Robo-Advisors a God Send to Investing ?

The topic of the Robo-Advisor has come up many times lately, and I think I (as a former programmer and current IT person) have a unique perspective on this topic (having a journeyman’s understanding of financial matters as well).

A simple explanation of this investing vehicle from Wikipedia is:

Robo-advisors are a class of financial adviser that provides portfolio management online with minimal human intervention.

Robo Advisor

Hand of God ?

What qualifies as a Robo-advisor? Pretty much anything that is a very loose set of heuristics and ideas, along with some technical flim-flammery. My first piece of advice is if anyone says they have a Robo-Advisor taking care of their investments, ask them if they understand what they are using. Handing your money over to an (allegedly) automated system that you don’t understand is just as bad as handing it to a Human Advisor who has little or no talent in investing. A task badly done by technology or a human is still a task badly done.

The important thing to remember is the Robo-advisor simply does what it is programmed to do, it “decides” on the basis of what it is told to do (it does not learn, or diverge from its programming). Many marketing blurbs speak of expensive algorithms that assure maximum investment performance, but I am skeptical.

The key thing to understand in this area, is the investing philosophy the Robo-advisor is going to follow. Here is a simple philosophy and method to go with it.

Passive Investing with Quarterly Balancing

Philosophy: set up a diverse portfolio with the following configuration:

  • 25% Canadian Index Fund
  • 25% US S&P 500 Index Fund
  • 25% International Index Fund
  • 25% Canadian Bond Fund

You recognize that as a simple couch potato configuration. Buy low mgmt fee ETFs or Index Funds.

Algorithm: Every 3 months, compare holdings percentages and if any position is greater than 5% off 25% (plus or minus) rebalance using existing funds.

This pretty much is what a Robo-Advisor might do for you (note you can do this as well, you are simply automating it). From a simple point of view, this seems like a relatively good way of doing things, or does it?

What the philosophy doesn’t say:

  • What funds or ETFs should be used, so what stops the programmer of the Robo-Advisor to have you buy funds with a company that might pay them a fee? This kind of “buying bias” is being seen in the market place already.
  • What stops the program from suddenly changing funds, and churning your money (i.e. losing it to purchase fees and such)?
  • How much are you going to pay for the service? Are you paying for something you could just as easily do yourself (yes, I realize many folks don’t want to do this, but that does not mean they should be paying through the nose for the privilege either).

These are just some very simplistic questions to ask.

I’d really like to see some kind of regulation or standards in the area of Robo-Advisors, but I suspect specific regulation may not occur until there is a scandal of some kind (in the area).



{ 8 comments… add one }
  • BruceMcK August 31, 2016, 3:29 PM

    Good post. Thanks. Investing with a 3-fund ETF portfolio is shockingly simple and easy. The investing industry loves to conflate financial planning, investment advice and investment management to make it look too complex for an individual to do. The media and bloggers need to continue to emphasize this, and how important simplicity and low cost are in investing.

    Many robo-advisors would be better than buying high-fee mutual funds or market indexed GICs for people that don’t want to do DIY. Many of them are not very open about what funds they hold and how the portfolios are designed, hiding it behind high-falutin “algorithms”. They are really a marketing driven half-step to true low cost long-term investing.

  • Bernie October 15, 2015, 8:44 AM

    For the life of me I can’t understand why anyone would use a robo-advisory service to manage an index fund portfolio unless the service was free. It’s so simple and cheap to manage indexes yourself. This isn’t rocket science.

    • bigcajunman October 15, 2015, 9:05 AM

      Aaahhh, but Rocket Science DOES use computers, makes you think (sarcasm).

      • Bernie October 15, 2015, 9:18 AM

        A DIY index investor with an abacus could match the rebalancing skills of the robo-advisor (irony)…lol

    • bigcajunman October 15, 2015, 10:04 AM

      Agreed, but I am assuming most of the robo-advisors use more complicated heuristics.

      • aB October 15, 2015, 10:47 AM

        Automated tax loss harvesting, would be the one reason I would use a robo-advisor.
        Actually crystallizing a loss, even if it is just to buy the same thing (follows a different benchmark.. whatever), is a little scary.

        • bigcajunman October 15, 2015, 10:54 AM

          … and making sure that the “algorithm” used isn’t doing this to bump up commissions as well.

        • Bernie October 15, 2015, 11:33 AM

          In fairness to the people who offer Robo-advisor service commissions are not charged on top of the Robo service fees. That said some discount brokers offer index funds free of commissions. I like free and would go this route if I were to invest in index funds.

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