The new ruling that is supposed to be implemented on April 10, 2017, is an expansion of the “investment advice fiduciary” part of the Employee Retirement Income Security Act (ERISA) of 1974. Under this new rule, any financial professionals that work with qualified plans, like IRAs or 401(k)s, will be required to act as a fiduciary. In order to do so, an advisor needs to act in the best interests of the client and to put client’s interest above his or her own.
However, with the rise of the robo-advisor, does the lack of human interaction serve in the client’s best interest? We will investigate this idea through this article.
What Are Robo-Advisors?
In the competitive financial industry, a growing trend has been the reduction of fees for the investor. With successful exchange-traded funds (ETFs) like Vanguard having very low expense ratios, the industry has seen a tightening of its fee structure throughout almost every investment vehicle. Investors are beginning to be swayed by passive management at a lower cost over higher priced active management – a matter that has been at the center of several ongoing debates. Check out our Complete Guide to Mutual Fund Expenses to become familiarized with the various fees structures.
However, investors are still left to decide their own asset allocation strategy, make investment choices and employ a reliable financial advisor to help them through the process; for a fee of course. Within the context of providing hassle-free investment advice at a lower cost, robo-advisors were created primarily for investors who do not need the comprehensive services of a typical financial advisor.
A robo-advisor is an online wealth management tool that provides automated, algorithm-based portfolio management advice without any human interference. Due to the lack of human influence, this enables the robo-advisors to charge a much lower fee than traditional-based wealth management systems. And since the robo-advisor structure has much lower fees, it permits for a lower minimum asset base to open an account. This is unlike the traditional human advisors who may have a higher minimum asset requirement clause. Within this context, you can know if you are paying more than the required fees for any of your existing or future mutual fund investments.
Investors would simply visit one of the many robo-advisors, such as Betterment or Schwab Intelligent Portfolios, to get started. These websites work by having the investor input a few personal details like age, income and investment goals. From there, the algorithm selects an appropriate asset allocation strategy based on low-cost investment options to meet the investor’s pre-defined goals.
Robo-Advisors vs. Human Advisors
The robo-advisor is a great tool for investors looking for simple and affordable investment management service. However, it does not offer the same level of service and guidance that a human advisor does.
In its simple form, robo-advisors offer portfolio rebalancing and investment tax management services. Depending on an investor’s criteria, robo-advisors can reallocate the investor’s portfolio based on his or her age and pre-defined or projected life events that might change his or her financial needs. For example, as an investor gets closer to retirement, the robo-advisor can continually make the portfolio more conservative, moving funds from stocks into bonds or cash.
Human advisors are more expensive than their automated counterparts because the former can offer a more comprehensive and customized service. Typically, human advisors offer investment planning and even a comprehensive financial planning service, especially those with a Certified Financial Planner (CFP) designation. Advisors with a CFP designation can provide a comprehensive financial plan for their clients, with investment and portfolio management as just one of the service’s verticals.
Therefore, it is evident that beyond the services that robo-advisors provide, human advisors can provide other complex, value-added services including retirement planning, estate planning, tax management, education planning, risk management and life insurance.
Fiduciary Rule’s Impact on Robo-Advisors
The fiduciary rule applies only to any broker-dealer or investment company that offers advice to retirement accounts. Robo-advisors are currently under a “grey” area due to the lack of human influence or control.
Although robo-advisors have very low fees, which the Department of Labor (DOL) likes, it raises the question of whether a robo-advisor can still act in the client’s best interest. Unlike human advisors who will be held liable in the event of a fiduciary fault, robo-advisors simply run off algorithms based on the client’s information. As of now, the DOL has not clearly stated if the investment company running the funds or the team that designed the algorithm would be at fault if it was found liable for not acting in a client’s best interest.
Besides, while broker-dealers and human financial advisors know the consequences for not complying with the DOL rule, robo-advisors do not. Until the DOL clearly spells out robo-advisor’s limitations in the fiduciary rule, it is hard to truly see the impact they will have on this segment of the industry.
To learn more about the multifaceted impact of the DOL ruling on various participants of the industry and the investor community, check our DOL section.
The Bottom Line
Overall, robo-advisors are a good addition to the financial advice industry. If the DOL rule does not impact robo-advisors, their popularity will continue to grow. Many financial advisors will not want to take the risk of being a fiduciary for retirement accounts with values lower than their minimum asset level. For investors who don’t have the asset level to qualify for or cannot afford the higher fees of a human advisor, a robo-advisor could be a suitable solution.
In short, robo-advisors can be the alternative to help guide investors who can’t afford the full service of a human advisor but do not want to self-manage their own portfolios.
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