Probably not, especially if the Robo-portfolio remains static vs. dynamic.
Robo-advisors – computer-based investment services – claim to do a better job managing your money than the flesh-and-blood kind. They charge less: around 0.25% of your assets yearly vs. 1% for regular advisors. However, these computer-based newcomers might not be worth the lower fees. The odds of a computer protecting your money in a downturn are not encouraging. Additionally, when markets reverse course and head north, the results might be even worse.
Is Technology Good?
In finance, there are cases when technology appears to be working for us, and also against us. Almost all investors agree that lower commission rates and improved trade executions show technology’s positive benefits. On the other hand, it is unclear if high-frequency trading is positive or negative. Remember the Flash Crash, when DJIA lost 700 points in a few minutes? Computer trading contributed to the temporary destabilization of the stock market.
Distinguish Great Marketing from Real Advice
One area where the use of technology is more frequent is in financial services marketing. Robo-advisors claim to be the next best thing for investment services. Essentially, you enter information about your age, wealth, and risk tolerance. In return, you receive a recommended portfolio of stocks, natural resources, real estate, and bonds. The portfolio components are somewhat different based on whether the account is taxable or tax deferred. However, a slick website does not necessarily mean that you are now on a path to slick investment returns. It is important that you don’t confuse financial planning with financial intelligence or financial advice.
A Simple Test
As a test, we entered the profile of a fictional investor into a Robo-system to see what it recommends. Here were the assumptions:
- 50 years-old
- Current retirement assets of $100k
- On a scale of one to 10, the risk appetite selected was five
The computer recommended, for a taxable account, 26% in U.S. stocks, 17% in foreign stocks, 11% in emerging market stocks, 11% in dividend stocks, and 35% in municipal bonds. We then placed the components of the Robo-plan into a back-testing simulation program in the recommended ratios and found the following performance from January 2009 through the end of 2018:
- $100,000 grew to $109,876
- 2017 was the best year with a return of 17.96%
- 2018 was the worst year with a return of -6.85%
Compare the Robo-model with an investment in a simple S&P 500 Index ETF over the same time frame and we see:
- $100,000 grew to $347,718
- 2013 was the best year with a return of 33.45%
- 2018 was the worst year with a return of – 5.21%
Ok, maybe that Test is Unfair
Now, most would admit that this comparison is not very fair to the Robo-advisors because the time frame covered is during one of the greatest bull markets in history. So, let’s adjust and assume 50% of the assets were invested in an S&P 500 Index ETF and the other 50% were invested in a 20-Year Treasury Bond ETF. Here is what happened:
- $100,000 grew to $235,343
- 2014 was the best year with a return of 19.92%
- 2018 was the worst year with a return of -3.41%
Robo-advisors Have Great Websites
While the tested Robo-enterprise deploys excellent website development, the portfolio recommendations represent a very old-school, buy-and-hold approach. The new technology does little to protect your assets during times of crisis when you may incur significant losses across the board. Further, technology did little to allow you to enjoy what happened to be one of the greatest bull-market runs of all time.
Buy and Hold is Not Always the Best
Author Miguel de Cervantes, in the novel Don Quixote, writes “It is the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket.” The technology used by Robo-advisors is missing diversification because it seems that all their client’s eggs are in a buy-and-hold basket.
A crisis can disrupt a buy-and-hold basket, and the lack of investment method diversification allows for the assets to fall together. This becomes evident when you look at the performance history of almost any non-agile, buy-and-hold portfolio of stock and bonds. A better strategy may be to allow a wealth advisor to move money dynamically and proactively from one asset class to another (e.g., from stocks to bonds, and vice versa). The results can be quite different from the results of using Robo-advisors.
