This article originally appeared in the November 2015 issue of 425 Business.
Robo advisers are the hip new investing product presented to you by a financial industry trying to help you reach your monetary goals. Traditionally, Wall Street’s rosy offerings have cloaked high fees and low returns, but this time they are on to something with a technology-driven solution that automates and brings clarity to the three principles I’ve long advocated: save for a rainy day; don’t put all of your eggs in one basket; and there is no such thing as a free lunch.
For the past three decades, as workplace-sponsored 401(k) plans have replaced traditional corporate pension plans, millions of investors have taken on the responsibility of saving and investing for their own retirement. In turning to Wall Street for a little guidance, these same investors have come face to face with an industry obsessed with “beating the market” with high-priced, actively managed mutual funds. As a result, many investors mistakenly think that the best way to reach their financial goals is to select the top-performing funds.
The unfortunate part of this strategy is not that over 80 percent of actively managed funds underperform their respective benchmarks over time, it is that the average investor doesn’t stick with his or her selected funds, instead switching often and capturing less than half of the stock market’s long-term return.
For the past 18 years, I have advocated a different approach to building portfolios and long-term wealth — that is through the ownership of low-cost index funds that capture the entire return of stocks and bonds within your allocation.
Recognizing that a large number of investors with less than $100,000 of assets need prudent financial advice, the founders of new automated advisory services created computer algorithms to help address two important decisions: how your assets are allocated between stocks and bonds, and how much you are going to save to reach your financial goals. Forget the other Wall Street noise about which funds to own based on past performance — that information is counterproductive to building wealth. Your asset allocation and your savings rate (prior to retirement) are the only two decisions that really matter.
Along with traditional firms like Vanguard and Charles Schwab, startups Wealthfront, Betterment, and FutureAdvisor also have robo advisers. After walking you through a questionnaire and a summary of risk profiles, these services establish an appropriate asset allocation for you between bonds and stock portfolios made up of (almost exclusively) low-cost index funds.
Over time, the robo adviser rebalances your portfolio to reflect changes in the market and personal changes in your life. The software guides you through financial plan creation, with special emphasis on how much you need to save to reach your financial goals.
Robo advisers have it right. If you are going to work with an adviser, whether it is computer-driven or a person, its role should be to clarify your financial options.
Given the digital nature of robo advisers, the breadth of financial planning they offer is limited and might not be best for investors who require more complex wealth management. It is also very easy to ignore a robo adviser’s suggestion to hang tight during times of extreme market volatility. However, for the vast majority of investors who simply need to take the first step in saving and investing during the accumulation stages of their careers, robo advisers are a great way to start.
Taking responsibility for the saving and spending decisions you make in your everyday life is what building long-term wealth is all about. Finally, the financial-services industry has created a smart and low-cost solution to help you achieve your goals.