Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first

Misunderstanding Asset Allocation

Diversification is one of the most often used and most often misunderstood concepts in investing.  Investors are frequently advised to diversify their portfolios.  Most people are rarely told what true portfolio diversification is, how to correctly construct a diversified portfolio or what to expect from the portfolio in terms of risk and rewards.

The idea of using a diversified investment portfolio is usually attributed to an article published by Prof. Harry Markowitz in the Journal of Finance in 1952. The article gave birth to what has been called “modern portfolio theory” (MPT).  It is widely accepted but I think it fair to say most people who claim to understand MPT do not.  If they did they would not invest as they do.

Markowitz was, first and foremost, a mathematician who applied mathematics to investment portfolios. The calculus that he used is not that complex if calculus is your thing but most people who swear by MPT cannot do the math themselves nor do they understand it.

The goal of MPT is not to get the highest return but to get an efficient return for the amount of risk that the investor is willing to assume. In a nutshell, Markowitz believed that by constructing a portfolio with a number of stocks, the winners will balance out the losers. Deciding upon which stocks to buy and how many has always been the vexing problem.

There have been a number of studies over the years that suggest the correct number of stocks to buy to gain diversification of the risk of a catastrophic loss is somewhere between 15 and 20.  Some people believe that they should buy a much larger basket, such as an index fund that tracks the entire S&P 500.

The large basket, index fund approach is the result of the capital asset pricing model (CAPM) which suggests that maximum diversification comes from buying a pro rata share of all available assets. The CAPM was introduced by Prof. William Sharpe in 1970.

Both Markowitz and Sharpe are trying to solve the same problem, constructing a portfolio that efficiently deals with the risk of loss. Understanding the significant difference between the two approaches is where most people get lost.

Markowitz suggested that one way to mitigate the risk of investing was to create a portfolio that contained a mix of non-correlated assets.   Non-correlated assets perform differently during periods when market conditions change.

A classic example of non-correlated assets might be an oil company and an airline. Oil company profits tend to rise when oil prices go up because the companies can get increased prices and margins.  Airline company profits tend to fall when oil prices increase as their operating expenses increase. Oil prices and other commodity prices fluctuate up and down with supply and demand, weather, political decisions and other macro economic factors.

This economic see-saw is usually felt in the credit markets. Fixed income securities are generally safer than equities.  Investors generally seek safer investments and like steady income.  But investors will move out of fixed income securities and into equities when interest rates are low as they have been in recent years.  Low interest rates often translate into higher profits for companies that borrow money pushing the price of their shares up.

That is why it is fairly easy to predict that people will begin to take the profits that they have made in equities in recent years and put their funds into fixed income securities as interest rates begin to rise.  Remarkably, a lot of people who are in the business of asset allocation simply ignore that fact.

A great many portfolios, especially those prepared by robo-advisors, construct portfolios allocated between equities and fixed income securities based upon the investor’s age. They argue that younger people can assume the risk of investing more aggressively into equities.  Neither Markowitz nor Sharpe ever considered an investor’s age as part of their analysis. The focus should not be on how old the investor is today, but what the markets are doing today and what do you anticipate that they will do in the near term.

Markowitz believed that portfolio construction should begin with observations and beliefs about the future performance of the available securities. That means that you should buy securities whose price you think will appreciate. You may be wrong due to market or other factors but if you are buying stocks that will react differently to those market factors you should not suffer catastrophic losses.

The CAPM on the other hand looks primarily at a stock’s volatility or beta. The beta is determined by how much more or less volatile a company’s stock is than a broader index. A stock whose volatility is the same as the index has a beta of 1. That is why people are encouraged to purchase an index or other large basket of stocks to get their portfolio’s beta closer to 1.

The essential difference between these two approaches is that Markowitz was looking at the fundamental factors that contributed to each company’s performance.  This fundamental securities analysis looks at a company’s business, management, competition etc. and tries to determine if the company will be profitable in the future and if so, how profitable.

CAPM on the other hand, looks at the how the company’s shares have performed versus the index in the past.  It is grounded in technical securities analysis which specifically looks at how a stock’s price has acted in the past and projects how that stock will trend into the future.  Technical analysis looks at the market rather than the company. It suggests that everything that anyone would want to know about a company is reflected in the current price of its shares.

I learned basic technical analysis in the commodities markets years ago where most traders charted the markets which were governed more or less by supply and demand for the underlying commodity.  I know many short term traders who swear by technical analysis but not so many who would use it to predict long term trends for investment. Past performance, after all, is never an indication of future performance.

I also take issue with the idea that everything that anyone would want to know about a company is reflected in its share price.  I buy a stock it is because I believe that the price will appreciate. The person who is selling that stock to me generally believes that it will appreciate no further or else logic suggests that they would not sell it.

Neither approach is right or wrong. Both are trying to predict the future which will always be an imperfect science. Both Markowitz and Sharpe are Nobel Prize winners.

Over the years I would carefully research the companies in which I invested. I would read multiple research reports on each company, some positive, some negative, published by analysts whose opinions I came to trust.  Research is a time consuming project. I now have an advisor who does this for me.

My advisor suggests that I only invest in companies thathave a history of paying regular dividends. That fact alone usually reduces volatility.

Robo investment advisors are firmly rooted in CAPM. They ignore fundamental facts about companies and markets.  If you buy an index fund, then the results you will get will mirror whatever the market does. This is fine when the market is going up. I have continually advised anyone who would listen that robos are a bad idea and when the market turns down, which it eventually will, people who are in robos and who stay invested in robos will take losses that they should not have to take.


