Casull Financial Advisory - RIA (Registered Investment Advisor) Member of Finra & SIPC
Captain Kirk versus The ROBO Advisor Tuesday Aug 25 2015
What would Captain Kirk of the Star Ship Enterprise have to say about algorithm managed asset allocation investment accounts, otherwise known as “ROBO Advisors, or ROBO’s?" If you watched much Star Trek, you would know that human emotion played a big part in how Kirk saved the day in many episodes. Human emotions also play a key role in the various markets. Let’s take a look at the facts.
ROBO advisors are non-human Internet Financial Advisors that utilize a computer algorithm to manage the assets held inside of client investment accounts for alleged low fees. The prospective client goes to the website of the ROBO Advisor and before opening an account, each client is required to fill out a brief, benign questionnaire, most have 10 questions. The questions are designed to allegedly convey the client’s financial experience, goals, expectations, and risk tolerance. This useless questionnaire is basically an attempt by these ROBO Advisors to cover their butts in conforming to Regulation 2090 that mandates a Financial Advisor must know their clients financial situation, goals, etc. Can a computer "know" a person?
Being an independent Financial Advisor, one would expect me to have a gripe against the ROBO firms, And I sure do. It's not that I consider them to be competition, ANd I'm not the stereotypica middle aged guy that resists change. In my opinion, ROBO firms are selling a product to a clientele that is ignorant as to how the markets work, with the expectation of low fees and "comparable" performance. ROBO Advisory fees are as high as .75% assessed on the account balance per year. Our Fees are the same.
As I said before, the ROBO advisors are mathematical algorithm computers programmed to place the buy and sell orders of the holdings inside of the accounts based on the risk tolerance score of that aforementioned questionnaire. Let’s say that the market today showed signs that Europe’s market was going downward. The computer would make an adjustment, likely reducing the European holding inside of that account. But how much of the European holding should the computer sell? All of it? WAIT! What if the numbers change tomorrow, and the European market actually rebounds with strength because a new treaty with a tyrannical country has been forged? This revelation is an emotional one. A computer wouldn't know that this is a good thing by itself, computers don't understand what is good or bad, instead the program would wait for the new market prices, and make further adjustment, thus "reacting" to that which has already happened. If the European holding has all been sold, that part of the account will suffer greatly by not taking advantage of the rise to come that the GOOD "EMOTION" NEWS would likely cause. So basically the account gets hit twice. This scenario has revealed the two major gripes I have with ROBO advisors, Emotion irrelevence, and reactive, NOT proactive, management. As conveyed in many episodes of Star Trek, human emotion usually won out over computer logic. All market analysts know that the market runs on emotional ques. "Consumer confidence" is one of the most widely used indexes in determining market strength. "Confidence" is an emotion. Would a computer know to make adjustments to expect a huge market downturn if terrorists flew a jet into a building? No. The computer is only looking at the current prices to make decisions. The computer would only make adjustments AFTER the market dropped, and in this scenario, the market would drop considerably in a very short time. Isn’t that, “locking the barn door after the horses run out”?
"Target Date Funds" should be mentioned here, as well. There is a trend by many Financial Advisors to utilize investment products called "Target Date Funds". These are funds that are managed by computer algorithms, and have the same mechanics found in ROBO Advisor management. Naturally, I have the same reservations about them too. They are "marekting" them to inexperienced investors and Advisors that just want to "set it, and forget it".
Do you want your investment/retirement accounts "SET and FORGOTTEN"?