In 7 Simple Reasons Why You Should Use a Robo-Advisor, we made the case for why and how a robo-advisor can work for you. But are robo-advisors worth it? Despite their rising popularity, they’re not the perfect investing platform for everyone.
In this article, we’ll look at five reasons you should not be using a robo-advisor (or roboadvisor, as they’re also called) to manage your investments.
1. You Like Do-it-Yourself Investing
If you are primarily interested in self-directed investing, you might find robo-advisors a bit boring.
In fact, boring is pretty much what they’re supposed to be. The whole idea behind robo-advisors is that they handle all of the investing for you. Your only responsibility is to fund your account.
If you like picking your own investments, though, robo-advisors won’t work for you. This is even truer if you are an active trader, since active trading is the exact opposite of what these platforms are all about.
They invest in index funds that don’t even trade much within the funds themselves. Since they are based on an index, they only trade when necessary to keep the portfolio aligned with that index. They don’t even invest in actively managed mutual funds that do trade frequently.
If you have any interest at all in researching your own stock picks, identifying potential winners, or managing your own portfolio, robo-advisors are definitely not for you. You’ll be much better off investing your money with one of the large discount brokerage firms. These not only offer a very wide variety of investment securities, but also provide the tools that will help you become a better investor.
2. You Like a “Human Touch” with Your Investing
Robo-advisors investment management fees are just a fraction of what you’ll pay for similar services with traditional human investment advisors. But there’s a reason why they can charge those low fees – there’s no interaction with a human investment advisor.
One of the most basic factors that make robo-advisors so cheap is the lack of human involvement. You take a quiz, and then the computer system sets up and manages your portfolio.
You’ll have a limited ability to discuss your portfolio or the future of your investments with a human being. And when you do connect with a person, the conversation will be general. This is because your account is not assigned a human investment advisor. It’s computer managed with contact limited to customer service.
If you prefer regular interaction with a human advisor, you will be better off using a traditional investment manager. When you do, you will have an advisor assigned to your account. Then you can pick up the phone and talk to that advisor about anything you want.
3. You’re Hoping to Beat the Market
Many investors don’t simply want to invest with the market; they want to beat it. That is, they want to earn higher returns on a consistent basis.
Reaching this goal takes a great deal of skill and portfolio customization. That’s the type of investment activity only a human can manage. And in each case, that person would have to be gifted, since beating the market consistently is difficult.
When you invest with robo-advisors, there’s little chance you’ll ever beat the market. That’s because robo-advisors weren’t designed to beat the market. Their purpose is to make sure that your portfolio performs in sync with the general market.
In fact, since robo-advisors typically diversify at least some of your money into bonds and cash, your overall portfolio will typically return something less than what a 100% stock portfolio would. (However, in a down market, it would likely have a better performance.)
Betterment’s FAQ page even makes the point clear that its portfolio is designed to keep up with the market and not under-perform, but it is not designed to beat the market. This is not an admission of weakness but an acknowledgment of reality that every investor should be aware of.
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Many investors who are uncomfortable doing their own investing are less concerned with outperforming the market. But if that’s important to you — and you or your advisor can make it happen — you’re better off avoiding a robo-advisor.
4. Robo-advisors May Not Work in a Range-bound Market
Robo-advisors only started coming out in the aftermath of the last stock market crash. Since that time, we’ve had a certified buy-and-hold market. That is, the market has gone straight up for the past eight years.
In that environment, robo-advisors have performed well. After all, their investment strategy is based on buy-and-hold. This makes them well-suited to today’s investment environment.
But what happens if we move into a range-bound market? That’s where the general market trades within a range. It doesn’t advance, and it doesn’t crash. It mostly trades in a narrow band — maybe just a couple thousand points above and below its midpoint.
Since robo-advisors are based on buy-and-hold, you will likely get lackluster returns in a range-bound market. Remember, robo-advisors are not set up to beat the market, only to keep pace with it. If the market is going nowhere, your robo-advisor account is likely to do the same.
Human-directed investing has greater potential to produce positive returns in a range-bound market. Instead of investing in market indexes, individuals can invest in special situations. They can invest in individual companies that are growing in a flat market, companies rolling out new products, or out-of-favor stocks. These options may net better returns in that particular market.
5. Robo-advisors Have Yet to Survive a Bear Market
This is probably the biggest open question when it comes to robo-advisors. Since most platforms only came about after the financial meltdown, there’s no track record as to how they’ll perform in a declining market, particularly one that’s protracted. Should the markets fall three years in a row, you’ll likely lose money in your robo-advisor portfolio.
Will the public remain loyal to robo-advisors in that kind of market? We’ll have to wait and see.
It’s entirely possible that many people who invest with robo-advisors are doing so because they think that they’re relatively safe investments. For example, the whole reason people invest in mutual funds and exchange traded funds is because they’re diversified, and many people believe they’re more resistant to market downturns.
A robo-advisor is simply a fund of funds, which means that your portfolio is comprised entirely of funds. Should the market decline in a major way, the value of those funds will decline. A downturn could quickly torpedo the public perception that robo-advisors are a safe investment.
It comes back to the fact that robo-advisors will, at best, track the market. They won’t underperform it, but they won’t outperform it either. If the market is going down, so will your robo-advisor investments.
Not all robots were born (or manufactured) equal. If you are really eager to start investing with a robo advisor, one of our recommended choices is Wealthfront. They have an easily attainable minimum balance, low fees, and a simple, convenient interface. They’re a great choice to start investing quickly.
Are you an investor who is still robo-advisor resistant? What are your reasons for not investing with one?Topics: Investing