It’s become very popular in recent years to automate your investment services through the various “Robo-Advisor” services. Orcam’s clients have access to Schwab’s Institutional Intelligent Portfolios which means that the other Robo Advisors can’t do anything that we can’t do. In fact, Schwab’s platform is customizable which means that we have an advantage over the fixed portfolios that the other Robos are creating. So, for Orcam’s low 0.35% fee you could get all the benefits of a real human advisor PLUS the automated portfolio option.
While much of our process is systematic and there are many advantages to automating an investment process (such as eliminating behavioral biases) we have several concerns with this style of investment management:
1) Robots can’t assess and maintain your personal risk profile correctly. We find the risk profiling by all the major Robo Advisors to be woefully (even frighteningly) inadequate. After a series of short questions the robot places the investor in a pool based on their version of “risk”. However, financial risk is a very dynamic and personal concept. What’s risky to one risk averse investor might be much riskier to another risk averse investor. A robot simply cannot assess all of the personal factors that go into proper risk profiling because risk is little more than a number to a robot. The Robo Advisors forego this very personal process in order to save on costs. And in doing so they actually add to the costs of the investor by profiling you incorrectly.
We feel that risk profiling is THE most important thing that a human advisor can provide and a robot simply cannot properly assess your understanding of risk and maintain it consistently.
2) The Robo-Advisors all use Modern Portfolio Theory (MPT) to determine portfolio allocations. The problem with MPT is that it is a nice textbook theory of portfolio construction, but bears little resemblance to our actual financial lives. It relies on concepts such as “the long run”, “standard deviation” and linear financial markets to construct portfolios, however, these concepts don’t apply in the way that MPT theorizes.
For instance, most people’s financial lives are not a “long-term” at all, yet MPT implies that most investors can ride out the stock market’s ups and downs because the data shows that the stock market tends to rise over multi-decade periods. While this might be true it is not relevant to most investors whose financial needs are often much less than a multi-decade period.
Your financial life is dynamic. Your risk profile will change over the course of your life and the markets are constantly in flux. While we believe in a tax and fee efficient approach, we also know how important it is to keep one’s risk profile updated to account for changes in the markets and your personal life. MPT doesn’t account for this as it’s a static equilibrium based model of the financial world. This often results in a cookie cutter asset allocation that doesn’t properly manage the risks in the portfolio at times.
MPT assesses “risk” as “standard deviation” or volatility. This results in a portfolio construction process that doesn’t generate portfolios that properly view risk in the same way that an investor sees risk. In reality, risk is much more than just volatility. In fact, volatility might be a very good thing in a portfolio (for instance, when all the volatility is positive). But a robot doesn’t properly account for these factors.
All of this results in poor performance. As we saw in 2014, the Robo Advisors all generated performance that was sub-par relative to a basic 60/40 portfolio or the Global Financial Asset Portfolio. In my opinion, it’s largely due to a flawed methodology for asset allocation.
3) Lastly, we feel as though much of the Robo Advisor business is predicated on good marketing. Slogans like “passive indexing” and “tax loss harvesting” are powerful marketing terms that don’t bear much weight. The poor performance in 2014 showed that Robo’s are ultimately active asset pickers just like everyone else (and not very good ones). And tax loss harvesting ultimately comes down to being tax deferral and, in many cases, market timing. The Robo firms are very good at marketing their ideas in exchange for higher fees, but at the end of the day they are selling a “passive” approach that is really not much better than a simple Vanguard allocation. There is simply no reason to pay a premium for such a thing. If you want passive indexing then buy a simple 3 or 4 fund Vanguard approach, save the added fees and rebalance once a year. It’s that simple! You don’t have to pay an advisor or a Robo Advisor to do things that may or may not help you, but will certainly help THEM.
Conclusion – The Robo Advisors are likely fine for someone with fairly basic financial needs who can’t afford to work with an advisor full-time or is very comfortable as a do-it-yourself investor, however, financial advisory fees are becoming highly competitive. Orcam’s asset management service is LESS expensive than many of the Robo Advisors and provides a more personal and comprehensive overall service. As much as we like automation, robots have their own weaknesses and I personally would never invest my own assets in a purely automated service.