Computer says, 'Maybe'

One of the unwelcome consequences of the introduction of the retail distribution review (RDR) at the end of 2012 was a significant increase of the 'advice gap'.

The RDR significantly increased the minimum qualifications for financial advisers, banned investment and pension commission as a payment for advice, and tightened up the definition of 'independent' advice.

As predicted at the time, some advisers, instead of choosing to obtain the higher qualifications and cope with having to charge clients higher fees, decided to retire. This was most markedly seen with almost all of the banks exiting the advice market, although some banks have now started to return to advising.

Simple economics dictates that a reduction in the supply of advisers, coupled with those remaining advisers being more higher qualified, would lead to an increase in the cost of advice, thereby excluding many potential clients at the bottom.

I'm sure there has been an increase in the cost of advice but the increase in relative demand (due to their being fewer advisers) and an unconnected rise in regulatory costs, has resulted in many of them moving upmarket, which arguably created the advice gap.

There is much talk about how to address this mass-market advice gap, including the unwinding of much of the RDR, which I feel would be a regrettable move given that we are only two-and-a-half years into this new professional world.

I would argue that financial advisers deserve at least a decade to firmly establish a profession that truly serves the public, putting financial advisers on an equal footing with solicitors and accountants.

One of the proposed mass market advice gap solutions, which many financial advisers are now embracing, is the concept of so called robo-advisers.

Robo-advisers are online programmes that offer asset allocation and model portfolios tailored to clients' answers to a risk questionnaire.

While this can be useful in steering clients towards an appropriate investment portfolio, I personally think that robo-advisers are fundamentally flawed for the following key reasons.
 

Focus - Unlike real financial advisers, robo-advisers don't take into account the client's full financial situation. They are simply trying to direct the client to an appropriate investment solution. They don't address the question of whether or not the client should be investing in the first place, e.g. would they be better off insuring themselves and their family?
 

Risk - The robo-advisers I have looked at have all failed to accurately get across the true nature of investment risk. They discuss volatility or historic monthly or annual losses, but they don't cover historic peak to trough losses, i.e. the maximum you could have lost by buying at a previous high. This peak to trough is arguably far more relevant than how much you might lose in a bad month.
 

Emotion - With the best will in the world, people are emotional beings and when markets have a wobble, as they have done recently, some people need a little hand holding to avoid panicking and realising a genuine (as opposed to paper) loss. A robo-adviser is unable to pop round for a cup of tea and a reassuring chat.
 

Accountability - While commonly known as robo-advisers (the key word being adviser) and steering clients to a specific investment portfolio based on the client's answers to risk associated questions, the small print normally states that they do not actually give advice. Consequently if things do go wrong, you may find that you are unable to claim compensation.
 

Value - Finally, it's worth noting that some robo-advisers are not much cheaper than a real adviser; as a result you are likely to be much better off dealing with a real person.

Scott Gallacher is a director at Rowley Turton

He writes the regular IFA comment in Private Client Adviser