With the rapid growth of automated investment tools, in February 2017, the SEC reissued FINRA’s 2015 Investor Alert, bringing into focus potential risks and limitations of these apparently simple tools. The Investor Alert arms investors with tips on how to navigate this new technological landscape.
Next, consider the tool’s limitations and assumptions. Every robo-adviser uses a specific methodology to generate its recommendations. This methodology should be revealed in the tool’s online disclosures. Read these carefully. Some of the assumptions the tool makes may be incorrect or may simply not reflect your needs or economic reality. A robo-adviser may be programmed not to react to market shifts – thus, while interest rates are raising, the robo-adviser may continue assuming that they remain low. The tool’s recommendations will not reflect economic market reality, and this misguided process will directly affect your wallet. Similarly, the robo-adviser may be programmed to only consider investments offered by an affiliated firm, inherently limiting your pool of options. Make sure you understand these limitations.
A robo-adviser’s recommendations may simply not be right for your financial needs and goals. Different tools assess different factors in generating their recommendations – including age, investment experience, tax situation, need for cash, or willingness to risk losing the investment for a higher return. Some of these factors may be more salient for your situation than others. The more you understand how the tool works, what its limitations and assumptions are, the more likely it is that your choice will reflect, and meet, your needs.
It is equally important to recognize that the information the robo-adviser seeks from you and the information you provide in response directly affect its recommendations. Pay attention to the questions asked by the robo-adviser – the framing of the question will necessarily dictate your answer which in turn affects the generated recommendation. Carefully input your answers – a single mistake or oversight may result in recommendations not right for you. Be aware that some tools may ask questions that are designed to fit you into its predetermined options. Again, if anything is unclear, ask the tool sponsor.
It is ultimately up to you to decide whether you wish to rely on a particular robo-adviser in making your investment decisions. How much human interaction – with its personalized service, human judgment, and potential oversight – is important to you?