Punk Rock Finance: Is Robo-Advising All That?

This concept isn’t as new as it might seem. Human financial advisors have relied on algorithm-driven investing by way of specialized software for well over a decade. In other words, traditional advisors already use algorithms to determine portfolio allocations for their clients based on those clients’ stated goals, time horizon and desired level of risk. What’s new about robo-advising is that it has made such software directly available to consumers, and at a lower cost.

Robo-advisors are popular. While market estimates vary, it’s clear that millions of human clients entrust more than a trillion dollars in combined assets to the care of robots.

But such robots have mixed success. The investment app Titan tracked 44 robo-advisors over the 12 months ending Sept. 30, 2021, and found that returns ranged from a low of 13.37% to a high of 25.17%, compared to a 29.4% total return on the S&P 500 during the same period. In other words, you could have beaten the robots by simply buying index funds. (Index funds are funds that mirror the contents of an entire market index, such as the S&P 500; such funds therefore perform as well, or as badly, as the overall market.)

If you can beat robots with index funds, why would anyone invest with a robot?

It’s a good question, and one that mirrors an ongoing tension in the financial world. On average, active investment management by human advisors does not outperform what’s called “passive” investing. Passive investing means buying index funds in order to capture the performance of the overall market; active management, by contrast, seeks to beat the market — but runs the risk of underperforming. Active management also carries higher fees than simply purchasing index funds, because of the human labor involved in selecting stocks.

Some of today’s human advisors don’t recommend, or perform, active management for their clients, but instead simply recommend index funds and other relatively low-risk investments, and then help clients adjust their portfolios as their goals change. Human advisors also sometimes help their clients avoid panic selling.

“The downside to robo-advisors is that they won't stop you from selling your investments when you feel like running for the exit signs during a market downturn,” said Spencer Sherman, who founded financial consulting firm Abacus Wealth.

Yet there are also benefits to robo-advisors, which tend to carry the lowest fees of any type of advising.

“Robo-advisors can work well for people who want to do things themselves but have the robo-advisor automatically rebalance their portfolio,” said Sherman. Rebalancing means selling certain assets and buying others as prices fluctuate, in order to maintain a specific desired portfolio allocation. Such portfolio maintenance is something that wealthy investors have long had human advisors perform on their behalf, and is now available to ordinary investors at a low cost, thanks to automation.

For those Punk Rock Financiers who want the help of automated investing to augment their own ability to buy, sell and rebalance, there are some powerful tools available.

Once you’ve set up an account, you’ll be presented with the option to “create a pie.” This will determine how M1 will invest the funds you deposit. You can create a pie from scratch, or — and here’s the power of this platform — you can select from a menu of portfolio allocations built by experts. You’ll have the option of choosing from some of the most popular preconfigured portfolios and can select a portfolio with one click. You can also opt for what M1 calls “expert pies” based on famous investors’ known strategies. For example, if you select the Warren Buffett pie, your holdings would match the allocation of Buffett’s famous Berkshire Hathaway fund.

Using M1, you can easily rebalance your pie. Recall that rebalancing is a process that helps you buy low and sell high — by selling assets that have gone up in value and buying ones that have gone down, in order to return your portfolio to your originally selected allocation.

Note that you must log into the app and tap the rebalance button in order to do this. M1 will not automatically rebalance on your behalf without your explicit instruction to do so.

Merrill Guided Investing also offers the option to speak with a human advisor, and then benefit from the automated and low-fee services of a robot.

“When life changes — you retire, get married, etc. — your asset allocation needs might change,” Sherman said. “A human advisor can discern these opportunities for changing the asset allocation and collaborate with you on how to best do that. A robo-advisor won't know or be able to call you to change the allocation. You'd have to know how to change your allocation yourself.”

Maybe that’s the essence of Punk Rock Finance — to understand the strengths and limitations of the newest tech tools, and to use them only when they’re truly helpful.