Tag Archives: advice

Can You Trust A Roboadvisor With Your Money?

The definition of robo-advisor still isn’t fully set in stone, but roughly speaking it’s a software tool which manages your portfolio and gives financial advice and action items without the need to consult (often) an outside human advisor. Because there are so many Americans with similar financial goals, responsibilities and amounts saved it makes sense to offload some of the advisor burden onto an algorithm; unlike in business, often the best move with your finances is just to do exactly what others are doing and have done before. Can You Trust a Roboadvisor? Survey Says… Gallup set out to answer that very question, asking Americans if they would want a single human financial advisor, a roboadvisor, a combination of the two, access to on-call financial advisors… or other/none/not sure. The plurality went to the human advisors: 49% saying they wanted the individual attention of a single advisor, and 18% opted for the stable of on-call advisors. There was a follow-up question as well which really underscored how wary of roboadvisors we still are: 62% of respondents wanted only human help or a majority of human help, while 27% preferred to trust a roboadvisor with a majority of decisions… with humans on call. Only 9% of respondents wanted only digital advice… surely an important datapoint for the large number of Financial Technology companies currently targeting the space! Robots Don’t Have Good Bedside Manner The survey is worth reading in full, but it leads us to bring up a lot of interesting, recurring themes with human experience and automation. Although we’re warming up… at least in part… to the idea of some of our financial advice and investing tips coming from an algorithm, humans still prefer the emotional check of another human to the cold, calculating rationality of a machine. Can you Trust a Roboadvisor? “Take me to your bank account routing number!” (And this comes up over and over again in various fields!) We alluded to the bedside manner of doctors in this section’s heading, which has long been an important field of study , and can certainly help patient outcome . It came up in elevators – where humans resisted user-operated elevators when elevator operators once were supreme – which has echoes today in state laws and policy. And, perhaps at the forefront of public discussion – it comes up in automated cars (ironically, automated automobiles ), where the safety record of robot-operated vehicles is superb compared to our fallible human peers. Perhaps, like so many other things in life, our reluctance to trust a robo-advisor comes at least in part because of psychology. There is a concept where things that look real but not exactly real (a concept known as the uncanny valley ) cause the greatest reactions of disgust amongst humans (So, FinTech… careful about how friendly you make your robo-advisors). A psychological explanation might mean we are wary of robo-advisors for the same reason we’re wary of zombies – we don’t want something to try to be human, we want there to be some human with responsibility at the end of the day. (Even if we lose a few basis points with the human.) What Benefits Will Come if We Trust our Roboadvisors? There are many great theoretical effects that would come to us if we can convince enough of our peers to trust a robo-advisor. First, the cost benefit is incredible . Like all software, the marginal cost of spinning up another instance of a roboadvisor is just-about non-existant. Just as the marginal cost of you reading this webpage is immeasurable (we serve up 100s of thousands of pageviews a month for < $10), automating common financial advice could go a long way to expanding access for those in most need of help. In other words, it can go a long way towards solving that paradox of financial advice – often those who need it the most are the least able to pay. Second, it can automate a lot of the incredible value-adds that are tough to do today. Tax-loss harvesting is the first thing that comes to mind. If you’re unfamiliar, the IRS allows you to write down your income when you sell stocks at a loss, so long as you don’t buy the exact (or substantially similar) asset within a fixed time frame. It’s incredibly tedious work to always be shifting in and out of funds to capture tax benefits and computing the breakeven for when it is worth making the switch – not to mention the reporting requirements for your tax returns. On top of tax-loss harvesting, robo-advisors and algorithmic management can help you find opportunities in account types, tracking eligibility to the dollar in real time as you earn throughout the year. It can help recognize shortfalls and surpluses in checking accounts, automatically moving money to long term savings. With a little advancement, it can even help you plan purchases – finding the best combination of savings vehicle, and maybe even one day the best rewards when you go to pay for whatever you are buying. And that’s just off the top of my head. Surely you can think of some more. Third, it opens up the best financial advisors to more people. Humans are always going to be better at the human element, no matter how much we end up trusting our robo-advisors. However, a move to majority automatic financial advice would mean our best advisors would have more throughput and be able to see more ‘patients’ – either for periodic checks on a long term plan, or to address those corner cases which software wasn’t built to handle. What Will We See Next? Just like the aforementioned driverless cars, expect to see a lot more innovation in the robo-advisor field. As people appear to not mind at least some of their advice coming automatically, expect to see a lot of financial technology firms moving to advisor-guided robo-advisement sessions, or more human staff on call while people have their robo-advisement sessions. The future is undoubtedly bright in the field, and the momentum towards automation is clearly there. Clearly we’re going to see big changes – even innovation that we had no idea was possible or probable – before too long. The only thing we know for certain is that big changes are coming… and people will probably become more and more comfortable with the offerings out there. So, dear reader – could you trust a roboadvisor with your money today? What would it take for you to give a robot control – or at least allow it to guide you? What do you think we’ll see in the next few years?

