As investors, we are overwhelmed by the race to ever higher returns. We tend to lose sight of what is important for our financial goals, what strategy really suits our circumstances, and just how far we should go before overburdening our portfolios with risk. As humans, we are prone to making mistakes but awareness about some of the repeat investor errors together with the use of robo advisors could potentially help you avoid them and keep on track.
- Drifting with no plans
Most people when start investing do not necessarily have a specific goal in mind. It is all left to be taken care of later. Experts suggest to the contrary, tough. Your investment plan should be guided by your specific financial goals. Once you focus on your goals, the next question is how much risk you are comfortable with in your portfolio. Robo advisors, like Betterment, allow an investor to pick investment goals based on which it creates portfolio(s) with an appropriate risk and asset allocation designed to help them meet their goal(s).
Goals based investing is proven to help investors to be more disciplined in their investing approach than one without a mapped out methodology. Knowing how much you need to save and how often and your risk tolerance, robo advisors like Betterment can choose an asset allocation for your specific goal portfolio to yield an optimized level of risk-adjusted returns. Often this is what makes robo advisors starkly different from active managers who are more focused on beating a given benchmark instead of making client goals a focal point of their investment strategies.
- Having Too Short Of A Horizon
When asked what your time horizon is, most of us would respond with “long term.” We all aim to save for our retirements, but along the way we get distracted by short term stock market gyrations. If the market tanks by 5% today, what difference does it make to your retirement portfolio allocation mix? Likely, nothing. When your investment horizon is long term, meaning 10 or more years from now, you should give little attention to short term performance of the markets. Investing with robo advisors is one way to avoid this mistake as they encourage a buy-and-hold strategy which by its very nature does not care for how the markets are doing short term, except using downturns as opportunities to load up on good investments.
- Watching The Financial News
While it is good to keep up with what is happening in the world, financial news can be a distraction for your investment philosophy. When you hear about a star stock doing amazingly well and analysts and media gurus alike bestowing it with their blessings, chances are you would want to buy it too. If you want to stay away from what media’s next favorite big thing is, choose robo advisors because they use your investment goals as their handbook to decide on appropriate investment options for you.
- Not Rebalancing
Rebalancing is a regular check up of your portfolio to see how it is doing. As the markets keep growing both in complexity and size, it becomes important to evaluate your portfolio from an asset allocation perspective on a frequent basis. Doing this on your own could cost you plus leave your portfolio at a less than optimal asset allocation mix. That is why take the assistance of robo advisors here, too. Most robo advisors provide free of cost, daily rebalancing services (thanks to their sophisticated algorithms that have built in features to perform efficient rebalancing) to bring your portfolio back in line with target allocation.
- Exhibiting overconfidence in your manager’s ability
In his book, “Random Walk Down the Wall Street,” Burton Malkiel says, “there are four factors that create irrational market behavior: overconfidence, biased judgments, herd mentality, and loss aversion.” Clearly then when an investor believes his manager will be able to outperform the market is a mistake because nobody can consistently beat the market, even if they did in the past. Your investment decision should be impartial, aligning with your goals and robo advisors help you be rational in your investment choices by choosing a passive portfolio over actively managed ones.
- Holding High Turnover Funds
There are innumerable studies proving the underperformance of majority of the active fund managers. The high turnover in these funds adds to investment costs that drive down your returns[1]. In addition the fees charged by active managers for their services are so high that any performance alpha disappears in net of fee returns. Active management also leads to lower after-tax returns as the distributions and gains they make to their investors are taxed at a higher rate than long term capital gains. To achieve higher after-tax, net-of fee returns an indexing strategy should be used. Robo advisors are a growing class of online wealth managers that offer low cost, diversified portfolios using indexed ETFs. By pursuing an indexing strategy for your important financial goals, you can steer clear of the temptation to active manage.
- Assuming Past Returns Will Continue
We all have heard of those debates on what the next big investment is, right? Past performance can never guarantee future performance. Forecasts and predictions using historical data will still be a projection. So do not make the mistake of trying to chase superior investments based on their track record. Instead use a buy-and-hold strategy with a long term view. To bring this investing discipline in your life, use robo advisors. In order to keep their costs low, robo advisors avoid active management traps and encourage investing for the long haul with low cost index ETF portfolios.
The mistakes outlined above have always been all too common, but technology has enabled robo advisors which can prove a great assistance in avoiding them. A portfolio of high returning investments that actually yield less on an after-tax net-of-fee basis is not prudent. Rather it is the avoidance of common investor mistakes and staying focus on your financial goals and really meeting them is!
[1] To read up more on why active management is more expensive, refer to article titled, “Best Advice on Investment: Buy-and-Hold”