The Robo-Advisor movement with its simplicity, hi-tech efficiency, and low cost has gained the attention of the general investing public. Once thought of as a fad by traditional financial advisors, “Robo’s” have entered the mainstream and appear to be in it for the long run. It’s time investor’s start asking some important questions about what this means for their money.
What are Robo Advisors?
Most Robo Advisors like Betterment, Schwab Intelligent Portfolios, Wealthfront, FutureAdvisor, etc., operate similarly, walking you through a brief risk tolerance questionnaire that assigns you to a pre built model portfolio based on your answers. Given the fact that they all use passive, market tracking, index based ETF’s (Exchange Traded Funds) to build their portfolios; you’re likely to find the investment experience fairly similar across the board. This makes the differences between them harder to see for anyone trying to choose between providers.
Is Robo-advice Advice at All?
While there are great things coming out of this movement, investors need to recognize its limitations. Can something designed to offer turnkey automation always act in the specific best interests of each individual investor? To contrast with a similar movement in the law industry, even legal document platforms such as LegalZoom recognize their limitations; fully disclosing “they are not a law firm or a substitute for an attorney or law firm.”
To discount the importance of human intervention is to suggest that an algorithm can provide all the necessary guidance to being a successful investor. Research has shown that one of the largest inhibitors to investor success is controlling their own emotions. Dalbar Inc. a Boston based research firm demonstrates the gap in performance based on the 20 year return of 9.22% for the S&P 500 compared to the average equity investor return of 5.02% through 2014. There are many factors that contribute to this performance gap, but behavior can’t be discounted.
Most of these providers began gaining serious momentum after the 2008-2009 financial crisis. Betterment and Wealthfront were both founded 2008, Future Advisor in 2010 and Schwab Intelligent Portfolios in 2015. The over 6-year bull market to follow didn’t offer much of an emotional test to the discipline required of buy-and-hold investors. When markets go south, even subtle changes such as adjusting a portfolio to be more conservative until volatility passes can have a significant impact on long-term performance. What safety net exists to ensure decisions are being made based on long-term goals and not emotion? At the very least, the absence of quality human interaction adds some hurdles to the management of investor behavior.
Are Robo's Fiduciaries?
An advisor acting as a fiduciary is required to place the clients best interests above their own. This one’s tough to answer because it's hard to argue that an all ETF portfolio is the most appropriate vehicle for every investor. Therefore, is the Robo Advisor actually doing what’s in the best interest of each individual client? Even though they may suggest the reasoning for using ETF’s is due to the passive, low cost, research driven investment ideology, you could easily argue that Robo Advisors use them largely because they’re easy and inexpensive to trade.
Furthermore, how are the ETF's objectively selected? For instance: are Schwab Intelligent Portfolios being completely objective when using underlying Schwab ETF’s in their portfolios? The same can be said of FutureAdvisor, a company owned by Blackrock that incorporates iShares ETF's. This isn’t a shot at the merits of ETF’s as either a good or bad investment vehicle. It’s a discussion focused on whether or not an all ETF asset allocation is most appropriate for every investor.
Technology has always been about becoming more efficient and improving the quality of life. However, it’s important to remember that it has its limitations. I built WealthShape with the idea of reinventing the way quality investment advice is delivered. Technology plays a big role in what I do. The tough questions I’ve asked should be asked by anyone intending to hire a financial advisor, Robo or not. Eventually, if enough get answered, investors will be in a far better position to compare the benefits and drawbacks of each option.
Timothy Baker, CFP® is the Founder and CEO of Wealthshape LLC, an advice and investment management firm built on reason and empirical evidence. WealthShape strives to be a market leader in factor-based investing by carefully designing advanced multiple provider portfolios delivered at a low cost to investors from all walks of life.
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By Tim Baker, CFP®
Advice and investment design should rely on long term, proven evidence. This column is dedicated to helping investors across the country, from all walks of life to understand the benefits of disciplined investing and the importance of planning.