The Downsides of Deferring to Robo-Advisers

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

Just like any other product, it’s important to do a cost-benefit analysis of whether this product is right for you. Here are the advantages and disadvantages of using a robo-adviser. Potential disadvantages of using robo-advisers may include:

  • Lack of a personal advisory relationship with a human adviser – While this may be an advantage for some, having a human adviser can be important when a person has questions about their product/portfolio or in cases where technical issues arise and automated answering services are unable to help. Another related disadvantage is that the client may be unable to get clarification about the contract.
  • No extensive information gathering stage – The questionnaire may not include all the necessary initial (or follow up) questions to fully evaluate your investment needs. Additionally, these questions may not be as tailored to your familiarity with investment products and communication style, as you may otherwise get from a human adviser. Furthermore, whereas a financial planner at a full-service firm can help integrate your finances, taxes, estate plans and other non-monetary concerns, a robo-adviser is limited in the services it can provide to you.
  • Limited means of communication – A client may only be able to communicate with an advisor through internet communication.
  • Client’s limited access to funds – robo-advisers can limit a client’s access to their funds in three ways.
    • Robo-advisers may have the discretionary option to delay a client’s access to funds. While it is not uncommon for companies to limit users’ access to their funds, some robo-adviser contracts state that the company has the right to impose a longer waiting periods, during which the client would not be able to trade with or withdraw those funds. More concerning are the agreements that give robo-advisers wide latitude to impose a longer or indeterminate waiting period without disclosing in the agreement what would warrant robo-adviser to take such actions.
    • Robo-advisers may require Clients to hold a certain amount of cash in their portfolio. This can be problematic for two reasons. The first reason is that a client may not be aware of the robo-adviser’s requirement to hold a specific amount or percentage of their portfolio in cash. The second reason is that depending on what triggers the rebalancing in your specific portfolio, this requirement may result in clients being required to hold more cash in accounts managed exclusively by robo-advisers than would be required under the traditional human advisor model. You can read more about FINRA’s view on effective practices and principles regarding rebalancing here.
  • The client may not be entitled to important notices – For example, a robo-adviser may not have to give notice to investor if there’s a change in the advisory agreement.
  • The decision-making responsibility may be shifted heavily from the robo-adviser to the client – As discussed in a previous post, a contract may place what has traditionally been an adviser’s responsibility (to make an informed decision, determine the appropriateness of the product, monitor client’s accounts and make suggestions based on the individual) onto the client.
  • Robo-adviser’s potentially decreased liability – Also discussed in the previous post was the potential for robo-advisers to contractually provide from indemnification provisions and disclaim duties and liabilities, as well as limit the scope of their relationship with the client.
  • Limited Portfolio Options – Because many robo-advisers use a standard formula or set of portfolios, if you have a unique situation, for example with differing time horizons, a robo-adviser’s asset allocation may not be the best fit for your needs.
  • Fees – In addition to advisory fees, it’s important to consider other fees that you may incur (both with human financial advisers and robo-advisers): trading fees, account maintenance fees, account transfer fees, wire transfer fees, checking account service fees, paper statement fees, account closing fees.