A Robo Advisor is a digital application that offers clients financial advice created by algorithms, artificial intelligence, or mathematical formulas. The term Robo Advisor is short for robot advisor. However, the phrase Robo Advisor is inaccurate. To explain, a Robo Advisor is a digital construct, usually an algorithm or artificial intelligence (AI) rather than an actual robot.
A Brief History of Robo Advisors
The first known Robo Advisor was a semi-automated financial manager offered by Mint in 2006. More sophisticated Robo Advisors appeared during the Great Financial Meltdown in 2008. In fact, Robo Advisors’ appearance resulted from the popular distrust of human financial advisors and investment bankers.
In 2010, John Stein launched Betterment, the first Robo Advisor marketed to the general public. Over the next few years traditional asset managers like Vanguard, Morgan Stanley, Charles Schwab, and JPMorgan Chase entered the Robo Advisor market.
By 2018 Robo Advisors were managing $200 billion in assets, Barrons estimates. Notably, Vanguard’s Personal Advisor Services was the largest Robo Advisor overseeing $101 billion in assets. Schwab is the second largest Robo Advisor managing $27 billion assets. In addition, government agencies like the Nevada State Treasurer are turning to Robo Advisors to manage public investments.
5 Reasons Why Even Robo Financial Advisors Do Not Beat The Market
- The goal of most Robo Advisors is not actually to beat the market but to automatically invest your money based on your requirements and risk tolerance. Most legitimate Robo Advisors do not even claim to beat the market.
- Beating the market means beating the yearly return of the S&P500 for example. But most investors have a risk tolerance meaning they want a diversified portfolio that hedges against too much risk, e.g. the risk of being 100% invested in stocks. So, if you are invested 40% bonds and 60% stocks in your portfolio you will have zero chance of beating the market.
- Most Robo Advisor platforms offer many different types of portfolios, such as Ellevest who offer socially responsible impact funds. You could even be invested in many different types of funds simultaneously, which are not directly comparable to the underlying S&P 500 index.
- Expecting an automated algorithm that beats the market to be available to retail investors is wishful thinking. If there was such a system, it would be kept secret and owned only by tier 1 investment banks. Such a system does not exist. The automated systems that are in place are arbitrage systems that seek to exploit tiny differences in the bid and ask prices for a specific asset, also known as scalping.
- As Robo Advisors or even 92% professional active fund managers cannot beat the market over a given 5 year period* the Robo Advisor services focus on tax efficient investing (tax harvesting) and portfolio balancing.
So, What Are The Benefits of Robo Advisors?
Primarily, the key advantages of Robo Advisors are:
- Clear visibility into the risk and performance of your portfolio
- A portfolio that is automatically constructed based on your risk tolerance, preferences, and even ethical biases.
- Tax loss harvesting is a real burden for investors, most Robo Advisors do this for you automatically.
Full article originally published here.