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I've seen a lot of talk lately about robo-advisers that manage stock portfolios for minimal expenses. The expenses are usually paid by ETF's.

I am not very well versed in all this stock and portfolio business. What exaclty is the risk of using a robo-adviser compared with a financial advisor?

Would someone care to elaborate how they work? I see they make tax "reductions" and portfolio rebalancing automatically.

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If you are looking for an advisor to just build a portfolio and then manage it, a robo-advisor can be beneficial (especially if the alternative is doing it your self, assuming that you are not well versed in the markets).

The primary risk with one is that it does not build a portfolio that accurately represents your needs and risk tolerance. Some firms base the number of questions they ask you on sign up based not on what is needed to get a good profile, but on how many before people decide that it is too much hassle and bail. That usually results in poorer profiles. Also a live advisor may be better at really getting at your risk tolerance. Many of day our risk tolerance is one thing but in reality we are not so risk tolerant.

Once the profile is built. The algorithms maintain your portfolio on a day by day basis. If rebalancing opportunities occur they take advantage of it.

The primary benefit of a robo-advisor is lower fees or smaller minimum account balances. The downside is the lack of human interaction and financial advise outside of putting together a portfolio.

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They've been around long enough now for there to be past performance figures you can google for. I think you'll find the results aren't very encouraging.

I personally don't think there's a huge risk that the robots will lose all your money, but there's every reason to expect they aren't likely to perform better than traditional managers or beat the market. At the end of the day the robots are employing a lot of analysis and management techniques that traditional managers have been using, and since traditional managers use computers to do it efficiently there's not much gain IMO. Yes in theory labour is expensive so cutting it out is good, but in practise, in this case, the amount of money being managed is huge and the human cost is pretty insignificant. I personally don't believe that the reduced fees represent the cost of the human management, I think it's just marketing.

There might be some risk that the robots can be 'gamed' but I doubt the potential is very great (your return might in theory be a fraction of a percent less over time because it's going on). The problem here is that the algorithms are functionally broadly known. No doubt every robo adviser has its own algorithms that in theory are the closely guarded secret, but in reality a broad swath of the functional behaviour will be understood by many people in the right circles, and that gives rise to predictability, and if you can predict investment/trading patterns you can make money from those patterns. That means humans making money (taking margin away) from the robots, or robots making money from other robots that are behind the curve. If robo advisers continue to take off I would expect them to under perform more and more.

  • I think this could be an excellent answer, but you need to cite the sources that you refer to via "google it". – Joe Feb 8 '16 at 15:10
  • This ignores the cheaper-ness of robo-advisers. If a traditional adviser charges 1% of assets every year, that's a huge drag over decades compared to a robo-adviser charging 0.35%. – stannius Feb 12 '16 at 8:29
  • @stannius Well, it's all about performance isn't it, do you think the performance of robo-advisers thus far have been worth the 0.65% cost reduction? A slowing global economy means there is less fat in the system, and consumer losses (or return reductions) has lead to scrutiny and increasing pressure due to competition on fund managers to take less margin. Funds can really only be more competitive by reducing fees, and robo-advisers, I suggest, are a way of introducing cut price service without directly admitting they've been over charging consumers since the dawn of time. – Michael Feb 12 '16 at 10:47

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