Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100%...
Transcript of Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100%...
![Page 1: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/1.jpg)
Financial Robo-Advice: Fancy Software Is Not a Substitute for
Trustworthiness and Good Science
By Zvi Bodie October 1, 2018
All rights reserved Bodie Associates 2018 1
![Page 2: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/2.jpg)
TheMainPoints
• Pure100%robo-advicehassofarbeenafailure.
• Almostallprovidersofadviceofferahybridservicethatincludesahumanadvisor.
• Almostalladvice–roboorhuman--isbiasedtowardsencouraginginvestmentinequities.
• ThereisadangerthatparticipantsinDCretirementplanswillfaceriskunprepared.
All rights reserved Bodie Associates 2018 2
![Page 3: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/3.jpg)
6KeyQuestions
• Whatisthehistoryofrobo-advice?• Howgoodisrobo-advicetoday?• Whatisworsethannothavinginsurance?• Cantheregulatorsbetrustedtoactinthebestinterestofordinarypeople?
• Whatisthefutureforrobo-advice?• Caninnovativestructuredproductssubstituteforgoodadvice?
All rights reserved Bodie Associates 2018 3
![Page 4: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/4.jpg)
“TechnologyCanGiveEveryonetheHelpTheyNeed”
! Financialadvisorscanbeexpensive,can’talwayssufficientlyanswerallofthemanyquestionsweneedanswered,andmanyarefocusedonwealthierclients.
! Thesolution?Highqualityretirementcalculators,detailedonlineinformationandserviceslikeroboadvisors—canhelpeveryoneaccessthedetailedmodelingyouneedtoassesswhereyoustand,discoverwaystostrengthenyourfinancesandmakebetterdecisionsaboutyourmoneyandwhen,whereandhowtoretire.
All rights reserved Bodie Associates 2018 4
![Page 5: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/5.jpg)
The Case of Financial Engines
• First robo-advice service founded in 1996 applying William Sharpe’s model
• Widespread adoption by plan sponsors to satisfy regulatory requirement to offer help to participants
• Evolution towards hybrid model through acquisition of advisory firm and recent merger with Edelman.
• It is now the largest independent RIA in the U.S.
All rights reserved Bodie Associates 2018 5
![Page 6: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/6.jpg)
Roleofhumanadvisors
“SomedayBobandSuemaybeabletositattheirdiningtablewithanon-lineprogramandmakegoodretirementincomechoicesbythemselves.Butitseemslikelythatforsomewhileanexperienced,unbiased,andfrugalhumanadvisormaybewellworththeaddedcost,atleastattheoutset.”WilliamSharpe,RetirementIncomeScenarioMatrices.(2017)
All rights reserved Bodie Associates 2018 6
![Page 7: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/7.jpg)
How good is robo-advice today?
All rights reserved Bodie Associates 2018 7
! Advice is flawed Example: Betterment
“At Betterment, we believe that … the more long-term your investing goals, the more risk you can afford to safely take.” No free lunch: You cannot earn a risk premium safely, no matter how long your time horizon.
![Page 8: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/8.jpg)
TheBestOnlineRetirementIncomeCalculators
All rights reserved Bodie Associates 2018 8
Accuracy Usability Education Weighted Result
ESPlanner Basic 3 3 3 3 New Retirement 3 3 2 2.8 AARP 3 2 2 2.6 MarketWatch 3 1 2 2.4 T. Rowe Price 2 3 2 2.2 Schwab 2 2 2 2 Vanguard 1 3 2 1.6 Bankrate 2 1 1 1.6 Fidelity 1 2 1 1.2
Retirement Calculator Scorecard
![Page 9: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/9.jpg)
Adviceisnotconsistentwitheconomics.
Robo-advice (wrong) Economics (right)
Saving is for the short run. Investing is for the long run.
Saving = income minus consumption; investing= saving
The only way to manage risk is to diversify.
Three ways to manage risk: hedge, insure, or diversify.
Stocks become safe in the long run.
If they did, there would not be an equity risk premium.
All rights reserved Bodie Associates 2018 9
![Page 10: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/10.jpg)
4FallaciesAboutStocks
Fallacy#1:Stocksarenotriskyinthelongrun.Fallacy#2:Stocksareagoodhedgeagainst
inflation.Fallacy#3:Dollar-cost-averagingimprovesyour
risk-rewardtradeoff.Fallacy#4:Youcanidentifythebestequity
managersbysimplylookingattheirtrackrecords.
