Robo-Advisors Seeking to Automate Your Retirement

Robo Advisors

Robo-advising has really been growing over the past few years, offering lower-cost investment advice. We do not want to turn our future over to machines.

Technology has provided many enhancements to our lives, including the ways that it has dramatically changed the way we invest. We’ve certainly come a long way from the days when everything was done on paper, and the biggest change has been how we interact with our investments, with access to things we could not even have dreamed of in the old days now at our fingertips.

We can think of the evolution in investing as producing quantitative changes in how we invest, and that in itself is where the big win is here. Our investing success depends on both quantitative and qualitative evolution, and in spite of the massive growth on the quantitative side, the qualitative side, the part that humans still need to play, hasn’t evolved much at all since the old days.

The quantitative attributes of technology, what the technology does to help us manage information, can be used for either good or bad, depending on the qualitative inputs that we use. Programs are only as good as the rules that we set for them, and the quality of the advice that robo-advisors provide completely depend on the advice that is being programmed in by the humans that design the automation, what exactly is being sought to automate.

If we presume that the human advisors provide good advice, and this advise can be dispensed in a generic way, where the needs of investors are fairly homogenous and do not require much if any individual attention beyond what we can program into our software, robo-advising can at least be seen to be a pretty good idea, especially among those whose portfolios aren’t big enough to be worth bothering with by human advisors and the choice comes down to a robo-advisor or not getting served by these people.

Given the way that human advisors approach advising investors, which really involve an attempt to automate the advising function themselves, relying on very broad strokes anyway, where the human advisors have been programmed by their education to a great degree to try to emulate what a robot may do, investors who rely on robo-investing don’t give up very much and going with a robot might even be the better of the two choices.

Both robo-advisors and human ones rely primarily on what is called modern portfolio theory to guide them. Human advisors are taught this curriculum, while robots get it programmed into their algorithms, and both take us to similar places.

Modern portfolio theory may have been modern in its day, in the 1950’s, perhaps more modern than the way this was done prior to this time, but modern doesn’t necessarily mean very good or even all that evolved. Modern portfolio theory is very much in the dark ages, where it focuses way too much on managing variance, and doesn’t pay much attention at all to the return side of the equation.

There are two main components in managing investments, risk and return. Modern portfolio theory does a poor job at both, even though people think that it at least manages risk well. Managing variance and managing risk aren’t the same thing at all though, and it’s easy to understand why not.

Let’s say we have two competing approaches, one that either goes up 10% or down 5%, with a 50% chance of either in a given year, versus something that goes up 1% each year without fail. If we are only investing for a year, and we are looking to manage risk, the risk is higher with the variable investment, which is losing 5% as opposed to making 1%, which is a risk-free.

Both the variance and the risk is higher with the variable investment in this case, but what if we are looking at a few years down the road? If we are focused on managing variance like modern portfolio theory does, we’re not going to like the variance of the variable investment and are going to want to at least water it down.

Holding our investment for 2 years or more will still involve a higher variance but the value of our investment will be 3% higher every two years. We now have a return of 5% over the two years versus only 2% with the risk-free investment, so this is not anything that it is smart to want to water down and we’ll just be hurting ourselves.

The risk-free investment isn’t even risk-free, even though it is free of investment risk. There’s also the risk of failing to earn enough to take care of our needs, which is the risk that matters, including both losing money and not having enough, which are both part of the greater risk of failing to achieve what we need from these investments.

Post-modern portfolio theory at least focuses on the end result more, and although this has been around for almost 30 years now, modern portfolio theory remains king, with both robot and human advisors. Variance is still king, as poorly thought out as this may be.

These Robots Are Programmed to See Us Fail

This is how advisors can justify greatly watering down our expected returns with our investments, mixing in all sorts of assets that produce poorer returns in order to manage variance. We’ve seen some real variance this year and while the markets have recovered, this strategy has you less exposed to these variances but pay a huge price in reducing our returns greatly and also end up increasing rather than decreasing our risk of falling short of our goals.

Given that the majority of investors are not on a course to achieve their investment goals in retirement, modern portfolio theory and the way that people are advised to save for retirement blows it on both the return and risk side of things, being so concerned with the wiggles along the way that they are afraid to climb up the mountain very far and leaving us stranded and hungry far from the summit that we need to reach in order to be comfortable.

