Is Your Robo-Advisor Hiding Something?

Robo-advisor platforms are on the rise, and many of us are familiar with the pros and cons of these platforms. On the “pro” side, robo-advisors provide their customers with high-quality, low-cost portfolios that are generally tax-efficient and come in an easy to use website package. The “cons” of using a robo-advisor are in line with what most people would expect, namely: lack of personalization, no holistic financial planning, and perhaps most importantly, no behavioral coach to help prevent catastrophic mistakes when the markets take a dive.

To the “con” side of the ledger, it’s time to add another potential danger: conflict of interest. Early iterations of robo-advisors have stuck to a passive investment philosophy. They are not affiliated with any mutual fund or ETF providers, so they generally filled, and continue to fill, their portfolios with high-quality, low-cost investments. Hence, no conflicts of interest.

It turns out, however, even software-based financial advisors can have conflicts of interest. Lately, large U.S. banks have rushed to bring their own version of robo-advisors to market. Unsurprisingly, those old Wall Street ways appear to have found their way into these firms’ offerings. The culprit is an individual investor’s old nemesis: revenue-sharing, or paying for shelf space. This practice likely takes place at any firm not holding themselves out as a Registered Investment Adviser. It involves mutual fund or ETF companies paying brokers for things like seminars, meals, travel, and hotel expenses. The expectation, of course, is that their funds or ETFs will end up as an investment option for the broker’s clients.

Banks that are implementing robo-advisory services have released disclosures ahead of their launch that makes clear they will be accepting revenue sharing payments. Here’s the language: “these payments present a conflict of interest for. . . to the extent they lead us to focus on funds from those fund families that commit significant financial and staffing resources to promotional and educational activities.” A computer will determine asset allocation, but a human will decide which funds that computer can use in the allocation. Which fund/ETF families do you think will make the cut? When it comes to these latest entrants to the robo-advising individual investors would be very well served to pay close attention to the fine print.

Contact Claris with any questions on robo-advisors or your financial future.

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