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. But these computer-based newcomers might not be worth the lower fees – especially because the odds of a computer protecting your money in a downturn are not encouraging. And when markets reverse course and head north, the results might be even worse.
Start with Technology is Good
In finance, as with most things in life, 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, where professional traders zip in and out of stocks in fractions of a second, is a positive or a negative. Remember the Flash Crash, when the DJIA lost 700 points in a few minutes as computer trading contributed to the temporary destabilization of the stock market?
Separate Great Marketing from Real Advice
One area where technology is likely to be used more frequently 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 into their website, and 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.
But technology in financial planning should not be confused with financial intelligence or financial advice. A slick website does not necessarily mean that you are now on a path to slick investment returns.
A Simple Test of the Robo
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% foreign stocks, 11% emerging market stocks, 11% dividend stocks, and 35% 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:
· That $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:
· That $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 Robos, 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:
· That $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%
Robos Have Great Websites
While the tested Robo-enterprise deploys excellent website development and is affiliated with many people who hold PhDs in finance, 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 asset correlations migrate toward one and significant losses may be incurred across the board. Further, the technology did little to allow you to enjoy what happened to be the one of the greatest bull-market runs of all time.
Buy and Hold is Not Always Best
Author Miguel de Cervantes, in the novel Don Quixote published in two volumes in 1605 and 1615, 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 Robos has not significantly advanced the concept of asset diversification and not putting all of your eggs in one basket. What is missing is diversification of investment method because it seems that all of 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 is to allow a wealth advisor to dynamically and proactively move money from one asset class to another (e.g., from stocks to bonds, and vice versa).
The results can be quite different.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. All indexes are unmanaged and cannot be invested into directly.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
Treasuries are a marketable, fixed-interest U.S. government debt security. Treasury bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.
Although exchange traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the trusts may not be able to exactly replicate the performance of the indexes because of trust expenses and other factors.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
This article was prepared by RSW Publishing.
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