When it comes to investing, being human is overrated. Way overrated. Normal human emotions can devastate investment performance. Human nature makes us greedy when stocks are rising and terrified when they’re plunging, and this leads millions of investors to buy high and sell low, precisely the opposite of what they are supposed to do. Many professional investors talk a good game but they also succumb to emotions, which helps explain why they underperform the market over time.
Can this be quantified? Yes, unfortunately. Research firm Dalbar found that over a 30-year period, the S&P 500 index had an annualized return of 10.35 percent, while the average mutual fund investor — hey, I can do this myself, just watch me! — made only 3.7 percent a year. This could be the most important financial statistic you ever see. The astounding disparity is caused by two different types of market timing. Fund investors buy high and sell low on both the macro level — already discussed — and the micro level. They buy funds that have been hot and dump those that have been cold. There is a natural cyclicality to the performance of different market sectors—sometimes growth outperforms while value lags or large caps trounce small caps, or vice versa—and, for most people, it is delusional to try to capitalize on these momentum shifts. But people try anyway, often without even realizing they are trying.
And if the cycles don’t trip you up, often sheer randomness will. Manager Johnny Hotstuff’s Making Performance Great Again fund will have three good years in a row and people will think Johnny’s a genius, forgetting for the moment that there are many thousands of funds and, invariably, some of them have to do well for three years running. It’s math. Lifetime .220 hitters sometimes have a great week or two—probability theory mandates it—but this doesn’t mean you should pay a lot to have them on your fantasy team.
So, robots. Bring on the robots.
Like some of the most successful hedge funds, robo-advisers use computer algorithms to create diversified portfolios for you. And they are cheap. You’ll probably pay .15 to .5 percent per year instead of the 1 percent or so charged by the typical investment adviser. According to a recent fee comparison by Value Penguin, WiseBanyan and Schwab charge no fees and Wealthfront and SigFig charge no fees for accounts under $10,000. Some financial advisers have minimums of $250,000 or more, but some robos — Acorns, Betterment, and Hedgeable — will let you open an account with a dollar or less.
Most robo-advisers rebalance your portfolio automatically — selling what’s hot to buy what’s not — and make asset-weighting adjustments as you age. Some of them even do tax-loss harvesting for you.
Putting a little money with a robo-adviser can help young people overcome their stock market jitters and their distrust of human advisers. The market has crashed twice since 2000 and only one in three millennials owns any stock. This is understandable — but that doesn’t mean it’s smart. Over time, stocks are the top-performing asset class.
Robots can be great at overriding your counterproductive emotions and handling asset allocation planning, but they aren’t perfect and may never be.
The first problem is intake. You answer up to 15 questions about your risk profile, goals and investment time horizon. But, as far as I know, none of the robo-advisers will tell you that if you’re young — younger than 35, say — your whole portfolio should be in stocks. And it probably should be.
And if you’re a “low-risk” type, none of them will say, “Hey, you’re 27, you shouldn’t have a ‘low-risk’ portfolio.” So there is potentially a garbage in/garbage out issue that a competent professional would help you avoid.
Beware: there can be significant variation in what robots suggest. How much should a 40-year-old man have in stocks? Oh, 60 percent says E*Trade Adaptive Portfolio. Better make that 90 percent say Betterment and Vanguard.
Robo-advisers let you tweak their suggestions. On the plus side, a young investor could say, “Robo, I want to be a bit more aggressive than what you have planned for me.” The negative? You might periodically inject some unhealthy doses of fear and greed into the portfolio.
Robos are fine for IRAs and taxable accounts, but only Wealthfront offers a 529 college savings plan. No robos will invest your 401(k) assets, although Personal Capital and Vanguard Personal Advisor Services will give you advice on how to manage those investments.
Robos won’t take a holistic view of your entire portfolio, which could be a problem if you have taxable accounts, a 401(k), and one or more 529 college accounts. If you need such advice, though, some robots will let you talk to a human — at least, they say it’s a human.
Andrew Feinberg is a writer and money manager. He is the author or co-author of five books on investing and personal finance, including Downsize Your Debt. His work has appeared in the New York Times Magazine, GQ, Barron’s, The New York Times, Playboy and The Wall Street Journal, among other publications.