Investment Wisdom From The Original Global Guru

Sir John Templeton, who passed away at the age of 95 in 2008, was the original Global Guru. Templeton provided me with an introduction to the world of global investing when I picked up a book on Templeton’s investment philosophy many years ago in Amsterdam. While today you can buy a Brazilian or Malaysian or South African stock with a click of the mouse, the world was a very different place when Templeton began his global investing career. John Templeton: A Pioneer in Global Investing Born in 1912, Templeton hailed from the South (Winchester, Tennessee), graduated from Yale in 1934 and won a Rhodes Scholarship to Oxford. After studying law in England, Templeton embarked on a whirlwind grand tour of the world that took him to 35 countries in seven months. That tour exposed him to the enormous investment opportunities that exist outside of the United States. In the very first display of his famous contrarian streak, Templeton came to Wall Street during the depths of the Great Depression to start his investment career in 1937. Templeton soon borrowed a then-princely sum of $10,000 ($170,000 in today’s dollars) as a 26-year-old investor and bought shares of 104 European companies trading at $1 per share or less. This was in 1939, the year German tanks rumbled into Poland, launching World War II. Though dozens of companies were already in bankruptcy, only four companies out of those 104 turned out to be worthless. Templeton held on to each stock for an average of four years and made a small fortune. In 1940, he bought a small investment firm that became the early foundation of his empire. Templeton then went on to build an investment management business whose name became synonymous with value-oriented global investing. He launched the Templeton Growth Fund in 1954 – notably in Canada, which then had no capital gains tax. He made his company public in 1959 when it only had five funds and $66 million under management, and eventually sold his business to Franklin Resources for $913 million in 1992. Templeton focused his final years largely on philanthropy, endowing the Centre for Management Studies at Oxford. He also established the Templeton Prize in 1972, which recognized achievement in work related to science, philosophy and spirituality. His Templeton Foundation, which today boasts an endowment of $1.5 billion, distributes $70 million annually in grants to study “what scientists and philosophers call the Big Questions.” Past winners have included Mother Theresa, Billy Graham, Desmond Tutu and the Dalai Lama. John Templeton: Contrarian to the Core Templeton’s investment track record was impressive, although, given his deeply contrarian style, inevitably quite volatile. A $10,000 investment in the Templeton Growth Fund in 1954 grew to roughly $2 million, with dividends reinvested, by 1992. That works out to a 14.5% annualized return since its inception. Templeton was perhaps best known for investing in Japan in the 1950s when “Made in Japan” was synonymous with free toy trinkets found in cereal boxes. And like all great investors, Templeton was not afraid of big bets. At one point in the 1960s, Templeton held more than 60% of the Templeton Growth Fund’s assets in Japan. That kind of a concentrated position in a global fund would be illegal on Wall Street today. But Templeton also had the savvy to exit markets when they were overvalued, selling out of Japan well before the market collapsed in 1989. Central to Templeton’s investment philosophy was buying superior stocks at cheap price points of “maximum pessimism.” He diligently applied this approach across a range of countries, industries and companies. As Templeton noted in an interview in Forbes in 1988: “People are always asking me where the outlook is good, but that’s the wrong question. The right question is, ‘Where is the outlook most miserable?’ ” My favorite Templeton anecdote was his bet against the U.S. dotcom bubble in 1999. Templeton famously predicted that 90% of the new Internet companies would be bankrupt within five years, and he very publicly shorted the U.S. tech sector. I think it’s a terrific irony that John Templeton – a value investor known for sussing out little known global opportunities – made his quickest and possibly biggest fortune by shorting U.S. stocks. John Templeton: Lessons for Today’s Market With most global stock markets trading in bear market territory, you may find some comfort in John Templeton’s most famous piece of advice: ” To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward .” This advice is simple – but not easy to implement. Templeton also added a small refinement to this approach. He recommended that you initially take a small position in your investment ideas before rushing in. If it’s a truly great bargain, there’s no need to hurry. Finally, what I found most refreshing about John Templeton is his relentless optimism. Templeton once asked a journalist to write about why the Dow Jones Industrial Average might rise to one million by the year 2100. At first blush, “Dow 1,000,000” sounds absurd. Yet, it turns out that thanks to the miracle of compound interest, the Dow would only need to rise about 5% per year to hit that level in 86 years.

