If you haven’t heard, an army of Robo-advisors are entering the world of portfolio management and they are ready to take over. For many advisors and financial firms this is like a bad Terminator movie, Rise of the Machines (actually that was pretty good). They are here to replace you (the financial advisory firm) and destroy you in the process.
Oh wait, I have seen this movie and it came out over a decade ago and it is less exciting than you think. You see Vanguard has been running cost efficient, diversified, asset allocation portfolios for years. Just look up the Vanguard LifeStrategy Funds. There is LifeStrategy Income (VASIX), Conservative Growth (VSCGX), Moderate Growth (VSMGX), and Growth (VASGX).
Hold on, there was also a sequel. iShares has been running their ETF-based asset allocation strategies since 2008. Consider looking up iShares Core Conservative Allocation (AOK), Moderate Allocation (AOM), Growth Allocation (AOR), and Aggressive Allocation (AOA).
If you are truly looking to cut costs, even lower than what “the robots” charge, consider those options.
However, that should not be the end of the discussion. Two of the core challenges that these allocation portfolios will face in the future, of which I outline in great detail in my book Unconventional Investing are:
1) You can “sell” low cost as long as you remain in conventional asset classes: Large, Mid, Small Stocks and Core bonds. However, given that PE ratios are, ummmm . . . not cheap, and rising rates cause bond prices to decline (and there really is no direction but up), these conventional portfolios will face major headwinds in the next decade.
My recommendation is to investigate alternative asset classes and strategies that can better equip your portfolio to withstand these negative currents. As an example, managed futures are a terrific diversifier for a portfolio as it is one of the only negatively correlated asset classes to the stock market. Therefore, in a year like 2008 when the stock market got clobbered, managed futures produced a positive return.
Using managed futures as just one example, papers have proven that they help BETTER diversify a portfolio. Yet, why won’t the Robo-advisors maintain any managed futures exposure, even if it is the right thing to do? They won’t because (in their eyes) it is too expensive. It requires active trading by a person, or yes, another robot. If they were to add that exposure, it would drive up their all-in costs to investors, and as a result, hurt their primary selling point = low cost.
But Tim, managed futures have underperformed the stock market in recent years? Right, because they are not correlated to the market. Remember what Wayne Gretzky said when asked what makes him such a good hockey player, “I skate to where the puck is going, not where it has been.”
2) The second issue is human behavior and this will never change. Look up the Vanguard portfolio performance records. They are not immune to strong bear markets like 2008. As I outline on page 56 of my book, if you claim you are aggressive and choose an allocation similar to the Vanguard LifeStrategy Growth allocation fund but cannot stomach your portfolio being down over 34% for the year, then you are not as aggressive as you think. Always consider the downside risk because the worst thing to do is react on emotions and sell low.
I am fairly certain of two things: 1) That the Robo-advisor portfolios will mirror the performance of the already in existence and lower cost Vanguard and iShares’ solutions. 2) People will react with emotions in the next bear market and will fire their Robo-advisor because their inexpensive model will not hedge much of any of the downside risk.
I am all for free markets and competitive pricing. However, the finance world is acting like it is new. It isn’t, Vanguard and iShares have been offering similar solutions for years. The only people in the financial planning world that are nervous (and it seems like a lot based on the amount of press) are those that are offering more expensive conventional allocation portfolios without extra value-added services.
My prediction, robo-advisors are here to stay. My second prediction, after the next major correction they will be forced to add alternative asset classes and strategies, and as a result will sell their service as they should = better portfolios, not cheaper portfolios.
In the meantime, I welcome people to visit my website and attend one of my classes where I outline these concepts in more detail.
Check out my books on Amazon and check out this video!