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The overhyped rise of robo-advisors has spurred a healthy debate on fees charged by advisors. In an insightful blog post, Michael Kitces makes the case for why robo-advisors will not be a threat to human advisors. In a similar vein, Mike Alfred, co-founder and CEO of the financial information company BrightScope, debunked much of the advisor bashing underlying the robo-advisor model. Nevertheless, some traditional advisors feel pressure to lower their fees to compete with robo-advisors, even though the services they offer are more comprehensive.
These advisors have succumbed to the basic premise used to justify robo-advisors’ existence: Cheap is good. Expensive is bad.
Do the data support this premise? There’s a significant amount of peer-reviewed research on this subject. It is eye-opening.
Looking at the research
A 2005 study concluded that consumers typically assume price and quality are correlated. This is especially true when they are unsure of what they are really getting.
Robert Cialdini illustrates this phenomenon in his book Influence: Science and Practice. Chivas Regal Scotch whiskey was struggling to penetrate a crowded market. Its managers came up with a brilliant idea that is now part of marketing lore: Don’t change the product — just increase the price so it will be far more expensive than its competitors. Sales took off. Clearly, buyers of Chivas Regal believe it is superior to its lower-cost competitors.
For me, the most compelling study was published in 2008 by professors at the California Institute of Technology and the Stanford Graduate School of Business. The authors of the study wanted to determine if changes in price affected the brains of consumers in a measurable way.
One might think consumers of food and wine should be influenced only by the taste of what they are eating or drinking. However, the authors referenced a number of studies that indicate that this is not the case. For example, participants who were told about the ingredients in a brand of beer reported better taste quality than those who weren’t.
The researchers scanned participants using functional MRI to test their theory that price increases in a product positively affect that portion of the brain that experiences pleasure. The subjects were told they were sampling five different cabernet sauvignons, which were identified only by retail prices. In fact, there were only three different wines. Two of them were administered twice. In each case of duplication, one of the two was identified as being much more expensive than the other.
The researchers found a direct correlation between an increase in the perceived price of wine and an increase in the part of the brain associated with pleasurable activities. They theorized that the expectation that a more expensive wine would be superior in taste to a less expensive one triggers higher activity in the part of the brain that experiences pleasure. These findings debunked previous beliefs that “experienced pleasantness” is solely a function of the intrinsic properties of a beverage and the state of the consumer’s thirst at the time of consumption.
There’s another intriguing ramification to the effect of higher prices on brain activity. In another study reported here, one of the co-authors of the wine study found that people who paid a higher price for the energy drink Red Bull demonstrated superior ability to solve brain teasers than those who paid a discounted price for the same drink.
The ramifications of these studies for advisors are profound. Initially, as argued by Kitces and Alfred, it’s important to compare the breadth of services you are providing to those offered by robo-advisors. In addition, you should take comfort that your clients are likely to be predisposed to associate your higher fees with higher quality, which their actual experience will likely validate. Conversely, they may associate the lower fees of robo-advisors with lower quality and service. Finally, the fact that your fees are higher may empower your clients to engage in a more thoughtful and analytical assessment of their financial situations, resulting in more informed decisions.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is The Smartest Sales Book You'll Ever Read. He limits his sales coaching practice to advisory firms that advocate evidence-based investing.
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