Let’s talk about Risk, Roboadvisors.

If you’re a reader of the blog, you might think I am biased to think roboadvisors are generally a bad idea because I’m an adviser when I’m not slapping my hands on the keyboard. And maybe you’re right, but it’s really a bit more nuanced than that.

The reality is I think automated investment platforms can really be quite wonderful for everyone involved — it’s the process of operational evolution.

The problem I have with the robo-lution™ as it stands today is this: very few, if any, of these “Roboadvisors” actually take the time to spell out the risk you face with the allocation they suggest — and that’s really a huge-rookie-move-mistake.

I’ll explain. Riddle me this: what kind of mood swings am I going to experience with the portfolios below?

I answered some questions and here’s Wealthfront’s report to me. See if you can find that answer…Screen Shot 2015-08-24 at 1.21.03 AM

Could I lose 20% at any given time? 10%? 30%?

What if 2008 happens again, what would this portfolio do in that scenario?… Go ahead, find me that answer. It’s okay, I’ll wait.

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Oh, there’s the “19% chance of loss… after 5 years”. If I slide it down to one year, there’s a 46% of loss.

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A loss”, isn’t really much context, but a loss… okay.

I’m pretty sure that’s not gonna cut it for most people in the heat of another 500 point market drop, but a loss… let’s go with that.

Or…. Better yet, Betterment. Because I’m 41, I should have a 90% stock portfolio. Because I’m 41. You see any mentions of risk there?

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After being shown these reports at each of these firms, you are then immediately asked to start filling out your virtual account application and sending them your money.

Could you imagine if, as part of the sign-up process, your roboadvisor said something like this?

Begin with The End in mind

I’m the type of person who likes to think of the best always, but be prepared for the worst. It’s the Boy Scout in me. But that’s not really a very shiny object to sell, is it? Which is why I hated being a stockbroker in my past life…

In stockbroker school they teach you to sell the hot dot, pretty much all the time, which is basically a sales pitch wrapped in the snuggly blanket of “advice”… usually something that will offer a “superior” return opportunity:

  • The hot manager with a great looking track record right now (rearview mirror)? Check.
  • a hot stock that’s been on a tear (confirmation bias). Roger.
  • or the hot stock that’s been beat up… you haven’t rolled a Big 6 or 8 all month, so this is obviously the roll that will; you’re due.
  • or maybe now is the time to pounce, buy the dip. Go all-in at the open. The cowboy bravado pitch usually works best on men. It’s almost patriotic even.

In the case of Wealthfront, If they were selling a hot dot — that hot dot might look something like this…

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Look at that “performance chart”; all that “additional return” just from doing index fund investing using buy & hold, and tax-loss harvesting daily — That’s AMAZING!!!

Now in general, none of these examples are specifically bad — heck some of it might even be good advice or information, but absent of actually quantifying the risk is the equivalent of playing russian roulette for a million dollars without even asking how many bullets are in the chamber first.

Now that actual volatility is here again, we’re starting to see the first signs of this playing itself out in the Twitter stream.

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I reached out to Kirtika, btw. She started in October of 2014 as a risk 9. I’m guessing she probably had no idea it could get this bad so quickly. How could she?

And that’s generally my problem with the Robos of the world. They’re resting and bowing at the foot of Buy & Hold like it’s some sort of religious experience, and not telling you the cost you’re going to have to bear to walk in those footsteps. 40 days in the desert is just the beginning.

Locusts? My go-to snack anymore; they taste like sunflower seeds in case you’re wondering.

Sadly, as the Robo processes exist today, these online “advisors” are basically asking you for blind faith. 3-5 questions, here’s your portfolio — invest now button. Invest in less than 5 minutes… should not necessarily be a major feature. And yet it is somehow.

Sure there’s a ton of books and data to prove buy & hold is a viable strategy — and they absolutely tout that as gospel, but there’s not one thing specific being offered about the fire & brimstone you’ll have to endure on the road to sainthood, before you begin your journey. Not one waypoint about how this all really works on the risk side, at all.

