Can Robo Advisors Improve Your Behavior?
By: Mathieu Gouraud
Tags: Behavioral Economics, Investing, Financial Planning, Robo Advisor

Have you seen the documentary the Social Dilemma?

After watching it, I’ve proceeded to delete all the social media apps on my phone.

My reaction was how scary it is that technology is starting to understand us. So much so that It has learned to manipulate our behaviors and profit from them.

But we can also use technology as a way to prompt good behaviors and improve our overall well-being.

With that in mind, I’ve been wanting to write an article on robo-advisors with a different take than most of the articles already out there.

I thought meshing the two ideas together would be a perfect fit.

A Brief History of Robo Advisors

The first robo-advisor company was launched after and as a result of the Great Financial Crisis of 2008.

The main purpose of robo-advisors at first was to provide investors a low-cost and well-diversified portfolio.

The robo-advisor would then rebalance the assets in a portfolio automatically for investors to manage their passive and long-term investments. All that through a simple and intuitive interface.

Now robo-advisors can do much much more than just rebalance your investments.

They are now able to perform tasks such as:

Minimizing your taxes through tax-loss harvesting

Providing more personalized investment selection (socially responsible investments, Halal investing)

Setting you up for retirement planning

Robo-Advisors are even starting to understand how you behave during times of market stress. As a result they are implementing tools that can improve your behavior and, subsequently, your investment returns.

How Robo Advisors can Improve Your Behavior

The best example of how robo-advisors can improve your behavior is an experiment that betterment conducted: Our Evidence-Based Approach to Improving Investor Behavior.

Betterment tested 3 features that they believed could improve investors’ behaviors and investment returns.

Email Notifications

During a market downturn in 2013, Betterment sent out an email to some of its customers explaining the reasons for the downturn and why they should remain invested.

They also abstained from sending an email to their other customers. this way they could compare the effects the email had on their customers’ behavior.

The findings were rather interesting:

The customers that tended to log in the most to the app reacted positively to the message as they were already looking for advice on actions to take with their money.

The ones that rarely logged in to the app reacted more negatively to the message. The underlying reason was that they were more likely to not think about their investments and receiving the message caused them stress.

The takeaway was that notifying clients about market downturns is not necessarily the best course of action for everyone and that these messages should be targeted only towards a specific subset of customers.

In-app Notifications

During another market downturn, Betterment sent out notifications to some of its customers who were logging into the app.

For those that received the notification, they were split into three different groups.

Got a message letting them know to stay the course and not take any action. Was advised to take this opportunity to make more deposits into their account. Was told the reason why they were currently losing money and told not to react.

Overall the notifications worked well at decreasing bad behavior (i.e. selling investments or making a significant allocation change). But group 2 and 3 decreased their rate of deposits and increased their withdrawal rate.

Betterment concluded that the best communication method was what they did for group 2: tell people what they should do for the most positive outcome.

Tax Impact

Another way Betterment tried to limit bad behavior was by incorporating how much tax customers would pay if they wanted to change allocation or withdraw their money.

If you withdraw your money or make an allocation change, you have to sell some of your investments. In a taxable account, selling a position in which you made a profit results in a capital gains tax.

Customers that had to pay taxes of $5 or more were 62% less likely to proceed with an allocation change or withdraw their money.

This means they were also more likely to benefit from higher investment returns by staying invested in the markets.

How else can robo advisors improve your behavior?

These are only 3 scenarios by which robo-advisors are able to improve behavior.

As we attempt more experiments, I’m confident that we will be able to find hundreds if not thousands of ways to improve behavior not just in investing but in managing money in general.

However, although robo-advisors can certainly improve our behaviors, can we benefit even more from a human approach?

Financial Advisors vs Robo Advisors

There is a raging debate going on in the financial advice industry between robo-advisors and traditional financial advisors.

Some financial advisors feel like they are at risk of becoming obsolete and replaced by robo-advisors.

But the truth is as much as Robo-Advisors are implementing ways to improve our investment behavior, they are still no replacement for a human financial advisor.

There is more than enough room for cooperation between robo-advisors and financial advisors. Some firms are recognizing this fact and are offering a hybrid model:

For example, Vanguard group has a hybrid offering called Personal Advisor Services,.

The robo component takes care of all the manual calculations and retrieves insights on client’s data. The human advisor takes care of the emotional and behavioral coaching part.

This combination allows financial advisors to give better advice to their clients as well as serve more clients for a lower fee.

Instead of trying to beat the market, Financial advisors should double down on acting more as therapist and behavioral coaches: coach clients into making better investment decisions, understanding and changing their clients’ money beliefs, being empathetic during hard times.

Robo-advisors will never be able to take on this role because they are too rational to understand human emotions.

Conclusion

My resulting conclusion is that robo-advisors can definitely improve your behavior.

However, I think financial advisors are still better when it comes to behavioral coaching.

If you don’t have a complex financial situation but feel stressed about your investments when the market is going down and you have a tendency to sell them as a result, you might benefit more from a hybrid approach.

Moreover, if you need help outside of investing, like optimizing your taxes and budgeting, a human financial advisor will be in a better position to help you.