Active Vs. Passive Investing And The ‘Suckers At The Poker Table’ Fallacy

By Druce Vertes, CFA Image credit: ©iStockphoto.com/animatedfunk Warren Buffett sometimes says things that seem… contradictory. For example, in the “You don’t have to be a genius to be a great investor” category: ” Success in investing doesn’t correlate with IQ once you’re above the level of 25.” “If you are in the investment business and have an IQ of 150, sell 30 points to someone else.” He loves tweaking academic proponents of the efficient market hypothesis (EMH): “I’d be a bum on the street with a tin cup if the markets were always efficient.” ” Naturally the disservice done students and gullible investment professionals who have swallowed EMH has been an extraordinary service to us . . . In any sort of a contest – financial, mental, or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try.” And yet Buffett also says most people should steer clear of active investing: Like those same gullible investment professionals and misguided EMH proponents, he recommends low-cost index funds. “A low-cost index fund is the most sensible equity investment for the great majority of investors.” “My advice to [his own self-selected!] trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.” How can Buffett say passive investing is best for most people and also an “enormous advantage” for active investors like him? If it helps everyone else, how can it also help him? The opposite view is sometimes described as the ” suckers at the poker table ” hypothesis – the theory that an increase in passive investing is bad for active investors like Buffett because the fewer suckers there are to fleece, the less profit there is for smart active investors. So which view is right? The “suckers at the poker table” theory, or Warren Buffett, who says passive investors make his job easier? And how can Buffett be right while at the same time saying most people should invest passively? Let’s do a simple thought experiment: What would happen if everyone was a passive investor except Warren Buffett? As is often the case, we find that Buffett is way ahead of everyone else. He is both correct and self-serving. Anyone can use an index to match the market on a holding period-return basis, and yet Buffett can still crush everyone else on a money-weighted basis. A brief theoretical digression: The Grossman-Stiglitz paradox holds that you can’t have a perfectly efficient market because that requires someone to be willing to arbitrage away any inefficient price. But arbitrageurs have to get paid. So they will only step in if they’re compensated for their time, data services, research, compliance, office rent, overhead, and an adequate after-tax, risk-adjusted return. So markets tend towards an equilibrium where prices are boundedly efficient, where there is no more mispricing than at the level that would make arbitrage profitable. The set of all investors is the market itself and, in the aggregate in any given period, earns the market return. The subset of index investors, by virtue of owning the market portfolio, also earns the market return. To make the indexers and non-indexers add up to the market, the non-index investors in the aggregate must also earn the market return. 1 In the aggregate, those “arbitrageur” active investors aren’t making any excess profits! Before expenses, they are matching the market, and after expenses they are underperforming. In order to have any profitable active investors, it seems you have to posit overconfident, “dumb” active money that loses money trading against the “smart” arbitrageurs. And that doesn’t make much sense. It implies the persistence of a class of irrational investors. If there’s a tug of war between smart money and dumb money, and a priori the dumb money is as strong as the smart money, and it’s to the smart money’s advantage to trick the dumb money whenever possible, why should that make prices efficient? It sounds like a theory of irrational traders and not very efficient markets. Let’s see if another thought experiment can shed some light: What happens if passive investors take over the market so there is only one active investor left: our hypothetical Warren Buffett? Let’s disregard for the moment changes in the composition of the index. We only have Buffett trading with passive investors. The passive investors just want to enter and exit the whole market. They don’t want to trade individual stocks or a non-market-weighted portfolio. And there are no other active investors to trade with other than Buffett, who makes a bid-ask market for the index, selling when it’s above his estimate of fair value and buying when it’s below fair value. A somewhat trivial example, which should be familiar to those who have done the CFA curriculum on holding period vs. money-weighted returns: Cash Flows Index Fair Value Index Price Premium/ Discount Holding Period Return Cost Averaging Investor 1 Dumb Investor 2 Dumb Investor 3 Warren Buffett Corporate Issuance Year 0 $ 100.00 100.00 0% (1,000) (1,000) (1,000) – 3,000 Year 1 $ 105.00 94.50 -10% -5.5% (1,000) – 945 (1,000) 1,055 Year 2 $ 110.25 121.28 10% 28.3% (1,000) (1,000) (1,000) 1,283 1,717 Final value $ 115.76 115.76 0% -4.5% 3,337 2,112 955 – Holding period return 5.0% 5.0% 5.0% 5.0% Money weighted return (IRR) 5.4% 2.7% -5.0% 28.3% The index fair value grows at 5% per year. It starts priced at fair value in Year 0, in Year 1, it trades at a 10% discount, in Year 2, at a 10% premium, and then finally returns to fair value in Year 3. The holding period