OAP 052: Robo Advisors – Why Automated Investing Is NOT The Wave of The Future

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Doesn't it just sound so cool even 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.

In today's podcast, I'll help you understand exactly why these robo advisors are not the investing wave of the future and why you should steer clear of them. I'll even prove that some of the most popular and widely "respected" robo advisors underperform the benchmark S&P 500 index despite what you might read on their website homepages. I think the results and data we present might make you think twice about investing your money with them.

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 (see screenshot) shows that not one single allocation or portfolio that they have beats the S&P 500 — not one!

Betterment Performance

  • 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."

Wealthfront Performance

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Free Options Trading Courses:

  • Options Basics [20 Videos]Whether you're a completely new trader or an experienced trader, you'll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
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  • Pricing & Volatility [12 Videos]This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We'll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
  • Neutral Options Strategies [7 Videos]The beauty of options is that you can trade the market within a neutral range either up or down. You'll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
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Real-Money, LIVE Trading:

  • IWM Iron Butterfly (Closing Trade): Exiting this IWM iron butterfly options trade gave us a $1,100+ profit after pinning the stock price one day before expiration at the peak of our spread.
  • CMG Iron Condor (Opening Trade): I just recorded my live trading platform (and real money account) as I walked through the process of entering a new iron condor trade in CMG stock. Inside you'll see me analyze, price and fill the trade in real-time.
  • APC Strangle (Closing Trade): Took about $150 out of this small APC strangle trade even after the stock moved completely against our short call strikes this month. But as always, implied volatility always trumps direction and because IV went down, the value of this spread dropped more-so than the impact of the directional move higher.
  • IYR Call Credit Spread (Adjusting Trade): This adjustment is good for 2 reasons. First, it reduces the overall risk in the trade if IYR continues to move higher. Second, it still leaves room for the stock to fall back down into our new profit window.
  • XHB Straddle (Closing Trade): We were able to bank a $120 profit early in the March expiration cycle for our XHB straddle with the stock trading right in the middle of our expected range.
  • AAPL Call Calendar (Opening Trade): Look behind the scenes as I use our new watchlist software to filter quickly and find this AAPL call calendar spread trade during overall low implied volatility in the market.
  • COF Strangle (Adjusting Trade): Here I recorded my live trading screen (and real money account) showing you the entire thought process we used to make an adjustment to my current short strangle in COF to reduce risk.
  • GDX Strangle (Opening Trade): With gold's high IV we are getting into a new strangle with a 70% chance of success and a decent credit for selling option premium.
  • IBB Iron Condor (Closing Trade): Today we're exiting an iron condor we traded in IBB for a $142 profit. Inside you'll see me analyze the exit price and fill the trade in real-time.

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About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.