Robo Advisors: rise of the machines.
I know Isaac Asimov’s Three Laws of Robotics, I’ve read Arthur C. Clarke’s 2001: A Space Odyssey and I love the Terminator movies (I’ll be back!).
From all this, I know three things: Robots are very smart. Robots always start off to help you. Robots tend to turn on you.
One of the newest crazes and buzzwords in personal finance is: “Robo Adviser.” If you’re not familiar with the term, it refers to investment management by algorithm, in the absence of human input.
With a “Robo” you are asked to complete an on-line risk assessment questionnaire. Your responses determine the prescribed portfolio of ETFs (Exchange-Traded Funds), with a built-in asset allocation best-suited to your needs. Once a year the portfolio is rebalanced to this prescribed asset allocation recipe.
Dynamics change as you shift from saving to spending
The “Robo” approach relies heavily upon a basic “buy/hold/rebalance” investment strategy. This passive strategy can work to your advantage during your accumulation years because those are the years when time is your friend and dollar cost averaging through market cycles offers the opportunity to give your returns a boost.
However, as we get older and begin to prepare for and transition into our spending years, things change. Unfortunately, too few people realize that the investment strategies that served them well during their saving years turn on their head and work to their disadvantage as the flow of funds reverses and saving turns to spending.
Dollar cost ravaging
During your spending years following retirement, time quickly changes from friend to foe where “dollar cost averaging” turns to “dollar cost ravaging” or what I call, The Mathematics of Catastrophe. During the second half of your life, the overly-simple money management approach followed by “Robo Advisers” can start to look like a “deed of the devil.”
Another concern is that “Robos” are unable to deal with the reality of expense variability. If you believe that a fixed, annual withdrawal rate from a diversified portfolio will address your income needs in retirement, I can suggest with confidence that you are at best short-changing yourself and at worst setting yourself up for a cataclysmic financial failure.
I have been in this business a long time and know beyond a shadow of a doubt that a properly constructed life plan is very important in the second half of your life. It is only when you know what you want to do, when you want to do it, how big you want to do it, and what it will cost to do it, that you can start to build the financial framework to make it happen.
Only through your life plan are you able to anticipate years of surplus and years of deficits and take the steps to bend them to your benefit. You need to bring together cash flow optimization, tax management and pension-style investment management to make it happen and, in the process, add hundreds of thousands of dollars to your lifetime assets and cash flow.
Robos ill equipped to link life to investment plan
Linking your life plan to your investment plan is the secret to success, but “robo investing” is not equipped to handle the nuances of that linkage. A Retirement Income Specialist knows that the type of money management you need is much more complex where the cash flow demands outlined in your life plan need are linked to your investment plan. Tax planning, income optimization and risk mitigation mean it is dangerous to leave your investment management running on auto-pilot.
Isaac Asimov’s first law of robotics holds that: A robot may not injure a human being or, through inaction, allow a human being to come to harm.
“Robo Adviser” firms would do well to review this law. When it comes to investors heading into the second half of their lives, “Robo Advisors” may well be about to break it.