Today’s early news that the U.K. voted to part ways with the European Union, in a historic vote commonly referred to by news media outlets as “Brexit,” has had a tumultuous effect on global financial markets. The uncertainty the future holds in Europe and elsewhere has led many investors to panic, and investments that are traditionally more volatile to begin with, such as stocks, moved sharply downward in many nations and sectors of the market. For many people, this volatility has declined the overall value of their portfolios, while many others may see this situation as an opportunity to capitalize on assets that may become temporarily undervalued. One issue that is sure to emerge from all of this is the role that robo-advisors play in determining portfolio allocations through algorithms that rely on historical data.
As recently as yesterday, polling in the U.K. seemed to indicate that, while the vote would be close, ultimately the decision would be made to remain in the E.U. As of yesterday, the allocation of assets in portfolios set by robo-advisors was set by market history that hadn’t yet felt the impact of the “leave” vote turning the financial world on its’ proverbial ear. To younger investors with longer time horizons whose robo-advisor-selected portfolios contained a high allocation to stocks, today might be a startling time to log into your account. For investors nearing retirement, startling might not begin to describe the feeling. In either case, a robo-advisor will tell you the same thing if you scramble to rebalance your portfolio by updating your risk profile: a generic, pre-scripted message.
For startled investors worldwide, a canned response to such a significant market shakeup isn’t going to provide much comfort. Is this a good time to sell stocks? Is this a good time to buy stocks? In either case, which ones? Though the Brexit vote may seem like an outlier scenario, it is just these types of situations that roil markets for better or worse, and can provide both drastic losses and potential opportunities. That’s where an algorithm based on historical data simply falls flat.
Working with a human fiduciary advisor can have advantages in situations such as the one we find ourselves in today. First, the depth of knowledge a true fiduciary has about your risk tolerance, your financial situation, and your goals provide a level of insight that defines a collaborative relationship; a robo-advisor may simply request your age, income, desired retirement age, and a few more basic questions about your tolerance for risk. Anyone who answers these questions exactly as you do will get an identical portfolio to yours, regardless of which of you is expecting your first child, which of you is about to get married (or divorced), which of you will be inheriting a large sum in the coming years or caring for an elderly parent, etc. In other words, the spectrum of factors that comprise your true financial picture may be broader than what you can expect from an algorithm-based investment service. These differences could result in a very different approach to investing in either the short or long terms, or even both.
Second, working with a human fiduciary gives you the ability to make anticipatory moves with the guidance of a seasoned professional, rather than being left to make any deviations from an algorithm based on your own ideas and emotions. Taking emotion out of investing is a very important part of the process of protecting your wealth, and in uncertain times, it can be difficult to make a decision about your future with emotion truly removed. While a robot certainly has no emotional component, it also follows rules that might not really be right for you. For example, if you have a significant allocation to stocks in your portfolio, and stocks decline in value, a robo-advisor may decide based on your profile that a rebalance is necessary to keep your portfolio aligned with your tolerance for risk.
An algorithm would then rebalance by selling more conservative investments to devote your original allocation to stocks, and if those stocks decline again, the process repeats, your conservative investments declining along with your more aggressive ones. Alternatively, with an actively managed portfolio, your human advisor might have told you ahead of a potentially volatile market or influencing event that it would be sensible to allocate more of your portfolio to conservative investments, then ride out some of the volatility while making strategic investments in assets which may have become undervalued during a downward swing in the overall market. Of course, this approach would not suit every investor, but for those with a more aggressive approach, it could be a winning strategy, whereas a more aggressive investor using an algorithm could simply see an overall decline in the value of their portfolio due to significant allocation to aggressive choices. To date, robo-investors have been most popular with younger investors with longer time horizons – those for whom algorithms tend to create more aggressive portfolios. While recent bull markets have been a source of opportunity for robo-advisors, the coming post-Brexit days will be a crucial test of their defining characteristics in the eyes of their largely younger audience – and perhaps a key lesson in the value of human relationships.
If you are concerned about your robo-advisor in the wake of the Brexit vote, if you’ve recently started a new job and are thinking about retirement planning, or even if you’d just like a second opinion on your current portfolio, contact BFA Wealth Management today. We offer complementary, no-obligation investment analysis to show you some of the ways we may be able to help, and we can work with you to make a financial plan and investment strategy designed with your real life in mind. Let’s talk.