The Pros and Cons of Robo Advising -- At A Glance

The Case for Robo Advising

BURTON MALKIEL: As investment dollars have increasingly been channeled into automated investment advisers, so have self-serving criticisms and misconceptions multiplied. Even the term “robo adviser” is used pejoratively to suggest that such services offer “a poor, inflexible, solution for the design of optimal portfolios tailored to the specific needs of individual investors.” Robo advisers are accused of providing second-rate portfolio solutions, suitable only for small investment accounts, who cannot afford a traditional investment adviser.

In fact, the service provided is, in many ways, superior to that of traditional advisers. With the help of experts in behavioral finance, automated advisers design a questionnaire to customize portfolios to the specific needs and risk tolerances of clients. Portfolio compositions are overseen by professionals with years of experience in securities markets and are broadly diversified in accordance with modern portfolio theory. Clients can set up their plan once, have it executed consistently, and are encouraged to save regularly.

Two features of robo advising, usually offered only to the wealthiest clients of traditional advisers, are even more effective when portfolios can be monitored 24/7 by computers. These are rebalancing and tax-loss harvesting.

Rebalancing keeps allocations of investments in different asset classes in line with the needs and risk-tolerance of the client. If the stock market goes up and too much is invested in stocks, some stocks are sold and the proceeds invested in other asset classes. This keeps the risk level of the portfolio consistent with the investor’s comfort level and can even increase portfolio returns. While traditional advisers offer this service, they monitor portfolios only periodically. Automated advisers do so continuously.

If some stocks or investment funds have declined below their purchase prices, they will be sold to produce capital losses and be replaced by similar (but not identical) investments. By monitoring portfolios continuously, automated advisers are able to harvest losses far more effectively than traditional advisers.

Perhaps the most important advantage of automated advisers is their absence of conflicts of interest and their low fees. Traditional advisers charge between 1% and 2% for their services. Automated advisers charge as little as ¼ of 1% or even less for starter portfolios. Moreover, many traditional advisers select high-cost funds for the client’s portfolio and receive additional compensation for doing so. The automated adviser uses low-cost exchange-traded funds and has no interest except that of his client.

Perhaps most important is that the automated advisers chose index funds for their investment portfolios. Years of experience prove that index funds produce above-average net returns. Broad-based exchange-traded index funds can be purchased with expense ratios of 0.05%.

In sum, automated advisers offer the most sophisticated portfolio management services available. Because fees are substantially lower than those of traditional advisers, the extra net returns directly benefit the client. Moreover, by entrusting the execution of a long-run investment strategy to an automated adviser, the investor can, in effect, automate good investment behavior.

Burton G. Malkiel, the Chemical Bank chairman’s professor of economics, emeritus, and senior economist at Princeton University, is author of “A Random Walk Down Wall Street,” 11th ed 2015, and chief investment officer of automated investor Wealthfront.

Robo Advisers: A New Take on an Old Idea

RICK FERRI: By now, you’ve probably heard the term “robo adviser.” The new breed of stand-alone robo advisers are automated investment solutions that allow people to go online, complete a questionnaire, receive an investment recommendation and implement the strategy, typically using portfolios of exchange-traded funds—without ever speaking to a human being. Computers manage your ETF-only portfolio by providing a variety of ongoing, automated functions such as maintaining your allocations and managing regular deposits and withdrawals.

Robo-adviser technology is being positioned as new and revolutionary by the companies that

offer these services, but the ability to automate investing is neither new nor revolutionary. It started decades ago in the mutual-fund industry.

Mutual-fund companies have offered online solutions since the arrival of the Internet. You go to one of the many mutual-fund websites, take an investment questionnaire, receive an investment recommendation for a balanced mutual fund based on how the questionnaire was answered, open an online account, invest in the recommended fund through a bank transfer, and automate deposits and withdrawals by clicking on-line options—and do this without ever speaking to anyone.

Here’s the interesting news: There’s no extra charge to use these automated investment features, unlike the new, stand-alone robo-adviser firms that charge fees.

From what I can see, the biggest difference between what new robo advisers are doing versus what existing mutual-fund companies have been doing for a long time is that the robos have been aggressively marketing their all-ETF portfolios as a better mousetrap. The robos have attracted hundreds of millions of dollars in venture capital, and are using part of that money to convince the public that what they’re doing with ETFs is somehow better than mutual funds. That’s not true. In fact, the ETFs selected by the robos are often the same funds recommended by automated mutual-fund services offered by fund companies.

