Delegate, but never abdicate. This applies anytime you’re working with a financial professional—be it a money manager, financial advisor, accountant, tax attorney, investment newsletter editor… pick a title, and I’ll shout the same warning. Now, robo advisors are on the list.
True, unlike the others, robo advisors can’t be motivated by greed or guilty of negligence. After all, “robo advisor” is just a catchy stand-in for “computer program.”
But the companies that design and operate robo advisors are certainly motivated by self-interest. No problem with that. You are, too.
So, how can you safeguard your interests if you opt to delegate management of your nest egg to a robo advisor? Most offer little flexibility to customize, so picking the right program from the outset is essential.
- What is the central hypothesis behind the program? Is it designed to mimic an index? What are its goals and do they mesh with yours? As you move closer to retirement age, for example, preserving capital becomes more important than keeping up with the market.
- Do you fit its target? Case in point: Wall Street Daily profiled a three-year-old company that already has $1 billion under management. “It’s aimed at a younger, tech-savvy demographic that may be uncomfortable with professional money managers,” the report said. (I wonder if their robo advisor will tell them to get their credit card debt under control before they start investing?) That’s likely not a good fit for boomers.
- What is the time structure? While mimicking an index over the long haul has appeal, it can spell doom for baby boomers and retirees. Once you start tapping into your nest egg to live, you can’t tolerate wild market swings and hope for a comeback someday.
- How well diversified are your options? The robo advisor will spit out a list of ETFs for you to pick and choose from. Individually, these might all be suitable options. But an optimally diversified portfolio has weakly correlated holdings spread in a way that minimizes volatility.
- Are you adequately protected against high inflation? Inflation is a significant risk for those living on a fixed income. As you age and have fewer working years left, it becomes exponentially more important to protect yourself. If you’re no longer pulling in a steadily increasing salary, your portfolio is your only backstop against inflation. (TIPS won’t cut it.)
There is no “set it and forget it” investment option today. Human judgment—your judgment—is required. No one wants his life savings wiped out by a computer glitch.