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Financial Planning > Trusts and Estates > Trust Planning

How Do You Beat a Robo-Advisor? Trust

By Ed Silverstein

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No matter how dire some predictions are for small financial advisory firms, clients still prefer to trust humans rather than machines or software, which is likely to keep an important role for the human advisor.

This personal relationship, which is marked by trust in the advisor, differs from the relationship between a person and technology – though advisors will still need to rely on tech to advise their clients.

“Technology by itself cannot create trust,” Robert C. Merton, a Nobel laureate in economics now teaching at MIT, recently told ThinkAdvisor. “The successful advisor must have the trust of their clients.”

When it comes to trust, he offers an illustrative example from the field of medicine. If someone asked an advice app on a cellphone what to do about a painful knee, and the app answers “cut it off” – you would not follow that advice.

“We do not know the motivation behind the advice. Is it in our interests or someone else’s? We do not know the validity of the model used to reach the conclusion of the advice given. It could be a very flawed model. And we do not [know] the data that were used in the model to reach the conclusion. It could be poor, incomplete or biased data and it may have been transcribed incorrectly,” Merton said.

There is a related issue of transparency. “Financial advice, like medical advice, is inherently opaque, meaning that it cannot be made transparent enough to avoid having to rely on trust,” he added.

Given the importance of trust in the advisor-client relationship, Merton recommends financial advisors (the breathing kind) should:

  • Check what they are doing to retain and enhance trust with their clients.
  • Make sure the business model being used supports the creation of trust.
  • Take advantage of technology to improve/enhance what the advisor does.
  • Do not view technology as a “competitor or substitute” for the advisor.
  • Understand and assess the financial technology they employ to certify trusting its use in client solutions.

Moreover, Luis A. Aguilar, a former Securities and Exchange (SEC) commissioner now on the board of Envestnet and on the Board of Advisors of Personal Capital, suggests comparing relationships when evaluating trust. “A personal relationship with another human is the best way to build an enduring trust relationship,” he said. “I doubt that a machine will really care about my future and my family’s future.”

But a somewhat differing view comes from Vasant Dhar, a professor at New York University’s Stern School of Business.

“Technology can surely create trust on its own in transporting us if our collective experience is that it rarely makes mistakes and doesn’t kill us. We’re not there yet,” he said. “But in the world of investing, which is fraught with uncertainty and unpredictability, trust is indeed a lot harder to engender, but not impossible.”

“At the moment, robo-advisors do little more than portfolio optimization; that is, given your positions, they tell you how to size them,” he explained. “This is an easy enough task, and most people would probably trust the machine with this simple task.”

However, trust “is harder to create when a machine makes recommendations, like ‘buy Google’ without the basis for such a recommendation,” Dhar said.

It is noteworthy, however, “the bar for machines isn’t particularly high” when it comes to making buy/sell recommendations, he says. After all, “not many” human financial advisors outperform the S&P 500 after fees, Dhar said.

He points out, as well, that generally, for systems that have a predictive element, “trust depends on the number of data points we observe during our experience with the technology.”

“I would probably trust a machine more with short-term predictions than long-term ones because there are more data points,” he added. Moreover, data are “key to building predictive models, which are in turn key to establishing trust. If you can show clients that the robot adds value using lots of data points, they are more likely to trust it.”

Humans vs. Robots: Who Gets the Job?

Related to the issue of trust, there is a key question: Will robo-advisors put human financial advisors out of work?  Here are some responses from thought leaders.

“It could put some human advisors out of work, especially those with poor track records who charge high fees,” Dhar says. He recommends that human advisors may want to use more technology — and compare the predictions of automated systems with their own analysis and integrate the two.

“Some jobs will be lost or materially changed, and others will not,” Merton said. “And indeed, the fintech/robo technology will likely enhance the value of trustworthy and competent advisors.”

From his vantage point, Howard Yu, a professor of strategy and innovation at IMD, said, too, that robo-advisors will not put human advisors out of work.

“Financial advisory demands trust,” he said. “In other words, that human interface with empathy and understanding of financial aspiration will always play an important role. This is akin to health care. Despite the automation of [the] human expert, [the] doctor will still be required, despite their changing role.”

“I believe they actually complement each other,” agrees Jonathan Stein, CEO of Betterment, when asked if robo-advisors could put human financial advisors out of work. “As investment management becomes more automated, the role of the human advisor will invariably shift. Their value-add will be built around behavioral coaching, estate planning, and building strong relationships with their clients so they can offer the best advice possible.”

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