can work no more counter-cyclically in the realm of portfolio management than it can in any other aspect of our lives.
Unfortunately, software cannot, on its own, solve for this elemental feature of the human condition. Nor can an average advisor. This is work that only a great advisor can do.
Knowing a client personally enough to anticipate what market environments will trigger their worst impulses toward either crippling fear or reckless greed is a task uniquely suited to emotionally intelligent, skilled human advisors. And for a wealthy investor with a lot to lose, this relationship becomes indispensable. Major emotional mistakes in the investing realm are not calculated in basis points, they are tallied in the hundreds of thousands of dollars, or, in extreme cases, in the millions.
Wealthy people know this. They’ve learned to forge alliances with doctors, lawyers, accountants, consultants and advisors whom they can trust and confide in. The costs have paled in comparison with the benefits – in some cases, over generations. Consistently good counsel pays for itself where large sums of money are at risk – and we are all at risk at all times. In comparison, “free advice” or nearly free is worth exactly what it costs, nothing.
Social intelligence cannot be programmed. Hard-earned trust cannot be arbed or gamified. And, at its highest levels, empathy cannot be machine-learnt. Great advisors get into this business because they care and that is why they flourish. Advisors who do not care, or who peddle one-size-fits-all solutions where nuance is important, can absolutely be replaced by software. And they should be.
Average advisors are worried about what automation means for their job security.
Great advisors are embracing it as yet another tool that can help them deliver the personal aspect of advice that’s literally unquantifiable when the chips are down. Forward-thinking investment firms are using software to their advantage – saving time, saving expense, saving energy – so that they can maximize what makes them special to clients – their humanity.
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