Whenever I’m listening to a presentation by someone who speaks with a classic British accent, it seems like he (or she) is accorded a lot more respect and credibility than others in the room. People swoon for what sounds like intelligent, thoughtful advice just because of that delivery in formal Queen’s English. I swear you could spout complete nonsense but add a British accent and people will respond like it’s the Holy Grail.
Something similar seems to be happening these days with the word “algorithm.” Tell someone you’ve got a cool new algorithm for automating a common task, even a simple one, and just wait for the “oohs” and “ahhs” to come out. We’re almost at the point where people think artificial intelligence is superior to actual intelligence.
Such is the case with all the new personal financial websites and apps that promise to do for investors what flesh-and-blood wealth advisors have been doing for decades. Only many of these sites – like personalcapital.com, betterment.com, wealthfront.com and others – claim they’ll do it cheaper and even more efficiently. And just like that British accent, people are swooning, including many financial writers for top-notch publications like the New York Times, Forbes and CNBC who have given these sites an enthusiastic thumbs-up.
OK, so I know what you’re thinking. You think I’m going to bash these auto-bot investment sites because they’re threatening to put me out of business. Actually, no. I’m not going to bash them – much – and I’m not dusting off my resume because I’m worried I’ll need a new job anytime soon either. Here’s why.
These robo-investment sites serve as a place where someone can go and invest money at very low fees and all of the decisions are taken care of through this shiny new algorithm. For some people, these sites offer big selling points – hassle-free investment in mostly low-cost index funds, with a rebalance of your portfolio on a regular basis. The bigger appeal is, why pay an advisor or firm that will charge you more for doing a lot less?
Sounds great, but is it for everyone? Take, for example, betterment.com’s explanation of how it rebalances an investor’s portfolio:
We rebalance by selling and buying, reshuffling assets that are already in the portfolio. When cash flows are not sufficient to keep your portfolio’s drift within a certain tolerance, we sell just enough of the overweight asset classes, and use the proceeds to buy into the underweight asset classes to reduce the drift to zero. Sell/Buy rebalancing is triggered whenever the portfolio drift reaches 5%. Our algorithms check your drift once per day, and rebalance if necessary.
So if I understand this correctly, you should regularly sell the investments that do well, and reallocate to the investments that aren’t performing? Hmmm…something about that doesn’t feel right, does it? Is this sophisticated investing, or investment by Siri?
Needless to say, I am not a huge proponent of rebalancing. If you owned Apple stock in 2005, it was around $5/share. Your computer probably would have told you, “Time for rebalancing, sir,” and your stock would have been sold off and allocated to less performing assets in your portfolio. Over and over and over again. And of course today, Apple is trading around $127/share. (Then again, robo-investing doesn’t allow you to invest in individual stocks – only index funds – a much bigger issue itself that I covered in a previous article: Proper Diversification.)
Granted, a lot of humans missed the Apple run-up too. But the ones who didn’t relied mostly on sound analysis of the company’s future prospects and projected earnings, all the things that even these “sophisticated” algorithms don’t take into account. In 2005, Apple was four years into its dominance of digital music with its line of iPods, and just two years away from introducing the iPhone, which would set the standard for portable telephones. Try explaining that to an algorithm that is recommending to sell based on a “rebalancing” formula.
Make no mistake. When to sell is the most fundamental decision for successful investing. If you aren’t making the decisions based on sound analysis, I am convinced that any success you have is just plain luck. And be careful: luck can turn to “unluck” in the blink of your monitor.
The bottom line is that robo-investment sites are just an easy way to invest money. Not effective, just easy. And that’s fine for some people…particularly folks who aren’t interested in a relationship with a financial professional, and those who are comfortable with lackluster performance. Almost anything is better than inertia. The short-term rebalancing by these sites might keep your portfolio humming along in line with the markets, but never beating them, and over the long-term you’ll miss out on the stocks that go up 1,000% over time.
Our years of experience navigating the financial markets on behalf of our clients have taught us that successful investing need not be complex. It can be simple, but it requires a few things that seem to be conspicuously missing from these investing sites: a well thought-out plan, reliable research and, above all, patience. Maybe someday there will be one button to push that really will make all this possible, but we’re not there yet.
A “motorway” is just a highway, a “roundabout” is just a traffic circle, a “bloke” is just another dude, and a “robo-investor” is just a fad…another device the industry has created to give you only what you paid for it: not much.