“Hold on and hang in there”, or “stay strong” isn’t going to work for very long.

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I’ll tell you how this probably ends for most of these investors. It’ll end like it did with my trainer telling me to “pump out one more — you can do it” for six months straight. I stuffed him in a locker with some air fresheners and a bag of Cheetos. Of course my fitness level has gone to sh*t, but I feel much better now.

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Reality is a really nice place to operate from, most days.

The reality is, if you are investor at one of these firms you have absolutely no idea what your Risk is at present.

And you could. Statistically anyway.

And you’d probably be a better investor for knowing that information — ideally, before you invest. Don’t you think that perspective & context would be helpful? You’d actually know (as much as we can) what to expect on crazy days like these.

Mentally you could anchor yourself to some semblance of reality instead of “hanging in there” and “staying strong”, sloshing around in a world of mental math and Apple Watch alerts telling you how much your portfolio sucks right now.

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The single biggest limitation to maintaining the Buy & Hold strategy is overcoming human behavioral biases, namely greed and fear. 

Greed is easy. Almost anyone can be talked out of greed. Look man, you’ve got two Ferraris and a pet monkey that smokes cigars and pours a mean Manhattan… do we really need a giraffe, too?

Or… maybe, probably, something more like this: look folks, your house is paid off, your portfolio is providing exactly the income you need at 5% a year, do you really think doubling down on Biotechs and Apple is the right move here?

But fear?Screen Shot 2015-08-24 at 10.50.45 AM

No one but you can get you out of that freight train of thought. Once your fight-or-flight lizard brain kicks in there’s not a single molecule of reason anyone is going to be able to push into your sympathetic nervous system. Nope. Sorry. It’s probably too late. You need a timeout. Go mediate.

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We, as humans, are literally hard-wired to feel physical pain when the losses start to come in hard; that’s really a thing.

There’s no short cut around that, that’s the limitation of our highly evolved monkey brains. You have to have experience, and context. Yet, these robot overlords have really spent very little time preparing you for this inevitability.

Oh, sure they sent their 1% letter to calm people on Friday, during the 500 point drop. 

But what happens when/if the market drops 1000 points again like today? And maybe this goes on for 6 another months; up and down like a very manic, very fast yo-yo, instead of resolving itself before your phone’s battery dies. That’s actually more likely than not a reality you’ll need to deal with almost as much as the easy days.

So, how many times is that “hang in there” going to resonate? Or maybe the better advice is just don’t look… ignore everything.

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Don’t look at your Apple Watch or your really slick app, your notifications, your alerts, your email. Don’t look at anything… that’s probably good advice, but not really something most have the fortitude to do, is it? That’s not very realistic…

And sure, it doesn’t rain forever, I know that — and you know that, empirically, but I’m already starting to see more cracks still, these last few days in particular….

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I’m not trying to pick on Wealthfront in particular… search Betterment on Twitter too, they’re out there.

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And granted none of this is a landslide, or even necessarily a canary. Maybe it’s just a few bad eggs on a few really tough days; I get it. Heck this isn’t even really anything more than a standard correction, at least right now. But maybe this time is different? It always feels that way, but I know this because I know how markets work.

Of course, the Wealthfront C-suite, which only knows a bull market since they incepted in one, is quick to dismiss that a bear market will derail their investors, and maybe their growth. Daniel Carroll, “Founder” and Chief Strategy Officer of Wealthfront:

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I hope they’re right about the next bear market — I really do — because if they do lose these people as investors, that means they lost these people more money than they were comfortable with risking, so they bailed — and that was (and is) totally avoidable.

And right now, if we look at where Wealthfront’s invested, their entire firm is positioned super aggressively, because their investors on the whole are positioned super aggressively. In other words, Wealthfront’s Value At Risk is nothing more than the collective Value At Risk of their client base… and it is very, very high right now.

