Modern technology is paving and changing the path of many industries. In the future, your financial advisor will most likely be a robot – a Robo-advisor. Robo-advisors are automated, online financial and investment advisors. Using minimal human intervention, the advantages of Robo-advice include cost efficiency, consistency, and accessibility.
Robo-advisors contribute a handful of benefits to both clients and financial advisors but a prominent shortcoming is its inability to provide a human touch to its advice. Although Robo-advisors with AI and machine learning capabilities can design great portfolios, so far, they exclude an important aspect of investing – emotion.
The Impact of Human Guidance
The Dalbar’s Investor Returns report in 2017 showed that the average investor has underperformed the average return on the stock market index. The average 20 year annual return on the S&P stock index was 7.68%. In comparison, the average 20 year annual return for the Average Equity Fund Investor was 4.79%. This underperformance gap of -2.89% was found to be largely due to the behavioural and cognitive biases of investors.
In times of extreme market volatility and uncertainty, investors put more trust in human advisors. Human advisors can focus on increasing returns by taking into account all investor actions and decisions – something that Robo-advisors cannot.
Psychological behaviour plays a part in long-term success. Decisions made by investors based on their individual beliefs and actions impact long-term returns. An example of this is that when investors feel unease and tension arising from market uncertainty, they may make irrational decisions such as move in and out of their markets at inappropriate times.
Behavioural Economics
Behavioural economics studies the effects of psychological, cognitive, and emotional factors on investor decisions. By understanding behavioural economics and cognitive biases, financial advisors can help investors avoid poor investing decisions and ‘dissonance actions’.
A common behavioural economics theory – cognitive dissonance, explains the psychological distress felt when an individual has two contradictory beliefs. For example, your goal as an investor is to increase your wealth. However, over the course of investing, markets become volatile and you may feel distressed when you see your portfolio value decrease. To ease your concerns, you may make irrational decisions such as switching your KiwiSaver fund type or changing your investment plan. These actions, known as ‘dissonance actions’ may ease your temporary losses and distress, however, will likely lower your long-term returns.
Vanguard, one of the world’s largest investment management companies, has shown that advisors can add about 3% in net returns to client portfolios – half of this being attributed to understanding behavioural economics (Source: Vanguard).
Blending Technology with Human Advice
Technology is able to design investment portfolios faster, and in a way that is less error-prone compared to human advisors. Additionally, by understanding behavioural finance, human advisors can help clients gain greater lifetime returns.
Therefore, the most effective financial advisor is a hybrid digital advisor, which combines both AI and human advice.
National Capital blends the advantages of both technology and real-life advisors to help Kiwis get better outcomes from their KiwiSaver investments. As a Financial Advisor specialising in KiwiSaver research, we provide personalised digital KiwiSaver advice to help Kiwis reach their goals based on their financial situation and goals.