All rights reserved Bodie Associates
2018 10
![Page 11: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/11.jpg)
The“BodieParadox”
• Asthetimehorizongetslonger,theprobabilityofashortfallrelativetotherisk-freeassetgetssmallerandsmaller,butthemarketpriceofinsuranceagainsttheshortfall–a“shortfallput”--getslargerandlarger.
All rights reserved Bodie Associates 2018 11
![Page 12: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/12.jpg)
Explanationoftheparadox
Theexplanationforthisapparentparadoxisthattheprobabilityofashortfallisnotasufficientmetricofrisk.Theriskmetricmustalsoreflecttheseverityofapossibleshortfall.Thecostofinsuringagainstashortfalltakesintoaccountbothelementsandthusisabettermetricofshortfallrisk.
All rights reserved Bodie Associates 2018 12
![Page 13: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/13.jpg)
0
0 5 10 15 20 25 30
Time Horizon in Years
6% risk premium Cost of shortfall put
Probability of shortfall vs. cost of shortfall insurance
Prob
abili
ty
Fraction of investment
0.5
0.4
0.3
0.2
0.1
0.0
0.5
0.4
0.3
0.2
0.1
0.0
The“BodieParadox”
All rights reserved Bodie Associates 2018 13
![Page 14: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/14.jpg)
Lookingatdistributionofrateofreturnismisleading.
All rights reserved Bodie Associates 2018 14
![Page 15: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/15.jpg)
Lookatdistributionofterminalwealthorlifetimeincome.
All rights reserved Bodie Associates 2018 15
![Page 16: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/16.jpg)
Thegraphicontherightistheonetopayattentionto.
All rights reserved Bodie Associates 2018 16
![Page 17: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/17.jpg)
Needabetterwaytocommunicaterisk
LotsofoverlappingsimulationsDynamicchartshowingsimulationrunsoneatatime
All rights reserved Bodie Associates 2018 17
![Page 18: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/18.jpg)
Whatisworsethannothavinginsurance?
! Thinkingyouhaveinsurancewhenyoudonot.
! Distinguishessentialneedsfromwantsand“immunize”essentialswithrisk-freeassets.*
*Noassetiscompletelyriskfree.Theideaistogetascloseaspossible.
All rights reserved Bodie Associates 2018 18
![Page 19: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/19.jpg)
IstheSECacaptiveoftheindustry?
All rights reserved Bodie Associates 2018 19
![Page 20: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/20.jpg)
ROADMAPTOSAVINGANDINVESTING
Buthow“safe”isasavingsaccountifyouleaveallofyourmoneythereforalongtime,andtheinterestitearnsdoesn’tkeepupwithinflation?
All rights reserved Bodie Associates 2018 20
![Page 21: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/21.jpg)
Ibondsbeforestocks
All rights reserved Bodie Associates 2018 21
![Page 22: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/22.jpg)
Roboadvisers(WithHumanHelpers)
All rights reserved Bodie Associates 2018 22
![Page 23: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/23.jpg)
HybridApproach
All rights reserved Bodie Associates 2018 23
![Page 24: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/24.jpg)
Structuredproductsolutions
All rights reserved Bodie Associates 2018 24
![Page 25: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/25.jpg)
All rights reserved Bodie Associates 2018 25
![Page 26: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/26.jpg)
All rights reserved Bodie Associates 2018 26
![Page 27: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/27.jpg)
KeyQuestionsandAnswers
• Whatisthehistoryofrobo-advice?– Trendistowardshybridmodel.
• Howgoodisrobo-advicetoday?– Biasedtowardsequitiesandlogicallyflawed
• Whatisworsethannothavinginsurance?– Thinkingyoudowhenyoudonot.
All rights reserved Bodie Associates 2018 27
![Page 28: Financial Robo-Advice: Fancy Software Is Not a Substitute ...The Main Points • Pure 100% robo-advice has so far been a failure. • Almost all providers of advice offer a hybrid](https://reader034.fdocuments.in/reader034/viewer/2022050716/5e29798dd8fc8b3d340637ae/html5/thumbnails/28.jpg)
KeyQuestionsandAnswers
• Cantheregulatorsbetrustedtoactinthebestinterestofordinarypeople?– No.Theyareindustrycaptives.
• Whatisthefutureforrobo-advice?– Hybridmodel
• Caninnovativestructuredproductssubstituteforgoodadvice?– Intheoryyes,butnotyetinpractice.
All rights reserved Bodie Associates 2018 28