How Would Robo-Advisors Do in a Recession?

Ed. Note: This article first appeared in The Street

While a bear market seems light years away based on how the markets are performing, history tells us one eventually will occur.

Now modern technology has added a twist. With the popularity of robo-advisors for investing, the new question is how effective such tools will be when there's a downturn in the market and their human users want to let emotion into investing?

"During market highs and lows is when an individual's philosophies and established strategies are challenged," said Lou Cannataro, senior partner and wealth advisor at Cannataro Park Avenue Financial.

"This is where the robo-advisor alone cannot help, remind, clarify and demonstrate how to make the correct decisions and stay on track with your long term planning. One cannot input their personal goals, greatest fears, greatest obstacles and individual circumstances into an algorithm that handles all aspects of their life and planning."

However, some see a different side to it. Yuen Yung, chief executive at Casoro Capital, said robo-advisors could actually be extremely helpful during recessions or down times.

"During a recession, the whole idea is to stick with the investment plan or strategy, and a robo-advisor can actually help because it doesn't have emotion in the equation," Yung said. "The only issue I see is if investors don't follow the strategy, as the robo-advisor can't stop the investor from doing the wrong thing."

Yung said the average investor can and should utilize robo-investing.

"If your net worth and investable assets are above $1 million, then start thinking about a human advisor," he said.

"In regards to overall areas of investing that I believe robo-advisors are best utilized, I think it works well when investing per an asset allocation model that should periodically adjust," he added. "On the other hand, human investment advisors are best when there are no clear cut decisions and intuition and gut feel is important."

Robert Johnson, president and chief executive of The American College of Financial Services, however, reminds while robo-advisors are a wonderful concept during bull markets, bear markets bring different obstacles.

"In bear markets, people tend to panic, succumb to their behavioral biases and make emotionally charged decisions to exit markets," he said. "Left to their own devices, individual investors tend to 'buy high and sell low.'"

Johnson said when markets drop, investors tend to become unnerved and become very risk averse, succumbing to recency bias - believing that the recent past will continue into the future. Such moves by investors based on the immediate past can be hazardous to their wealth.

"Robo-advisors work splendidly in bull markets," he added. "They have problems when major negative market events occur and people want to rush for the exits. Without human advice, the client of a robo-advisor is more likely to have a knee-jerk reaction and exit the markets.

"A great deal of the value that human advisors can add is to help clients overcome their behavioral biases," Johnson said. "Human advisors provide counsel to investors during times of market dislocations, urging them to stick to their long-term plan and not try and time the market."

Johnson adds human advisors help reinforce an old, but important investment adage.

"Time in the market is more important than timing the market," he said.

Cannataro said oftentimes people can be our own worst enemy when it comes to their investments — something a robo-advisor may have a hard time fixing.

"The two emotions that often drive investment decisions are fear and greed," he said. "Then feelings can run from euphoria, hyperactivity, overconfidence to trepidation and fight-or-flight. These emotions are most controlling and possibly devastating during severe market downturns."

During a recession, he continues, these feelings are over stimulated and exacerbated out of uncertainty in the marketplace.

"Changing investment options through an emotive state can be counterproductive and risky," he adds. "By way of example, quite often the best time to invest is when everyone else is selling and the worst time to go all in is during moments of market euphoria."

Posted by: The Trust Advisor

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