As an investment advisor firmly entrenched in the world of exchange-traded funds, I often get asked about the arrival of automated investment services. The industry term for these companies has evolved into the “robo advisor” moniker because of the heavy online/computerized nature of the services.
Many people believe that these services are going to revolutionize the field of asset management to provide more efficient practices at a fraction of the cost. Other investors are skeptical about what you are paying for to begin with if they are just throwing you into a model and rebalancing on a quarterly basis.
Obviously my own personal analysis of these companies is going to be heavily biased by the fact that they are direct competitors with my firm. We both provide ongoing asset management services using low-cost ETFs, albeit in very different ways.
Nevertheless, I think it’s important to look at the unique characteristics of these companies to determine if a robo advisor is right for you. The decision to hire an investment advisor is one that should be driven by a variety of factors that may evolve over time as your needs and the world around you change.
Meb Faber recently did an excellent profile on the differences between the top providers in this space – i.e. Schwab, WealthFront, and Betterment. He back tested the asset allocation profiles for each service over multiple decades and came to an obvious conclusion. They are all pretty much the same.
All of the outcomes are generally preordained by the similar portfolio construction techniques and investment methodology. You are signing up for a “buy and hold” portfolio of ETFs that will make little real world changes with the exception of scheduled asset allocation rebalancing.
The only way you can significantly change your outcome is to instruct the computer to make your portfolio more conservative or aggressive, which is generally frowned upon. The whole point of these services is to keep you from making emotional decisions with your money – i.e. selling low and buying high.
Who should use a robo advisor?
If you are in the wealth accumulation phase of your life, are focused on other personal endeavors, and just want to buy a basket of stocks and bonds, then you should be with a robo advisor.
If you believe that there is no such thing as market beating returns or risk management is a fool’s errand, then you should be with a robo advisor.
If you are paying more than 1.00% for a full-service “buy and hold” investment advisor right now, then you should be with a robo advisor.
If you are just starting out in investing and are intimidated by the concept of building a portfolio, then you should be with a robo advisor.
Who should not use a robo advisor?
If you are concerned about managing downside risk in your portfolio through active asset allocation changes or stop losses, then you should not use a robo advisor.
If you require regular servicing of your account through cash management needs, investment questions, financial planning, or other general updates, then you should not use a robo advisor.
If you want to customize your investment objectives to meet your goals with respect to growth or income, then you should not use a robo advisor.
If you want to comingle multiple security styles such as mutual funds, ETFs, individual stocks, or closed-end funds, then you should not use a robo advisor.
If you enjoy a hands on approach that allows you flexibility to suggest changes or work together with your advisor, then you should not use a robo advisor.
The Bottom Line
Robo advisors are fantastic solutions for investors that desire a passive portfolio approach with proven tools for very little (if any) cost. I think they definitely bridge the gap between overpriced “buy-and-hold advisors” and the throw caution to the wind “do-it-yourself” crowd.
Nevertheless, these automated services leave much to be desired for those that request a strategic objective such as low volatility or high income. Retirees in particular should be wary about how these portfolios will ultimately react in the face of falling stock prices or rising interest rates.
In my conversations with investors, these are increasingly common topics that drive investment decisions at this stage of the market cycle. No matter what style of advisor you choose, make sure you thoroughly understand their fees, investment process, and the services they provide in order to ensure they are the best fit for your needs.
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