Robo advisers are shaking up the financial-advice industry—but their investment recommendations may not be as smart and objective as you might think.
These automated services use sophisticated software programs to generate and maintain customized portfolios for each client—typically at a lower cost than human advisers charge. In less than a decade, dozens of robo advisers, ranging from Charles Schwab and Vanguard to Betterment and Wealthfront, have attracted 45 million investors.
To explain this runaway popularity, I conducted an experiment. I presented 800 investors with hypothetical investment situations. Some participants were told they were receiving financial advice from a human adviser…others from an automated online algorithm, the software code behind robo advisers. The investors consistently reported more confidence in the robo advice. My conclusion: Investors tend to believe that algorithmic advice is superior because it’s consistent and takes emotions out of the process.
Reality check: Algorithms actually are fallible because they are selected by human programmers based on their assumptions. That means the robots running your finances could choose investments you don’t need or want. Example: A recent study found that Schwab’s Intelligent Portfolios assumed gold and cash were essential components of a portfolio and typically recommended a 10% or higher allocation of the two, regardless of your situation or risk tolerance. And if you provide multiple robo advisers with the exact same personal goals and risk tolerance, you can expect significantly different recommendations and results.
My advice: If you want to invest with a robo adviser, do thorough research first. Get sample portfolios from several before you decide where to invest.