Are Robo Advisors Safe?
A Robo Advisor is simply a traditional investment advisory firm that has automated the process of providing advice and portfolio management services to customers. You should not assume all Robo Advisors are a safe investment and the financial services industry is prone to scandals and fraud. So, to answer the question are Robo Advisors safe, you have to ask three questions.
- Are your assets safe and regulated with a specific investment firm?
- Are the automated processes (algorithms) used by Robo Advisors Safe?
- Are the online systems used by Robo Advisors Secure?
1. Are your assets safe and regulated with a specific investment firm?
According to Juniper Research the Robo Advisor industry had assets under management (AUM) of $220 billion in 2018 and it is set to rise to $4.1 trillion in 2022. Like all investment advisors, Robo Advisors must be registered as a broker / dealer comply to all applicable regulations by being a member of FINRA and the SIPC.
You should check the background of any investment firm you are planning to use by performing a search on the firm online @ FINRA.
Of course, any broker you use should also be a Securities Investor Protection Corporation (SIPC) member. This nonprofit organization will protect your investments up to a maximum of $500,000 ($250,000 in cash).
As the Robo Advisory industry is growing very quickly there are issues with transparency and marketing of the services. The SEC has laid out advice for investors to help them navigate through the process of evaluating and selecting good service providers.
2. Are the automated processes (algorithms) used to select your portfolio safe?
Transparency Matters for Robo Advisors.
There are some other areas of performance you must evaluate including security and transparency. Strangely, transparency is one of the most important areas of Robo Advisor performance, but many people ignore it. Transparency means the advisor clearly lists all features, capabilities and strategies.
For example, the manager lists all the equities in a portfolio and explains every strategy used. Management should tell you when they make a change or add a feature. In addition, they should provide clear explanations and justifications for any feature in plain English.
Hence, you should avoid a Robo Advisor with a low level of transparency. If you do not have at least a rudimentary grasp of what is going on, you should stay away from a robo advisor.
There have been two high profile SEC cases involving Robo Advisors. The biggest settlement was in 2018 against Wealthfront Advisors who were fined $250,000 for misleading investors about the tax loss harvesting services they would receive. They failed to provide the tax loss harvesting service they marketeds as standard to 69% of their customers over a 3 year period.
Are the online systems used by Robo Advisors Secure?
Are Robo Advisors Secure?
Finally, transparency is doubly important for security. For instance, an advisor should tell you about any security breach as soon as possible. They should warn you so you can change accounts and passwords before crooks get into your other accounts.
The advisor must clearly explain all security features and protocols. Moreover, security features should work quickly. For instance, there should be an easy but secure way to access your account if you lose your password. A good example of such backup access is an algorithm that sends a text to an encrypted phone if you change your password. They usually call such features 2-step authentication.
Plus, the advisor should list all the security protocols and features and explain them. If an advisor does not provide a clear picture of the security, you should avoid it.
The bottom line is that a Robo Advisor that does a poor job of security and transparency will cost you money. Thus, avoid any Robo Advisor that is lacking in either security or transparency.