ROBO-ADVICE: AN EFFECTIVE TOOL TO REDUCE INEQUALITIES?

Abstract

When it comes to financial choices, households face complex decisions. Choosing how much to save or consume out of a monthly income in a way that is optimal over working life and retirement is the fundamental issue in personal finance. This decision has significant repercussions on a household’s well-being and the well-being of their offspring because even slight differences in monthly saving rates can amount to substantial variation in long-term wealth accumulation. But the choice of how much to consume and save at each point in time is only the first of a series of intertwined decisions households face. For instance, households also need to decide whether they should invest their savings in stocks, bonds, housing, or other assets, all of which have very different risk-return profiles. Also, households need to choose how to finance their consumption, especially for durable goods such as cars, housing, or academic degrees. Financing choices have enormous consequences on financial and mental well-being, especially for individuals at the beginning of their careers and with lower-paying jobs who face the challenge of attempting to reduce their student and credit-card debt balances. Virtually every household around the globe faces these personal finance decisions on a daily basis, but very few of them are equipped to understand the trade-offs and make sound choices. Historically, human financial advisors and financial planners have provided support. However, due to the opportunity cost of time, financial advisors find it economically profitable to cater to wealthy individuals, who paradoxically are better equipped to make these decisions relative to vulnerable households in the first place. Differential access to financial advice has likely contributed to the growing wealth inequality documented in the U.S. and abroad over the last few decades. How can we ensure that sound financial advice is available to all households, especially the most vulnerable ones? Over the past decade, we have experienced a revolution in personal finance with the introduction of robo-advisors embedded in financial technology (fintech) applications (apps). Robo-advisors collect and analyze large amounts of transactional data and provide individuals with suggestions on how to improve their choices. Depending on the soundness and appropriateness of the algorithms they employ, robo-advisors have the potential to improve households’ decision making considerably. In what follows, we describe the nature and scope of robo-advisors in financial decision making and discuss a few examples of robo-advice designs that have delivered mixed success. Finally, we discuss some of the most critical policy debates around robo-advisors.