People who use robo-investing to manage their portfolios for them are committing themselves to a hideous approach to achieving their retirement goals, setting the bar well beyond the majority of people’s ability to save due to the pitiful returns they seek, where if the plan works or not you’re screwed either way.

Variance is not something we want to restrict with our investments, as variance is the fuel by which we achieve profit provided that we have a positive expectation with them. Variance does need to be accounted for but we must do so on a net basis, as we did in our example with the up 10% and down 5%.

This isn’t unlike going into business where we receive revenue from our business and then have to deduct our costs to determine our net profit, and investments work the same way. If we approach this by worrying about how much it will cost to do business without accounting for how much we will make from the deal, and instead choose something that involves less expenses but yields less of a return, we may be smug about our little profits while someone else smarter than we rakes in a lot more.

With investments with an overall positive expectation, like stocks, stocks that actually do have a competitive positive expectation that is and not just garbage or has-been ones that no one should be holding, when we look to manage their variance, we give up a lot more positive variance than eliminate negative variance. This is not a good deal and certainly should not be the driving force behind our strategies, lest we settle for peanuts. Many are happy with this, but they should not be.

The only way out of this to distance yourself from all conventional advice based upon this horrible strategy, from either robots or humans, and the humans that dispense this sort of advice are just another type of robot as they have been programmed the same way. Unless you are already wealthy enough so that you don’t need any return on investment, if the return you achieve as you invest matters to you, it’s never a good idea to want to water down your returns in the way that they want you to, especially if this path does not even put a scare into succeeding and guarantees failure.

Robot advising goes one step further from the human advisors, and require a passive approach rather than you or anyone else making any decisions about the composition and management of your portfolio, aside from the foolish rebalancing that they do for you. Rebalancing does not mean restoring the correct balance, it instead insists on fostering the broken strategy that the plan was based on.

It will split your assets between stocks and bonds, and as your stocks do well, the advisor will have you divert funds away from them to seek to water down this better performance even more. Should your stock positions pull back, they will basically cash some of them in to put them in bonds, assets that perform poorly in comparison.

This limits the upside of your portfolio even more as it succeeds, and makes recovering from downside variance all the more difficult. This strategy punishes you more and more no matter what happens, cropping your returns, cropping them more the better that they perform, and cropping their recovery as well when things turn down for a while.

You would think that these people would have looked back over time and compared how their hare-brained style of investing actually does versus other approaches, but that would spell the end of the thing since they would see how miserable it does. Modern portfolio theory hasn’t stayed modern for over 60 years from people examining it, and its reign has depended on people not asking any questions, and they still aren’t asking any a lifetime later.

With the robot version of this, we aren’t allowed to do anything. We can’t pick our investments, we can’t even decide how much of one asset class versus another that we want to be in, we aren’t allowed to manage real risk at all, all we can do is let the robots run the whole show.

If these were smart robots, like the better ones that the good quants design, the ones they use to actually make good money with, at least going with a robot would make sense, and make a lot of sense if we could design one for them that actually beat the daylights out of the market like it should.

We Can Achieve So Much More with Only Half a Brain

Beating stock market returns is the entry point for anyone with even the slightest amount of skill, and beating them significantly is not difficult at all provided that you have any sort of clue about what you are doing. You don’t even have to invest in anything but index funds to do this, and even broad ones such as the Nasdaq over a lifetime of investing has provided returns that simply blow away the other major indexes such as the S&P 500 and the Dow which people refer to as “the market.”

Should people wish to drill down to the good sectors within these indexes, or even put together a basket of good stocks, even better returns are achievable without much effort or even knowledge. People are too afraid to help themselves though, and they are even too afraid to just go with the S&P 500 or the Dow, as modern portfolio theory sees even their negative variance as too high while forgetting all about their positive variance, and choose to water this down significantly to almost cut their returns in half.

If you are wondering how you will survive in retirement and choose a watered down index like the S&P 500, and then cut that significantly with bonds, and this is not going to lead to a good place. Using a strategy like this should strike us as crazy, but it you don’t see it that way if that’s all you know. Advisors, humans and robots, do a great job of dumbing down everyone so that they do not even know there is any other place to be besides the funny farm.

