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Financial Advice Cannot be Outsourced to a Machine

While standardised and scalable services can provide benefits via lower costs and greater efficiency, these services are general and somewhat homogenous

Daniel Needham 15 September, 2014 | 3:51PM

The financial arrangements of advice businesses are going through huge structural change as they adjust to disruptive technologies and a new regulatory environment.

Comprehensive financial advice requires human engagement

To manage these businesses more efficiently and to reduce regulatory risk, advisers have increased their use of external risk-profiling services. However, industrialised risk management through off-the-shelf risk-profiling tools is dangerous.

While standardised and scalable services can provide benefits via lower costs and greater efficiency, these services are general and somewhat homogenous.

For the adviser, this means trading off efficiency with specificity as they move away from custom-built advice for individuals’ specific needs. It is important to remember financial advisers remain responsible for the advice they provide, in spite of the use of external tools to help advisers manage that advice.

Advisers must remain wary about how much of the advice process is industrialised or turned over to external tools. The biggest risk is outsourcing the advice itself.

Good advice is hard to measure, as the path not taken is not easily assessed. The client who embarks on a savings plan recommended by a financial adviser will experience a future that was far from guaranteed had they not met that adviser. The adviser who genuinely understands a client’s situation and helps them stick to their investment strategy during tough times is providing much more than the output of a simple risk tool and the advice process is much more than risk profiling.

This is equally true when one thinks about the risks that need to be considered within an investment plan. This may include helping the client plan for spending in the distant future, or managing the impact of very low-probability disasters, such a fire, flood, ill health and premature death.

The adviser must help set the right strategy to meet the client’s goals, ensure their ability to tolerate losses is understood, clarify the nature of risk, help clients appreciate the difference between temporary and permanent losses, explain what may happen in certain market environments and encourage investors to stick to their saving plan while dealing with specific events.

Comprehensive financial advice requires human engagement as the nature of risk is subjective and hard to quantify. It is only after properly analysing a client’s financial situation, investment objectives and capacity for loss, does risk preference play a minor role in setting the right investment strategy.

Relying solely on risk profiling tools leads to poor advice. In fact, the outsourcing to external tools without a strong due-diligence process and client-specific advice is potentially a much larger risk than traditional forms of risk profiling.

Sensible risk management requires subjective interpretation and a strong understanding of the client’s specific circumstances. Genuine financial advice is therefore complex and iterative.

In the pursuit of managing business and regulatory risk within advisory businesses, the advice industry may have introduced a much larger risk – outsourcing advice to simplistic risk-profiling frameworks.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Daniel Needham  is Global Chief Investment Officer for Morningstar Investment Management.

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