Algorithms vs Nothing

Robo Advisors are the most recent development in investment management for individual consumers.  Robo Advisors provide on-line investment management services as an alternative to a personal investment advisor or firm.  They promote the use of sophisticated modeling techniques and algorithms in portfolio construction.  Initially I didn’t pay much attention to their introduction to the marketplace.

In the last year or so, as it has become obvious to me that investment management is essentially a commodity, I have become more intrigued in their role in helping consumers (investors) receive low-cost guidance.  The addition of the robo advisor is an excellent step in the evolution of the asset management market.  They assist consumers by reducing expenses, in many cases dramatically, and also by introducing more discipline into the process.

What I am not certain about though is whether or not using algorithms in ongoing management will provide any additional value over simply using an option like a Vanguard Target Date Fund or Lifestrategy Fund.  Or even using something like the No Brainer 4 fund portfolio recommended by Dr Bill Bernstein.

The models are designed to provide superior allocation by identifying predictive behavior among asset classes.  The argument is that by using engineering and math better, more efficient portfolios can be constructed in the short run, leading to better results in the long run.

I wonder how predictive this behavior is in reality.  Are the trends or behaviors used to model the portfolios really helpful in short term reallocation decisions? Are the efficient portfolios going to end up producing better returns than a well-diversified portfolio of low-cost index funds? I am not sure I am buying what they are selling.

By and large, I like what the robo-advisors are doing to help consumers receive investment management at a much lower cost, but if I had to bet, I would put my money with the No Brainer portfolio.  Adding complexity to money management for most people may not produce a better outcome.

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