Robo-advisors are at least becoming more comprehensive, and are offering some new services to retirees like helping to project how long their money will last on the shoestring returns they are earning, or help them with figuring out their required minimum distributions with their retirement accounts, but there are software programs that can do the same thing for them without having to pay a half a percent on average off returns that are already so paltry.

Robo-investing is equivalent to putting your portfolio in a coma on purpose and paying for the indignity. Investment firms make a lot of money from these things, and while we tip our hat to them for their entrepreneurial spirit, the old adage of garbage in garbage out is very apt.

You do need to know what garbage looks like though to be able to tell. We feel bad for all the people who think that they have to rummage through trash cans to get by when there’s some great restaurants just down the street.

We do want to provide a taste of what good food looks like, so we’ll assume that we have $100,000 to invest 30 years ago to the day and today is the day we retire. The robots are going back in time with us, although they had plenty of them around 30 years ago as well, in human form, that sang the same tune.

We put half in the S&P 500 and half in a bond fund, and look at our account statement today and see that we have $540,000 in it now. We need to calculate the effects of inflation, and it takes $198,000 to buy what $100,000 bought 30 years ago, so we now have $272,000 in constant dollars, with the rest lost to inflation.

We need to calculate this in because if we have $100,000 today, we’re going to need to know what that buys in 30 years when we retire, and if history repeats, we’ll have $272,000 worth of loot to use. We expect to live another 20 years after that so that’s $13,700 to live on, not much at all.

If we instead invested this $100,000 in the Nasdaq 100 back then, after accounting for inflation, instead of just having $272,000, we now have the princely sum of $3,016,000. That leaves us with over $150,000 a year to spend over the next 20 years. That’s more like it, and this shows how bad these machine and human robots do.

People might be frightened to death to put all their money in the stock market though, and especially in the Nasdaq, even though there’s less reason to be scared of this index than the S&P 500, even though people neither know why the Nasdaq scares them more or how it actually compares risk-wise.

You don’t get more variance than what happened to the Nasdaq during the crash of 2000, so we’ll take a little peek at how that played out. We could say that when your $100,000 turns into $6 million and $3 million in 1990 dollars is enough, and who cares what happened along the way, but worrying about these things is even sillier.

We bought this index at 193 back then, and after the dust settled after the 2000 crash, it never went below 800. This means that after they dropped this huge bomb, the worst we did is get a 500% return over 12 years. That’s over 41% per year, and that’s the scary part?

This is a completely passive approach, where we do not look to spice this up at all or run from the massacres such as what happened in 2000 and 2008, and even with this year’s crash, which would have been extraordinarily easy to do when so much blood was running in the streets and we wisely chose to run away from these beasts.

We could have added greatly to our return just by sidestepping the worst of these moves, and in spite of beating the robot minds this badly, we want to show what a difference stepping aside from these big tornadoes can make.

We buy in 1990 at 183 and when the index really hit the skids and everyone knew we were in for a massacre in 2000, we get out at 3700. This isn’t a trader’s exit by any means, it’s one that anyone with a working brain could have achieved.

We’ll also be conservative with our re-entry and wait for things to really settle down and get back in at 1130. We got a return of 1922% on the first leg. The second leg is between 2003 and 2008 and we get to add an easy 70%. The third leg gets us 643% more, up until COVID hit enough that we all knew the market was going to crash. We get in once things bounce and add another 56%.

So now it’s time to tally up. The first leg takes us from $100,000 to $1.92 million. The second leg takes us to $3.27 million. The third leg gets us to $21 million, and the fourth has us now sitting with $32.76 million, or $16.54 million in 1990 dollars. That’s more than 5 times not timing things brought and 60 times better than the robots did. Who says timing markets doesn’t pay?

The robot heads did. Minimizing the real bad variance is a fabulous idea as we can see, just like you don’t want to be standing in the street when bullets are flying everywhere. Watering down things so you only get hit with half the number of bullets rather than running away is not smart and no way to protect yourself. Just say no to all the robots, to all of their ideas, and beware the human ones especially.



Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.

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