Risks of Robo-Advice

The beginning of February brought significant volatility to an investment marketplace that has been very quiet for the past year or two. The first week of February saw US markets drop by roughly 8% in value and the following week saw them regain approximately 2/3 of those losses.

During that drop however, something interesting happened that has not been widely discussed. More specifically, the website crashes of several robo-advisor sites.

“Robo-Advisor” is a term used to describe the online investment websites that offer limited to no human contact investing options for those that prefer to pay lower fees in exchange for basic investment management largely through index tracking.

The robo-advisor websites of two of the country’s largest providers – Wealthfront & Betterment – crashed on Monday February 5th as the US markets sank a little over 4% in one day. Similar outages were reported by US online brokerages such as Charles Schwab & Vanguard Group.

The robo platforms were quick to respond saying that these “glitches” were short-lived and most services were restored later that same day. But the question nobody seems to be asking is “Why did they crash?”. The reason for these crashes was largely due to an enormous number of online investors panicking and jumping onto their accounts to look at values and sell off some or all of their investments. These investors no longer have the opportunity to hear from a more rational voice in the form of an investment professional who would be there to calm them down and talk them off of a ledge.

So how did that work out for those that sold in a panic? As stated above, the market dropped 8% and has since regained roughly 2/3 of those losses. So, an investor with $1million in their online equity portfolio on Feb 1st who panicked and sold cashed in around $920,000 if they sold at the low point since they realized that $80,000 loss.

A similar investor that works with a professional adviser may have also panicked but then talked to their advisor about what to do. Their advisor told them to stay the course and that these market corrections are all part of a normal market cycle. That investor is still invested today, and their portfolio is showing a loss of -3.3% which is not ideal but a heck of a lot better than -8%. They also remain invested to regain those remaining losses in the coming weeks as things start to settle down.

Herein lies the true value of human advice and why people need to think twice about using a robo-advice platform. Many investors will tell themselves that they understand market cycles and can hold on during a downturn, but the proof would suggest otherwise.

There is no question that many have turned to robo-advisors due to bad experiences with human advisors and I will be the first to admit that our industry has plenty of people who should not be giving out advice. But the alternative is equally concerning when you give up all of the benefits of a human advisor who can incorporate financial planning, unexpected events and logical decision making into your investment plan instead of using a simple algorithm or merely tracking an index. The key as always is to find an adviser who has the appropriate training and knowledge to guide you properly and who will be there during market drops to keep you on track.