Robo-advisors take away what we [humans] have a hard time controlling – our emotions.
It’s the curse of most investors, who get wrapped up in stories of overnight success and striking it rich. Our emotions carry our thoughts into unrealistic places with the hopes that we are going to make big money from some fancy idea. Unfortunately, that fancy idea often leads to failure.
That’s where a robo-advisor comes in; they take the emotion out of investing. Currently, there are dozens of robo-advisors available for the average investor.These robo-advisors make investment suggestions based upon algorithms that analyze the current market conditions. Instead of recommending ‘hot-stocks,’ the algorithm suggests ways to balance a person’s portfolio to maximize returns. These recommendations are determined by market history and forecasted market direction.
Now, this seems like a logical way to invest, especially for new investors. But, the biggest attraction is that most robo-advisors have very low account minimums and also charge low fees.
In comparison, most wealth managers (actual people) have a $500,000 USD account minimum and charge 1% – 2% annually of the total account value. This is simply not an option for most.
I’m a huge fan of technology and finding more efficient ways to complete tasks… but I’m a bit weary of these robo-advisors, and I think you should be too.
First of all, these robo-advisors give you the false security that your account is bomb-proof. Our financial world is going through unknown territory, so no matter what an algorithm suggests the best move may be unknown to the robot.
Secondly, if a robo-advisor suggests you make a certain trade based off of what the market conditions are, then other robo-advisors are probably making the same suggestion. This would imply that many people would be making the same trade, which would then take value away from a specific investment (crowded investments are usually priced higher, eliminating much of the value).
Third (and most importantly), unhappy hedge fund clients are pulling their money from traditionally managed funds and reinvesting in computer-driven funds – and they are still losing money.
These hedge fund clients have been unhappy for the past couple of years because many hedge funds are having a very tough time making returns in our zero-percentage-rate environment. As a result, they have moved their money to robo-advisor type funds, but they are still losing money.
Finally, if you are considering using a robo-advisor, you should take a realistic view of what you’re actually after. Most clients of robo-advisors are millennials who have deposited small amounts into these computer guided systems. These accounts often have an annual fee that is around .5% of the total account size AND they charge about $1 per month. If you have an account with $500 in it, then you’re annual fees would be 2.9%, which is higher than a professionally managed account.
Keep in mind why theses robo-advisors were created in the first place: for companies to make passive money on a large scale. These companies have intentionally targeted a market (small-time investors) who may not be completely aware of what they are paying to have their money managed.
Perhaps in the future, these robo-advisors will lower fees or have a better track record. But, for now you should be aware that these services are definitely not the perfect answer to your investing woes.