Should you invest with a Robo-advisor?
There is currently a race to see which company will launch the first self-driving car. Artificial intelligence and automation have become the two biggest business opportunities in the next decade. The financial planning industry has it’s own version of a self-driving car – the “robo-advisor”.
“Robo-advisors” are a new version of a financial adviser that provides portfolio management and financial planning through apps and fancy websites. “Intelligent Portfolios” are showing tremendous growth. Fidelity, Charles Schwab and other firms have recognized the threat and have recently made major strategic decisions to offer more automation. The current leader in the field is Wealthfront. They have gained over $2B in new assets in only a few years.
This week one of my clients asked me if I thought the “robo-advisor” was a good alternative to traditional asset management. Would these services eventually replace financial advisors? To answer this question, I decided to do a little research.
My first step was to sign up for these services as a prospective investor. The technology was amazing and I could see why they have been an overnight success. The account opening process was quick and easy. These “robo-advisors” had me signed up in 5 minutes and had uncovered all of my investable assets and knew every detail about my financial life. The goal setting calculators were the best I had seen. The “robo-advisor” goal setting technology was better than the financial software used by many financial planners.
My second step was to see how they were going to gauge my risk tolerance. I ran various allocations for different goals and changed my age to see how this software would adjust to my risk profile. Surprising, the results were terrible! If this new automated asset allocation was equivalent to a automated self-driving car there would be a 10 car pile-up. The claims of better returns and diversification were unfounded. In one case, my moderate allocation looked like an aggressive allocation. All the services made unwarranted claims of offering a smarter way to invest with better returns over your “typical investor”. They showed how tax loss harvesting was going to add to returns and more global diversification and smart rebalancing would increase returns by over 4%. These claims may not hold in actual practice.
My last step was to review their asset allocations and back-test how they were constructed. How were they going to diversify my portfolio? How were they going to produce “better returns” as they stated on their websites? I blended all the asset allocations using my tools and compared it to other diversified portfolios in the Morningstar database. What I found was that any of these allocations would be the lowest rated in major categories. Two of the leading “robo-advisors” had a moderate model of almost 38% in developed markets and 10% in Emerging Markets. These moderate allocations over 5 years offered much more risk than the S&P 500 index and trailed the S&P 500 by over 40%! The fancy “robo-advisor” software that didn’t miss a detail on my goal planning had somehow failed to show me the 3, 5, and 10-year trailing returns. Calendar returns and a benchmark would have been nice to see as well.
At my wealth management firm, we don’t sell you pie charts or make claims of “better returns”. Our asset allocations are created to seek the best investment opportunities and not just give you market exposure. Now to answer the question that my client asked me earlier this week on: if he should invest with a “robo-advisor”. I believe that these automated services will help you to organize your finances, track your spending, and set goals for the future. However, if you are seeking a customized asset allocation, I’d invest my wealth with a real advisor who had knowledge of how to create a model portfolio and one that could ask me more in-depth questions of my risk tolerance.
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Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market.
They are methods used to help manage investment risk.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.
