High-frequency and other computer-controlled trading strategies are believed by some to have exacerbated the recent swings in the stock market. However, the rise of automation in the financial industry also appears to have helped many retail investors refrain from making emotional, knee-jerk portfolio changes. Indeed, earlier this week we learned that reactionary (panic) trading should often be avoided during a large market selloff, but it can understandably be hard to stay calm after turning on the television and seeing the Dow Jones Industrial Average down triple digits several days in a row. Investors utilizing a “robo-advisor,” though, would find it more challenging to make rapid portfolio adjustments when stocks are tumbling.
In many ways this is by design because a robo-advisor is a piece of financial technology that uses algorithms to construct portfolios for investors that are aligned with their risk tolerance, long-term goals, and other unique factors. Moreover, investors utilizing robo-advice do not actually decide what (and when) to buy and sell, and instead only adjust their investment profile’s variables. During last month's sharp selloff, for instance, any nervous investors could have informed the robo-advisor that they have become more risk adverse so that they are eventually shifted into a more conservative portfolio. Panic-selling everything and essentially cashing out, though, would have involved more hurdles, thereby helping many investors avoid making emotional-based trading decisions at a potentially inopportune time.
Hundreds of billions of dollars are now managed by robo-advisers, but many Americans are still unfamiliar with these digital investment tools. In fact, a survey conducted by Gallup and Wells Fargo found that just 5 percent of U.S. adults with $10,000 or more in investments said that they have heard or read “a lot” about robo-advisers, while 55 percent reported that they know “nothing” about this topic. Investors with at least some kind of familiarity with robo-advice appear to have a positive opinion, as evidenced by the 63 percent of such respondents who said they believe it can provide financial guidance at a lower overall cost than a traditional advisor. However, some (perhaps less tech-savvy) investor respondents seem willing to overlook higher fees because they believe a human can still do a better job of:
- Simplifying the investment process
- Being reliable in a turbulent stock market
- Aligning clients’ investments to their risk tolerance
- Focusing on investors’ best interests
- Making good investment recommendations
- Taking each client’s entire financial picture into account
- Helping people understand their investments
Another factor likely behind the overall low level of familiarity with robo-advice is that many investors rarely take advantage of the online tools already available to them. For example, less than half of surveyed investors said that they have gone online to make changes to their portfolio holdings (46 percent), rebalance their investments (45 percent), or calculate their retirement needs (46 percent). Basic online banking was also quite slow to catch on, and Wells Fargo executive Devon McConnell added that “Automated investing tools are still in their infancy … similar to online shopping ten years ago, there is an adoption curve and we anticipate the same pattern will unfold as more investors become familiar and comfortable with these new ways of investing.”
Sources: WSJ, Bloomberg, Gallup, Wells Fargo
Post author: Charles Couch