THE PROMISES AND PITFALLS OF ROBO-ADVISING 

Francesco D’Acunto

Nagpurnanand Prabhala

Alberto G. Rossi
 

 

 

ROBO-ADVISING 

What is robo-advising? Why is it useful? 

Our study 

Setting 

Impact on investors 

Risk, return, trading 

Unexpectedly, behavioral biases 

Impact on brokerage firm 

Takeaways 
 

 

 

 

 

 

HOUSEHOLD FINANCIAL PLANNING 

A complex problem to frame and solve 

Liquidity planning 

Tax planning 

Housing and mortgages 

Credit card debt 

Insurance 

Investments — wealth management, retirement 

Compounded by financial literacy issues 
 

 

 

 

 

FINANCIAL ADVICE 

Lots of room for advice in any one of these 

Liquidity planning 

Tax planning 

Housing and mortgages 

Credit card debt 

Insurance 

Investments — wealth management, retirement. 

Advising is human-intensive, fragmented, targeted at wealthy. 
FINTECH 

ADVISING

 B2B, B2C 
 

 

 

 

 

WHAT IS ROBO-ADVICE? 

Automated advice 

Same information as available to human, but algorithmic 

Why automate using algorithms? 

Cheaper, allows greater reach 

Easy execution — a click implements advice 

Not subject to advisor conflicts and biases 

Does this work? What are its effects? 
	 	 	 	

WHY DO CLIENTS VALUE

ROBO-ADVICE? 

Source: BlackRock, Investor Pulse 2015
	 	 	 	

WHY DO CLIENTS VALUE

ROBO-ADVICE? 

Source: BlackRock, Investor Pulse 2015
 

 

 

 

 

 

ROBO-ADVISING FOR RETAIL INVESTORS 

Most investors are not financially savvy 

They do not know how to invest their money 

They make systematic mistakes and display behavioral biases 

Financial advisors are expensive, might be biased 

Robo-advising potentially helpful 

Cheap and easy to use 

 But, does one size fit all with robo-advising? 
 

 

 

 

 

 

 

OUR SETTING 

A large full-service brokerage house in India 

800,000+ retail accounts 

In July 2015, they introduced a Portfolio Optimizer Tool 

obtains existing portfolio holdings from account 

performs Markowitz mean-variance optimization 

proposes optimal weights, depicts outcomes

 single-click execution if desired by investors. 

weights as determined by investors 
 

OUR SETTING

ROBO-ADVISING FOR RETAIL INVESTORS 

Obtain existing holdings from portfolio Maximize, analyze & button to execute 
 

 

 

 

ROBO-ADVISING & DIVERSIFICATION

NUMBER OF STOCKS HELD 

Investors less diversified 

before usage increase the 

size of their portfolio by 

more than 80% 

Those diversified before 

usage do not change 

(if anything, less stocks) 
 

 

 

 

 

ROBO-ADVISING & DIVERSIFICATION

PORTFOLIO VOLATILITY 

Investors less diversified 

before usage decrease the 

risk of their portfolio by 

more than 50% 

Those diversified before 

usage have barely lower 

volatility after usage 
 

 

 

ROBO-ADVISING & PERFORMANCE

INVESTMENT RETURNS 

Investors less diversified 

before usage also perform 

better trades on average 

Those diversified before 

usage have similar 

performance 
 

 

 

 

 

 

ROBO-ADVISING & PERFORMANCE

FEES PAID 

Investors most diversified 

before usage pay much 

higher fees overall 

They trade more even if no 

better performance. They 

use the optimizer too often 
 

GAINING AND LOSING WITH ROBO-ADVISING

Higher diversification 

Least sophisticated Higher Performance Investors 

No Change in Fees 

Lower diversification Most sophisticated 

Investors No Change in Performance 

Higher Fees Paid 
 

 

 

 

 

 

WHAT’S IN IT FOR THE SOPHISTICATED? 

Behavioral biases affect all investors, including sophisticated investors

 Disposition Effect 

do not sell loser stocks when should, sell gaining stock when should not 

 Trend Chasing

 purchase stocks that gained recently to “ride the wave” 

 Rank Effect 

sell stocks in portfolio with extreme returns 
 

 

 

 

 

 

 

WHAT’S IN IT FOR THE SOPHISTICATED? 

Behavioral biases affect all investors, including sophisticated investors

 Disposition Effect 

do not sell loser stocks when should, sell gaining stock when should not 

 Trend Chasing

 purchase stocks that gained recently to “ride the wave” 

 Rank Effect 

sell stocks in portfolio with extreme returns 

Biases decline for EVERYBODY in our setting 

Causal identification — missed calls versus calls picked up 
 

 

SO WHAT?

WHY ROBO-ADVISING IS IMPORTANT 

So far, two views of intervention on individual decision-making 

LIBERTARIANISM 

LIBERTARIAN 

PATERNALISM 

No intervention 

Everybody knows better 

for themselves 

Give a Default 

(Richard Thaler, “Nudge”) 

We know better 

than everybody 
 

 

 

SO WHAT?

WHY ROBO-ADVISING IS IMPORTANT 

Robo-advising with voluntary uptake helps overcome algorithm	aversion

LIBERTARIANISM 

No intervention 

Everybody knows better 

for themselves 

(Dawes, 1979) 

ROBO-ADVISING 

Explain best choice, 

easy implementation 

Ultimate active choice

 is the investor’s 

LIBERTARIAN 

PATERNALISM 

Give a Default 

(Richard Thaler, “Nudge”) 

We know better 

than everybody 
 

 

 

 

WHAT ABOUT THE BROKERAGE HOUSE? 

A flood of robo-advisors in the market now. 

Will the demand for human advisors decrease? 

Old North State Trust, LLC (2017) says “... we don’t expect robots to ... put us out of 

business.” 

Humans are more willing to trust machines for objective decisions, e.g., Netflix, 

Amazon. They trust driverless cars less even if safer and lose trust in algorithms quicker 

(Hosanagar and Cronk, 2016) 
Demand for human advising when robo-advising is introduced

Panel A. Change in Length of Client initiated Calls

Change in the Amount of Time Spent with Advisors (Client Calls) 

3 

Abnormal Length Calls Advisors to Clients Abnormal Length Calls Clients to Advisors 0 1 2 3 0 1 2 

0 50 100 150 200 250 

Number of Days after Adoption 

Panel B. Change in Length of Advisor initiated Calls

Change in the Amount of Time Spent with Advisors (Advisor Calls) 

0 50 100 150 200 250 

Number of Days after Adoption 
 

 

 

 

 

 

WHAT ABOUT THE BROKERAGE HOUSE? 

A flood of robo-advisors in the market now. 

Will the demand for human advisors decrease? 

Old North State Trust, LLC (2017) says “... we don’t expect robots to ... put us out of 

business.” 

Humans are more willing to trust machines for objective decisions, e.g., Netflix, 

Amazon. They trust driverless cars less even if safer and lose trust in algorithms quicker 

(Hosanagar and Cronk, 2016) 

Treating investors with robo-advising increases the demand for human advising, and 

probably, the type of advising. We are fleshing out these results with more detailed 

data on interactions between investors and advisors. 
THE PROMISES AND PITFALLS OF ROBO-ADVISING 

Francesco D’Acunto

Nagpurnanand Prabhala

Alberto G. Rossi