I think the new, stand-alone robo advisers do play a critical role in society, but for different reasons than you might think. First, the robos use mostly low-cost index-tracking ETFs. Teaching a philosophy of low-cost passive investing isn’t cheap or easy, and the robos’ efforts on that front are to be commended. They are educating young people on a cheaper, more efficient way to invest, and that’s a good thing.

Second, the robos are preparing their clients to work with like-minded human advisers when the clients’ needs evolve and call for higher levels of personalized care. When it does come time for them to speak to a human being, they’ll be that much better prepared by already understanding the importance of controlling costs and investing for the long haul.

An old idea becomes new after it gets a facelift and a new generation embraces it. As long as the idea was good to begin with, then it’s still good. Building low-cost, passive portfolios using index funds and ETFs is a good idea regardless of how it is done or who gets the credit. Robo advisers are part of this solution.

Rick Ferri ( @Rick_Ferri ) is founder of Portfolio Solutions LLC and the author of books on low-cost index fund and ETF investing. His blog is RickFerri.com .

Know What You Want Before Hiring a Robo Adviser

CHARLES ROTBLUT: Companies providing online financial advisory services are grouped under the moniker “robo advisers.” Despite the common name, they are not all the same. Some, or even all, robo advisers may not be suitable given your specific needs.

Before going with a robo adviser or even a traditional, human financial adviser, think about what you want help with. Do you simply want a suitable asset-allocation strategy? Are you looking for a firm to handle your investments? Or do you have more complex needs such as estate-planning or saving for college tuition? The services offered vary widely among both online and traditional advisory services, so think carefully about what you want before seeking out any adviser.

Then, think about the level of human interaction you want. When one of my colleagues surveyed robo advisers for an article we published earlier this year in the AAII Journal, she found wide variances. Some only communicated with clients via email or their online platforms. A few offered video conferencing or Skype calls. Some met with clients in person. Beyond email, there was no standard for how these firms communicated with clients.

It’s also important to understand that the online financial advisory industry is evolving rapidly. It’s entirely possible that the industry will look vastly different a few years from now. As such, there is no rush to start using a robo adviser. Rather, it would be prudent to compare your options to determine which service (online and traditional) is the best fit for your needs.

Charles Rotblut ( @charlesrotblut ) is a vice president with the American Association of Individual Investors.

Why the Future of Robo Advising Is Still Uncertain

MICHELLE PERRY HIGGINS: Robo advisers have recently gained a lot of publicity and seem to be the cat’s meow of the investment world, at least for now. But are they really a tsunami that will devastate the ranks of conventional financial advisers and traditional financial advisory firms? Or are they a flash-in-the-pan phenomenon, destined to fall by the wayside after the novelty wears off? It seems likely that both of these positions are misconceptions and the truth lies somewhere in the middle.

Robo advisers combine two aspects that, together, enable them to claim a differentiated presence in the financial marketplace. These two aspects are an online presence along the lines of E*Trade and automated tools that put into practice the precepts of Modern Portfolio Theory in assembling investment portfolios. The online presence makes them accessible to investors and the automation of the portfolio decision makes them available at low cost to a mass market. As a result, robo advisers have recently been collecting assets at a rapid rate.

But is this the end of the financial-advisory profession? Probably not, but there is little doubt that these relatively new players will have an effect. What that will be is still uncertain, but it is unlikely that they will sweep the field. For one thing, their major appeal, so far, has been to newer investors with relatively small portfolios who don’t yet have the minimum amount to be the target of traditional financial firms. Whether the robos will be able to move “upstream” in any significant way is still unknown. It may be that as their wealth grows, investors will feel the need to utilize the services of a sophisticated financial adviser who can take into account the totality of their increasingly complex financial circumstance.

However, the one thing that the robos have done is to highlight the fact that for many investors, the asset allocation decision has become commoditized to a great extent. Financial advisers can still provide that service, but to thrive they need to go beyond emphasizing the role of asset allocator in their practice. They need to emphasize the human touch, judgment enhanced by experience, and other qualities that machines still cannot provide, such as providing a steadying influence during bear markets. For these kinds of advisers, the robos will have a hard time making a dent.

Michelle Perry Higgins ( @RetirementMPH ) is a financial planner and principal at California Financial Advisors.