Many robo-advice providers are simply duplicating the archaic traditional financial advice process which prioritises an investor’s risk tolerance and delivers product-based solutions, according to Milliman.
In a paper titled ‘Why the automated advice industry can’t leave goals behind’, author Wade Matterson wrote that this approach in traditional financial advice originated from legislation that aimed to protect consumers over the past 15 years but delivered advice that was only superficially compliant.
The advice usually led to a product which did little to fulfil investors’ goals.
“Many automated advice providers are now falling into the same trap. They may offer lower-cost advice but their fees are still tied to an investment (often exchange-traded fund portfolio) rather than the advice they are delivering,” Matterson wrote.
The strict requirements set out by the Australian Securities and Investments Commission (ASIC) would become more burdensome for the emerging robo-advice industry as it increasingly adopted a more complex, goals-based advice process in its businesses.
“A more nuanced approach to risk profiling will move well beyond simple questionnaires which assess risk tolerance (an investor’s willingness to take on risk) to include different components such as risk aversion (the flip side of risk tolerance), risk capacity (the financial ability to endure losses) and risk need (the amount of risk needed to likely achieve goals),” Matterson wrote.
Behavioural finance concepts would play a larger role in the advice process and foreseeable future behaviour (or risk-return trade-offs) that investors would exhibit in different circumstances.
Robo-advice providers must focus on enhancing the quality of advice rather than only focusing on lowering the cost of advice, Matterson said.
