3 Reasons Why Robo Advisors Are Hazardous To Your Wealth

“Robo advisors will manage over $5 trillion in 10-years.” Have you seen headlines like this? According to the reports, robo advisors are so wonderful, they’re going to overtake the world and make it a better place to invest. Imagine, if you can, flowers and cute Bambis everywhere!

In reality, robo advisors are not really “advisors” but rather online software powered by algorithms. How does it work?

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After a person inputs their age, risk preferences, financial information, and other related data, the software spits out a recommended portfolio allocation. Generally, robo advisors use broadly diversified ETFs that own U.S stocks (NYSEARCA:SCHB), international stocks (NYSEARCA:VEA), emerging market stocks (NYSEARCA:VWO), and bonds (NYSEARCA:BND) as portfolio building blocks. While there may be slight variations between the portfolios recommended by different robo advisors, all of them use algorithms based around Modern Portfolio Theory or some hybrid version of it.

Most robo advisors are U.S. based, but similar iterations also exist in Australia, Canada, and Europe.

Despite the robo advisor hype, there are plenty of reasons to be skeptical. Let’s examine just three reasons why robo advisors are hazardous to your wealth.

Robo Advisors are Untested 

The latest generation of VC-backed robo advisors were launched at the perfect time; during a sustained period of rising stock prices. As a result, today’s robo advisors lack experience when it comes to managing assets during sustained periods of market turbulence and falling stocks prices (NYSEARCA:DVY).

In the aftermath of the 2008 financial crisis, Warren Buffett warned, “Beware of geeks bearing formulas.” He said that because Wall Street’s beautifully designed risk models (algorithms) contributed to the mass murder of $22 trillion.