[Ask FH] When should you use a Robo Advisor? And some thoughts about day trading…

I love hearing from readers. My readers mean everything to me, and if any reader is prepared to take the time to write me an email, I will always respond personally (although sometimes life does get in the way, so please forgive me if I take some time in responding to you).

I’ve recently received a number of really fantastic questions, and I think that my responses to them can benefit other readers out there. If you have anything about investing you want to ask at all, no matter how silly, drop me an email at [email protected] with the subject title “[ASK FH]”, and I will respond to you here (anonymised of course).

Question 1: When should you use a Robo Advisor?

“Which types of investors should consider robo advisors?

What would you say is the most important factor(s) when choosing a robo advisor?

What are the fees to bear in mind?

Robo advisors have limited track records except for those back-tested returns. How do I know whether they can survive another financial crisis or they can perform well? And how do I know my money is safe with them? Will they run into some sort of liquidity crisis?”

Financial Horse says:

Amazing question. Great timing as well, coming right after my article on the best robo advisor in Singapore. Let’s deal with them individually:

1. Which types of investors should consider robo advisors?

I’ve spent a lot of time thinking about this, and my conclusion is that robo advisors are great for 3 types of investors:

Small investment sums – The first category is investors who are only able to invest small sums each time, below S$1000, ideally around S$500. At this price point, constructing a diversified portfolio of stocks can be difficult because transaction costs as a percentage of your investment become prohibitive. For example, if you’re investing S$500 through DBS Vickers Cash Upfront, the minimum commission is S$10. Throw in SGX clearing fees, and you’re looking at a whopping 2.4% transaction fee on your investment. That’s money down the drain before you even start. If you use plain vanilla DBS Vickers with a minimum S$25 commission, that’s a 5.4% transaction fee. Robo advisors that don’t have minimum fees are a great alternative.

Lazy to buy – The other category of investors, are those who are simply too lazy to give a shit about investing. They simply can’t be bothered to sit down in front of their computer once every quarter and buy the S&P500 and a treasury bond index, and do simple rebalancing. For these guys, the robo advisor does the work for you, for a small fee of course.

Emotional trainwreck – The last category is for those investors who are too emotional for DIY investing. Sometimes in investing you just have to sit on your hands and do nothing, and watch as your stocks fall 10%, because you think that in the long run it will go back up. Some people cannot accept this. They compulsively check their stocks every 5 minutes, and sell it the moment it drops 5%. For these guys, robo advisors are a decent alternative, because it robs you of the control over individual stocks. Your only decision point is whether to take the money out of the robo advisor, which can be a great way of forcing you to stay in the market. It’s like an endowment plan, but with lower fees.

2. What would you say is the most important factor(s) when choosing a robo advisor?

2 factors: (1) asset allocation, and (2) fees.

On asset allocation, not all robo advisors are created equal. Some have heavier allocation to the US markets, while some have heavy gold components, and some have heavy bond allocations. You really need to know what you’re looking to get out of investing, and what your risk appetite is. Are you okay allocating half your life savings to a bet on the China stock market? What about the US market?

On fees, don’t forget that every 1% of fees charged, is another 1% that has to be earned back through investment returns. If a robo advisor charges 1.5% fees, ask yourself whether that robo advisor generates enough value that it will outperform a simple S&P500 or STI by 1.5%. If it doesn’t, you’re better off buying the S&P500 or STI.

3. What are the fees to bear in mind?

When you invest in a robo advisor, you’re actually paying 2 types of fees.

The first is the fee that your robo advisor charges you. It ranges from 0.5% to 1.5% of the assets invested.

The second is the fee on the ETFs that your robo advisor invests in. Depending on the ETFs chosen, this could range from 0.1% to 0.5% of the amount invested.

Don’t forget about withholding tax as well. If you’re investing in US ETFs, you have to pay a 30% withholding tax on your dividends. I wrote an article on this previously, do check it out if you need more info.

4. Robo advisors have limited track records except for those back-tested returns. How do I know whether they can survive another financial crisis or they can perform well? And how do I know my money is safe with them? Will they run into some sort of liquidity crisis?

That’s actually a really good question. I’m not a fan of robo advisors myself, but I’ll do my best to defend them here.

