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21ST CENTURY INVESTING WITH ROBO-ADVISORS
The robot uprising has been quieter than expected. In fact, few even heard it coming.
In recent years the quiet, efficient analyses of so-called "robo-advisors" has pushed to the forefront of investing services. Can the investing acumen of an entity comprised of programming code outperform traditional advisors?
In this article, we'll seek to answer this question through a review of the services offered by robo-advisors. We’ll consider the behavioral finance advantages to this new method and how engaging in this practice illuminates your risk tolerance. Finally, we'll review the costs involved and how robo-advisors can accomplish retirement goals.
A restriction on impulse
When you interact with a robo-advisor service, you're plotting a course then engaging the autopilot. This automation offers a distinct advantage that's less evident with traditional investing. When you've committed to a plan upfront, you're far less likely to deviate. Robo-advisor services have the unintended benefit of countering the problems of behavioral finance.
The emerging field of behavioral finance endeavors to explore the notion that you, the investor, are your worst enemy. In the past traditional economics has been the tool in understanding how and why business, markets, and individuals operate as they do. Today this is changing.
Experts have incorporated cognitive and behavioral psychological theory to understand why rational decision making can so dramatically breakdown causing loss of personal wealth and even decimate entire markets. Irrational thinking leads to economic problems.
Consider the findings of a paper published by The Research Foundation of CFA Institute Literature Review. The author explains, “one aspect of the discussion about rational and irrational investors that is important to consider is the extent to which professional traders and money managers are subject to the same behavioral biases that are more commonly discussed in the context of individual (typically assumed uninformed) investors." By removing humans, including yourself, from the process, you're creating a barrier to this problem.
You’re the programmer
Many mistakenly believe that opting for a robo-advisor takes away their financial control entirely. This idea is untrue.
While the robo-advisor will generate a tailored portfolio of investments, it will do so in response to your risk tolerance. You are driving the parameters. From this point, the robo-advisor will begin working.
This process leads to a greater agency. As you answer a series of questions about investment preferences, you'll come to an understanding of your psychological profile. The result: you're making decisions without the implicit or explicit influence of an “expert.” Instead of market fads or alluring speculative trades you will restrict your plan to more pertinent factors.
The primary attributes:
- Single/Dual Income
- Current Savings
- Risk Tolerance
The irony is that a robo-advisor will put you in the picture more than a traditional money manager will. There are no commissions or motivations to push certain investment products. The focus of the conversation is on where you are financially and where you want to go. You answer the questions in private without uncomfortable silences or the influence of needlessly opaque marketing materials.
Robo-advisors offer the lowest fees. The process is streamlined and efficient thereby rooting out costs that erode wealth in the long-term.
The reduced expenses also come from a low-cost selection of funds. Robo-advisors maximize returns by restricting the suggested mutual funds, ETFs, and bonds to those with the lowest expense ratios. The benefit of this practice is most visible over a long-term horizon where the magic of compound growth can amplify wealth. In many cases, these annual ETF costs will range from 0.05% to 0.75%. Be cognizant of your exposure to costs. Some annual fees will also apply. These differ from among robo-advisors, but you can expect to pay .15% to .75% annually as a service charge.
Retirement in the digital age
Robo-advisors are up to the task of retirement planning because it is a game of consistency and discipline. The automatic rebalancing option offered by many robo-advisors can help achieve the "slow and steady" mentality that is so crucial for long-term investors. Markets will rise and fall, but the machines will offer no emotional response even if you do. This unwavering focus is to your benefit.
Robo-advising platforms optimize their algorithms for tax loss harvesting. The aid of automation simplifies this complex practice. Those planning their retirement will find enormous value in this cost-cutting measure.
A robo-advisor is an excellent option for any investor. The simplified, low-cost approach is perfect for beginners and high net worth clients alike.
Statman, Meir. (2009, August 24). The Mistakes We Make—and Why We Make Them. The Wall Street Journal. http://www.wsj.com/articles/SB10001424052970204313604574326223160094150
Byrne, Alistair., Brooks, Mike. (2008, May). Behavioral Finance: Theories and Evidence. Research Foundation of CFA Institute. http://www.cfapubs.org/doi/pdf/10.2470/rflr.v3.n1.1