To paint this picture for you I took a snapshot of Wealthfront’s firmwide holdings from their quarterly 13F filing at the SEC, which discloses all of their portfolio positions.

I took some liberties. I’ll be upfront & honest & transparent about all of that; because millennials like that. I imagine everyone does, but the millennials are maybe different from all of us. I hear if you cut one just a little bit, candy corn drips from their veins.

So the liberties: I was tired last night and I didn’t want to take the time to do data entry on the 30 pages of positions Wealthfront has on their books, and I wanted to watch Mr. Robot, so I did some rounding.

Most of the positions in those 30 pages are designed to roughly mimic the S&P 500 in a product offering I think is absolutely heinous for the average investor. I say this because what if the investor wants to leave Wealthfront? If they do leave, they have to take hundreds of (maybe even a 1000) small position equities with them wherever they go next to invest … a logistical nightmare… but I digress.

To account for this mimicry, I used the S&P 500 index to attempt to capture their hundreds of individual stock positions. Then I rounded the numbers on the indexes too, to make the math equal 100% without spending hours more trying to be a super nerd instead of just a normal nerd. That being said — I’m pretty sure I’m in the general ballpark, and here’s what that ballpark looks like from here (roughly):

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Source: ETFreplay.com

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Source: ETFreplay.com

I am also backtesting to October 2012 only, because of the limitations of some of the products they’re using; they’re that new. And here’s what it looks like: As of 6-30-15 (if my math is even close to right), since 2012, assuming people aren’t ratcheting their risk up and down as the market goes up and down, Wealthfront is taking almost as much risk as the market itself (i.e. being invested 100% stocks in the S&P 500) and yet sadly, giving their investors approximately 1/2 of the return of the S&P 500. Now because I rounded, let’s not get too fixated on that, but if I’m even close to right (I could be off a percent here or there, I’ll admit that) I imagine sometime soon people’s patience for “hanging in there” is going to start to wear thin.

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Now before you get all worked up, let me say this too: I know diversification is smart, I believe in it. I also know the US has been one of the best houses in the neighborhood called earth these last few years so this isn’t necessarily a “fair” comparison. But I’m also a professional investor with all of this investing knowledge and factoids & context, because it’s carved deep into my abdullah oblongata.

I know & have seen firsthand the risk associated with being in a 90/10, or 80/20, or 70/30, or a 60/40 portfolio when things go wrong. Sometimes very wrong.

In contrast, most of Wealthfront’s and Betterment’s investors are new. They do not have these benefits or insights, nor do they have any muscle memory or context. Basically, they’ve watched a video about fire and now think they’re ready to grab a hose and swing from the back of the firetruck.

Meanwhile, advisers like me (whom are apparently all evil and dumb and completely unnecessary if you ask a roboadvisor) have gone into and dealt with hundreds of burning houses over the years, sometimes completely naked just because we know we can now. We know how hot the fire can get.

And here’s the kicker: these new investors, they’re paying attention now, because everyone pays attention on 500 point days. They’re looking at their Watch & Apps; staring. And these firms gave them the power to do it. In the face of all of that, here’s Wealthfront’s YTD performance (rebalancing daily, because that’s a feature too):

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Source: ETFreplay.com

I imagine Betterment is doing about the same, too.

But my point is this…

Did Mr. and Mrs. investor, really consider the risk associated before they invested with their robot? Did these robots help them really figure that out? I think we now know the answer is probably no.

My other (bigger) point is this: shame on you, Mr. and Mrs. RoboAdvisor.

Without providing real context and insight to help investors understand their risk, before someone invests, these automated platforms are nothing more than automated dealers in the same casino the brokers are dealing in; selling shiny objects. They’re just cheaper & faster at enabling really bad decision-making from the start.

What I’m basically saying is this: if you decide to ignore the risk part of risk/reward, results may vary.