return, which ignores flows, is 5%, matching the index. Dollar cost averaging Investor 1 buys $1,000 worth of stock each year and has a money-weighted return of 5.4% as a result of automatically buying more shares when they are cheap and fewer when they are expensive. Dumb Investor 2 panics when the market goes to a 10% discount and doesn’t buy that year and ends up with a 2.7% money-weighted return. Dumb Investor 3 panics even worse, sells when the market goes to a 10% discount, and ends up with a -5.0% money-weighted return. Warren Buffett stays out of the market until it trades at a 10% discount, sells at a 10% premium, and ends up with a 28.3% money-weighted return. Everyone gets the same 5% holding period return, which ignores flows. But on a money-weighted, risk-adjusted basis, of course, the returns are very different, and our Warren Buffett crushes the market. One way of looking at it is Buffett increases the size of the overall pie when the odds are in his favor, shrinks it when they aren’t, and outperforms without necessarily taking anything from the other investors, who earn the market return in each holding period. Another way of looking at it is to consider the whole scenario as one holding period during which Buffett took advantage of people who were selling low and buying high. Effectively, our Warren Buffett sets a floor under the market when events or cash flows make the passive investor inclined to sell excessively cheap and sets a ceiling when the market gets expensive. If you examine any individual year, everyone here is a passive investor in the sense of always holding the index. But if you think of the entire scenario as one holding period, only someone who owns the index and never trades is really a passive investor. Everyone else is buying high or selling low within the period. If you’re planning to invest for an objective other than buying and holding forever, you have to make decisions about when and how much to invest and when and how much to withdraw. On a sufficiently long timeline, the probability of being a completely passive investor goes to zero. Eventually, you have to make an active investment decision, and at that point, the shrewd investors are lying in wait. Everyone eventually has to pay Charon to cross the river Styx. It gets even better for Buffett when you incorporate index changes. An IPO comes out. The IPO is initially not in the index. Our hypothetical Warren Buffett sets the IPO price. He doesn’t have anyone to bid against or anyone to trade with besides the issuers since the stock is not yet in the index. Being an accommodating fellow, he sets the price at fair value minus his margin of safety, illiquidity discount, etc. The IPO eventually gets added to the index. Indexers have to buy the stock. Buffett solely determines the price at which it gets added to the index. In his obliging manner, he sets it at fair value for a liquid index stock plus a reasonable convenience premium. What a sweet deal! Pay a steep discount for any security not in the index and demand a big premium when they go into the index. Similar profits are available when securities exit the index. Going back to the Grossman-Stiglitz paradox, the arbitrageur active traders can do pretty well, even without the existence of a large pool of permanently underperforming “dumb money,” which is unnecessary and illogical. They pull a bit of Star Trek’s Kobayashi Maru scenario by going outside the bounds of picking stocks from within the index. The “suckers at the poker table” paradigm goes astray because there isn’t some exogenous fixed size of the investment pie investors are fighting over. The returns are endogenous: They are in part determined by how smart the investors are, how well the capital in the economy is allocated, and by everything else that impacts economic and market outcomes. The size of the profits pie is not fixed. When investors take a risk funding an early Apple (NASDAQ: AAPL ) or Wynn (NASDAQ: WYNN ), they increase the size of the overall pie, getting a bigger slice without taking a commensurate amount from everyone else. Smart money going into appropriately priced investment opportunities grows the whole pie. Dumb money going to bad businesses shrinks the pie. Once it’s not a strictly zero-sum game, you don’t need “suckers at the poker table” to outperform. Sufficiently smart money creates its own suckers. Bill Ackman, in his most recent Pershing Square letter, asked “Is There an Index Fund Bubble?” He pointed out that if index funds generally side with management, they make the activist’s job harder. But increased herding can be a self-fulfilling prophecy with bubble dynamics, and it increases opportunities outside liquid indexes. There are useful parallels between investing and poker , but investing is not a zero-sum game, dumb money is not the primary driver of returns for most strategies, and the “suckers at the poker table” is not a useful analogy for most long-term investors. 1 This accounting excludes issuers of stock, who are kind of important. Companies are net distributors of cash to their stockholders. They pay dividends and they on net buy back stock , these days. So everyone cannot be a passive investor in the S&P and reinvest dividends. If they tried, something would have to give. Investors would bid up stocks until someone capitulated and started selling, or companies started issuing stock, or something. When it’s not a zero-sum game, reasoning from accounting identities tends to be misleading. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.