'Robo Advisor' Investing Apps Have Risks Too, Regulators Warn

NEW YORK (TheStreet) -- As more retirement savers turn to online allocation "bots," regulators are already wringing their hands. The Securities and Exchange Commission and FINRA have issued a joint alert, pinpointing the potential hazards of "automated investment tools." As of late 2014, the top ten robo advisors claimed to manage nearly $10 billion in client assets. Perhaps even more impressive, robos like Betterment and Wealthfront, among others, raised nearly $300 million in venture capital last year.

The online services utilize algorithms to determine the proper investment mix for users. Even investment powerhouses like Vanguard and Charles Schwab (SCHW) have recently introduced their own automated advice platforms.

While the securities regulators admit robo advisors offer "clear benefits -- including low cost and ease of use," they say investors should understand the "risks and limitations" of automated allocators.

The Investor Alert, issued by the SEC’s Office of Investor Education and Advocacy and FINRA, provided five tips for investors considering automated investment tools:

  1. Before using an online allocation tool, find out if the service receives any form of consideration for recommending particular investments or products.
  2. Keep in mind that automated tools may rely on broad assumptions that may not reflect current economic conditions -- or your particular situation.
  3. The recommendations offered by such algorithms are dependent on the information you provide. Be sure you understand the questions being asked and be wary of ambiguous or misleading questions that may be driving the tool to predetermined conclusions.
  4. Remember that investment apps by their nature are not likely to provide personalized recommendations based on your overall tax situation, other investments you may own and your ability -- or desire -- to withstand losses.
  5. And be sure you know how the personal financial information you share will be used. The regulators say investors should also be on the watch for phishing schemes and identity theft scams disguised as online investment tools.

Automated analysis services can also vary depending on the level of regulatory scrutiny they are subject to. If specific investment recommendations are made, rather than general asset class advice, the provider must be a registered investment advisor. Subject to SEC or state regulatory authority, such robo advisors are required to disclose their investment process and methodology, as well as potential conflicts of interest.

Vanguard is just such a registered investment advisor, managing $3.0 trillion in assets. The mutual fund giant rolled out its "investment modeling technology" last year. The firm provides "communications and disclosures to make clear the assumptions and limitations of our tools and services," according to spokeswoman Katie Henderson.

One of the concerns the SEC/FINRA advisory raised was that automated tools may lack the value of "human judgment and oversight." But because Vanguard’s service includes consultation with an advisor, the firm prefers to label its service as a "hybrid" advice model, rather than as strictly a robo advisor, according to Henderson.

"Our new advice service, available to individual investors, leverages sophisticated technology, Vanguard's time-tested investment methodology and an ongoing relationship with a Vanguard advisor to develop a financial plan and ongoing portfolio management," Henderson told TheStreet. "Investors fill out an online questionnaire to initially understand an investor's risk profile and investing time horizon, but the portfolio recommendation as part of the financial plan is not generated without a consultation with a Vanguard advisor via phone or videoconferencing. So the human element is at the core of our service."

Last week, Vanguard cut its opening account minimum in half, allowing investors to access the service with a $50,000 deposit. The annual advisory fee is 0.30% of a client’s managed assets. The Personal Advisor service attracted more than $7 billion in new assets through March 31 of this year during its initial rollout, making it the largest automated investing service.

Meanwhile, Charles Schwab’s Intelligent Portfolios, a new automated investment advisory launched in March, enrolled 23,000 accounts and $1.5 billion in assets in its first six weeks of operation.

In research released Tuesday, Schwab found that two-thirds of all surveyed investors preferred "a human touch" in matters of investing, but 40% of Gen-Xers and Millennials would rather their portfolios be based on a computer algorithm.

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