How’s that for a headline? Do you think the mainstream financial media will pick it up. Oh think of the advertising hit they would take.
I’ve mostly ignored the robo-adviser trend but decided to take a peek. The fees are not too bad, but some fees are still hidden and none of the brokerages come close to TSP.
But it is not the fees that will matter in the long run. It is the generic diversified strategy they appear to all be following that will slaughter those nest eggs. It is very similar to TSP Lifecycle funds. Of course the level of your slaughter will all be based on your selection of “your risk tolerance”.
See, most investors think the “risk tolerance” question is about how high of returns you are hoping to make and do not see it more appropriately as how big a hit you are willing to take one day.
Unfortunately I do not think you can tell Mr. Robo you have low risk tolerance but want high returns because in robo-world it does not compute. In my world it does.
How about five years of high returns and only one year of bad returns? Sound good?
Good, because that is what you will get.
In my investing world view, to end up with the largest nest egg you need to reduce the real risk – large market losses. In robo-world, if you want to go for those high yearly returns you will have to accept some pretty big hits once and awhile.
Because they only manage risk the old-fashion way by diversifying your funds all-the-while using a buy and hope strategy. The classic diversification being 60% stocks and 40% bonds that gets “re-balanced” once and awhile. Let’s take a look at the diversifying effect on returns.
In the chart above I circled the TSP Lifecycle funds which are all diversified funds. Yes they lost less during the bear market but they also made less during the bull market… all depending on how much they have in equities.
Note how long it took all the funds to break even with the lowly TSP G fund after the market top in 2007. Pretty much all the US equity funds caught up to the G fund some time in 2012 – five years. The Lifecycle funds too.
If that seems reasonable to you, I have some land in Florida I would like to sell to you and I know a bunch of robo-advisers that would like to talk to you. We are still waiting on the TSP I fund to catch the G fund – don’t hold your breathe.
What is “risk” anyway
In the financial world, they have come up with many fancy meanings and measures of “risk” and the classic (marketing) definition is one of portfolio volatility. By this definition they simply lower your “risk” by increasing your allocation with less volatile bond funds to reduce your account balances ups and downs.
They proudly point out that their lower risk portfolios lost less during the bear market while completely ignoring the fact that it made less during the bull market – all meaning it was less volatile and thus lower “risk”.
The robots are more sophisticated than 60/40 portfolios. They now re-balance your allocations based on your age and “risk tolerance” when your allocations get too far above or below a certain level. The effective return is not going to change too much but you get more adjustments in their academically-crafted algo-driven diversification plan.
This rebalancing is all you are really getting from Mr. Robo in the investment arena and why it is offered at a low fee.
TSP Lifecycle Funds
The TSP Lifecycle funds do everything the robo-advisers do in terms of adjusting allocation levels, but since TSP has the G fund the administrators lean heavily on it during retirement and rightly so. To achieve a 3% return outside of TSP requires accepting a higher level of risk and one of my main points is higher risk involves lower long-term returns… which is often left out of the fee-seeking financial adviser’s pitch.
Note: The TSP Retirement Income fund is only 20% in equities, but could still benefit from some adjustments.
My Main Points
Here’s my main issue. There is no way robo advisers will ever call up every customer and tell them to get the hell out of the market when all the indicators head south. First, they were not designed to do this and second everyone can not get out at the top. It is the “everyone getting out” event that defines a market crash.
More likely you will continue to get the “do not panic” message weekly as the market teeters on edge and then the “don’t worry” the market always comes back after the plunge and of course they will tell you that no one saw it coming (YES THEY DID).
The bad news is the TSP Lifecycle funds are in the same buy & hold boat and you will ride the market’s roller coaster over the years. And like a roller coaster you will end up about where you started.
Today you are paying very high prices in any equity fund for future earnings or revenue or whatever measure you want to use. Buy and hold is not going to hack it from these high valuation levels.
If you want descent returns over the full market cycle you are going to have to step aside at some point and let the market reset. Then when all the headlines are at their worst you are going to have to jump back in.
Wall Street and now robo-advisers will never warn you prior to a market crash even though the markets do provide signs and symptoms that tell us when to start walking and when to run.
Perma-bears spend too much time out of the market. Perma-bulls stay in too long.
Don’t follow the herd. Robo-advisers are shepherds.
Most financial advisers are too, that is why they can replace them with robo-advisers.
PS. Invest safe, invest smart.