Doesn't it just sound so cool saying it: Robo Advisors. And although some of these automated investing companies have been around for 5+ years now, the recent rise in popularity of robo advisors like Wealthfront and Betterment is alarming.
If you haven't been keeping up with the latest FinTech craze, robo advisors are simply the next logical Wall Street sequence or disguise for money management. Instead of having a financial planner or "human" directing your portfolio, a computer algorithm or "robo advisor" makes investment decisions on your behalf. You input your age, current portfolio value, risk tolerance, etc. and the algorithm automatically determines the optimal allocation of stocks, bonds, cash, ETFs, emerging markets, and so on. All the number crunching and modeling are supposed to ensure that your portfolio is accurately diversified and theoretically safe.
The robo advisors lure being that computers are never emotional and can often make better decisions than humans. And since you don't have to hire a certified financial advisor that charges a higher fee, you'll save money with lower fees and other premium features like automatic rebalancing, tax-loss harvesting, etc. Now, while I generally agree with the premise of what robo advisors are trying to accomplish, I believe that they are incredibly inefficient it helping the average investor or retail trader.
Key Points from Today's Show:
- There are two main robo advisors out there right now; Betterment and Wealthfront. Robo advisors are computer advisors or an algorithm advisor trying to replace or be an alternative to a human advisor.
- On their platforms you enter your age, risk tolerance, and portfolio size, then the computer will automatically process your portfolio and give you your recommended allocation.
- Robo advisors assume that by investing in ETF's it reduces the cost of using a traditional financial advisor. They automatically rebalance your portfolio, and do an automatic tax loss harvesting — whenever you have a losing position they will automatically try to close it out and harvest the tax loss out of it to minimize the impact on your taxes.
- The reality is, none of these robo advisors actually work. Once you dig through their numbers, you can see that they do not make any better returns than the S&P 500.
- We know that the 60-40 stock allocation does not really perform better than say an options portfolio. So why would an automatic allocation of the same 60-40 stock portfolio perform better? It wouldn't. It still does not work.
- You have to take control of your own portfolio if you want better returns.
Robo Advisors Research:
- Emailed both Betterment and Wealthfront to ask about their performance numbers and data — in order to compare a Betterment or Wealthfront portfolio to a benchmark index like the S&P 500.
- Betterment states that customers can expect a 4.3% higher return than a typical DIY investor. This shows that it is completely misleading because they are not benchmarking against an index like the S&P 500.
- In fact, Betterment performance shows that not one single allocation or portfolio they have beats the S&P 500 — not one!
- In the last 12 months, the S&P 500 has been up 1.7%. Betterment's 100% stock allocation, their best highly tracking portfolio, is down by —5.1%.
- Wealthfront has no definitive place where you can actually find their return numbers for their portfolios. They simply replied (see screenshot) by stating that "the ETF's in their allocations will never exceed the benchmarks like an active fund might."