Firstly, most robo advisors are awarded a Capital Markets Services license by MAS. There are different classes of licenses, and with the higher tiers, it requires the robo advisor to have certain capital requirements and internal processes. This definitely isn’t fool proof (nothing is), but it does give you some comfort that the MAS has at least done some basic checks.

Some robo advisors like to pool their client funds, while some will segregate them for each client. This has a huge impact in an insolvency situation, because the pooled funds means that you’ll need to fight for your assets with other creditors, while the segregated funds means that whatever is separated and tagged to you will belong to you. Unfortunately there’s no easy way to know which system your robo advisor uses. Your best bet is to ask the customer service guy.

Whether the robo advisors can survive a financial crisis or liquidity crisis, is a much tougher question. You can ask me the same question about DBS and I probably can’t answer you with a definite yes. The way I see it, these robo advisors typically invest in highly liquid ETFs like the SPY and the QQQ. As an example, the SPY (SPDR S&P 500 ETF Trust) tracks the S&P500, and its total AUM is 270 billion USD, with an average daily trading volume worth 18 billion USD. To put that in perspective, its AUM is close to the size of Temasek’s entire portfolio, and its daily trading volume is about 15 times the entire daily trading volume of the SGX. But does this mean anything when we have another Lehman style event? Absolutely not.

No one knows who is going to survive the next financial crisis, because no one knows what the next financial crisis will look like. A lot of investment funds today spend their time preparing to fight yesterday’s war, so I can tell you that if Lehman were to repeat itself, a lot of them would do very well. But Lehman will not repeat itself, and the next financial crisis, will have different characteristics from 2008.

Question 2: Should I day trade?

(Note: I’ve redacted certain bits of information to protect his/her privacy)

“…

I currently don’t have any source of income, except the monthly allowance I get from my parents which is about $400. I currently have about $43,000 on hand through savings, $24,000 of which I’m using to pay on my own for my remaining university fees (3 more years worth as I’ve already paid my first year of education) till I graduate. Thankfully I didn’t need to take a bank loan as my savings could cover it.

And then there’s $13,000. This amount was originally given to me by my father to partly pay for my university fees, but I …  intend to return it to him immediately after I graduated.

This leaves me with around $6,000 for investing. Initially when I was on this whole investing journey, it was more towards long-term. But then, due to…, I realized that 20-30 years of investing was quite a long time, and thus I began to favor short-term profits much more. As such, do you think it would be wise if I utilized the $13,000 and $6,000 to partake in day trading, and subsequently return $13,000 within 3 years? Or should I stick to the original plan of buy and hold? I’m aware of the much higher risks, and letting emotions influence my decisions in investing is probably the worst thing to do, but as it currently stands, I need to achieve financial freedom as soon as possible. 

I probably sound like I don’t know what I’m talking about, and I must admit that that is to be very true. Thus, I would love to hear your opinions, probably cold hard truths as well, on it.

Thank you so much once again for taking the time to read this, can’t wait to hear from you soon!”

Financial Horse Says:

I suspect you already know what I’m going to say, but I’m going to say it anyway. Day trading is incredibly hard. A UCLA Berkeley study showed that 40% of traders quit within a month, 87% of traders quit within 3 years and 93% of traders quit within 5 years. If you want to do day trading, chances are you’ll lose money, grow disillusioned, and quit eventually. If you want to day trade your way to financial freedom, well, that sounds like the start of every good bankruptcy story.

But I cannot in good conscience tell you to stop day trading. You may well turn out to be the remaining 7% and go on to make a career out of it, eventually heading the Goldman Sachs trading desk and looking after an army of machine learning algorithms. If I tell you to quit day trading, I could well be depriving you of that chance.

So my advice to you is this. There are many ways to make money in this world. You can make money through short term trading, buying and holding, and multi-decade value investing. There’s no right or wrong here, only what works for you.

If you think that day trading is right for you, if you think that you have the necessary aptitude and emotional resolve, and you’re prepared to work at it every day until you finally find a process that works, then maybe give it a shot. You may still fail anyway, but hey, no one ever regrets their failures. We only regret the chances we never took.

P.S. For obvious reasons, we all know the conventional answer here is to not be silly and not try day trading, but hey, I’m not your mum. As long as you’re aware of the risks and are prepared to learn, the world is your oyster. 😉

Financial Horse has a set of 7 Commandments for Successful Investing, that I ask myself before making every investment, and that I will never break regardless of the situation. Enter your email below to receive a copy in your inbox!

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