Are Robo-advisors a Good Idea?

Question

I like the idea of a Robovisor like the Schwab Intelligent Portfolio, Wealthfront, etc. But recently, my own experiences have been...a little worrisome. Despite the market being fairly bullish, and my portfolio set on the maximum risk setting, the performance of the portfolio has been starkly lacking compared to some other indexes, either for the year, or since the portfolios have been active.

That feels somewhat worrisome - is there something I'm missing about the performance and appeal of these?

Edit: Some folks have asked about details of the portfolio:

It's a Schwab Intelligent Advisor Portfolio, with the maximum risk tolerance settings on. The current allocation is:

• Cash: 6.74% (Note this is something that's non-controllable in the allocation)

• FNDX : SCHWAB FUNDAMENTAL US LARGE CO ETF 17%

• FNDF : SCHWAB FUNDAMENTAL INL LARGE COM ETF 13%

• SCHX : SCHWAB US LARGE CAP ETF 11%

• FNDA : SCHWAB FUNDAMENTAL US SMALL COM ETF 11%

• SCHF : SCHWAB INTERNATIONAL EQUITY ETF 9%

• SCHA : SCHWAB US SMALL CAP ETF 7%

• FNDE : SCHWAB FUNDA EMG MKTS LARGE COM ETF 6%

• FNDC : SCHWAB FUNDAMENTAL INTL SMAL COM ETF 6%

• SCHE : SCHWAB EMERGING MARKETS EQUITY ETF 4%

• SCHC : SCHWAB INTERNATNAL SMALLCAP EQY ETF 4%

• SCHH : CHARLES SCHWAB US REIT ETF 4%

• VNQI : VANGUARD GLBAL EX US REAL ESTATE ETF 2%

• IFGL : ISHARES INTERNATIONAL DEV RL EST ETF 0% - small, small amount

Answer 1

If you only have equities (or equity funds) in your portfolio then yes I'd be concerned. I would look at the performance of the individual funds relative to these benchmarks (net of fees) over the last 5 or 10 years, and see if there are any underperformers that could be replaced.

If you have bond funds or other non-equity investments, then you are just using the wrong benchmark. You might include another benchmark and ensure your return is reasonable for your mix.

When the market goes down (I have no idea when that will be) then you might make up for some of that difference if your portfolio does not drop as much as the equity indices.

Answer 2

The idea of a roboadvisor is great. An algorithm can provide the things most people need from a financial advsior:

1. Diversification
2. Some adjustment in the portfolio according to one's risk-aversion
3. Encouragement to save more
4. A sense of confidence in investing

These things are both (1) reasonably simple to implement and (2) equally hard for a human advisor to get perfectly right as for a computer to do so. Retail financial advisors greatly exaggerate the magnitude and complexity of differences between people in order to seem more relevant/important. Roboadvisors reduce the differences between people to only a few characteristics, which is more in line with finance theory. But they both do the same thing at the end of the day using the same information.

What you have shown is an example where one algorithm underestimated your desire to be all in equities. The computer is probably following finance theory that says you should have diversification outside of equities to reduce your volatility, even if you have very little risk aversion (you can lever up if you really want more risk). A smart human advisor may have done the same thing. Or a bad one might have put you in really expensive and poorly diversified funds.

What you have shown is one failure of one algorithm (which may or may not be user error). This does not imply that roboadvisors in general are bad, or even that your roboadvisor is bad.

Would you say that human advisors are bad if you heard of one person who was not happy with theirs? Roboadvisors, like human advisors, may be good or bad and even good ones (human and robo) may make mistakes.

Answer 3

Last year I looked at a number of these Robovisor brokers, including Schwab. I also liked this idea and I was seriously considering the idea of simplifying my investing, turning it over to the 'pros' and letting them take care of it.

In order to see their choices, I created an account. While I no longer remember the exact details, my overall impression was that the annual fees were quite reasonable compared to most of the other brokers that I looked into but the annual performance for the life of the funds was sub par. Another drawback was that none of their fund choices had a long term track record. None included the 2008 bear market and for me, how a fund performs during the bad times is very telling.

Answer 4

There's nothing wrong with the idea that computers can automatically apply heuristics and pick stocks based on predefined rules. After all, most people are just following a set of rules they've developed.

The problem with "robo-advisors" is the idea that you should pay an advisor fee on top of management fees, for a service that is readily available for management fees alone. "Factor" or "Smart beta" ETFs or funds do the same job that a "robo-advisor" will, but you save money by cutting out the middle man.