The Passive Investment Problem

Buy it, hold it and forget it is the idea behind robo-advisors and is the reason that robo-advisors are detrimental to your financial health and well-being.  The hype behind robo-advisors comes from the advisors themselves who are determined to get your money out of the bank and onto their platforms.  When the market turns down, robos are going to have a lot of unhappy customers.

I spent more than 25 years representing investors who had been ripped off in the financial markets. In most cases they knew just enough about investing to get themselves into trouble.

One of the reasons that I write this blog is my desire to point out foolish investments and investment advice.  Much of that advice, because it is repeated over and over by an industry with a massive advertising budget, becomes “common knowledge” even though it is without a solid basis in fact.

Most professional investors use what is called fundamental securities analysis to make a determination of what stocks to buy and at what price they are willing to buy them.  Fundamental analysis was developed by Prof. Benjamin Graham in the late 1940s and his textbook is still used in business schools all over the world.

Fundamental investors analyze a company’s income statements and balance sheet. They look at its management, products, competitors and prospects for the future. The question they are faced with is the same question all investors face: if I buy this stock today, will the price go up in the future?

It is important to understand that this analysis is not an exact science.  What is more, markets are as often as not driven by irrational forces, fear and greed, as anything else.  Even some of the basic macro-economic factors that drive the markets such as interest rates and oil prices are political decisions, not rational ones determined by supply and demand.

But that is not a reason to give up on a rational, analytical approach to investing or stock selection.

The idea of passive investing has gained some traction of late for the wrong reasons.  Passive investing is the idea that you “buy and hold” a stock or a fund no matter what happens.  The theory, at least for investors with a long time horizon, is that the investment will be worth more when you need it, years in the future.

It should not take you long to realize that no one can predict what the market price of any stock will be years in the future. Fundamental analysis looks out a year or so and even that is difficult.

That “no one can predict the future” is one of the reasons that people advocate passive investing.  But their “buy, hold and it will be worth more when you need it” strategy does just that.

Advocates of passive investing will point to a number of academic studies, most from the 1990s that suggest that mutual funds, which are actively managed, failed to beat the market indexes over the long term.  These studies exist but are flawed for a number of reasons.

In the first place, beating the market index should never be the goal of any small investor.  To beat an index means that you will need to take risks that are higher than the index and those risks will often come back to bite you.  That is one of the reasons that mutual funds, the active investors that these academic studies are looking at, do not, on average, perform as well as an index.

The other reason is that mutual funds are not efficient. They are constrained by law, their own advertising and the ebb and flow of funds in and out.  Mutual funds are also subject to advertising costs, sales charges and management fees.  They should always yield less than a theoretical index that is not subject to these charges.

Notwithstanding, the passive investors are quick to repeat that the average investment advisor cannot beat an index.  I do not know why anyone would hire an “average “advisor or why any investment advisor would bother trying to beat an index.

Your goal should always be to have more money in your portfolio this year than last year and more again next year.  The way to accomplish this is to do the one thing those passive investors will never do, sell your positions when the market starts to go down.

How can you know when the markets are starting to go down? Fundamental analysis works both ways; it tells you what to buy and at what price and what to sell and when to sell it. Even if your analysis is wrong, there are ways to protect your portfolio against losses with stop-loss orders that get you out before you have given back all of the profits that you have made.

No one can predict when the market will peak. People can get greedy and fearful that if they get out now, they might miss another year of profits.  Of course, even if the market does go up for another year, two years from now it may be at levels below where it is today.  That means that you will have less money and be two years closer to retirement.

Investing is difficult. Fundamental analysis is a skill that takes time to learn and is time consuming for anyone.  If all you had to do to make money in the stock market was to buy an index ETF and leave it alone, everyone would do it.

Passive investing in general and robos in particular are for people who do not know enough about investing to do it well.  If you consider yourself to be in this group, either hire a competent advisor to do it for you or leave your money in the bank.  Anything else is foolish.


FINRA Reports on Robo-Advisors

A year ago FINRA and the SEC issued a joint investor alert regarding robo-investment advisors and other automated tools that offer advice to investors. The alert clearly suggested that investors should be wary because an automated tool may rely on incorrect economic assumptions.

That warning has dissuaded just about no one. Robo-advisors are a fad that is growing exponentially.  Mainstream brokerage firms have acquired existing robo-advisor firms and launched their own robo-platforms.

I have written several articles where I explained why robo-advisors cannot work. In addition to the fact that they may rely on incorrect assumptions, they are also not connected to the real world in any way.  While most investors are concerned with slowing growth in China, the changing price of oil and the continuing rise in interest rates, robo-advisors concern themselves with none of these.  Robo-advisors do not look at what is happening in the broad economy or what is likely to happen.

FINRA has just published a new report on digital investment advice that demonstrates just how poorly robo-advisors perform.  The report asks a great many important questions about the use of robo-investment advisors but answers none.

You can view the report here. .

The report defines the investing process in six steps; customer profiling, asset allocation, portfolio selection, trade execution, portfolio re-balancing, tax-loss harvesting and portfolio analysis. I don’t quibble with these steps, however, it is how the robo-advisors execute them that is the problem.

The report notes that there is a wide disparity between the platforms regarding the amount of information that they acquire about a prospective customer.  I wasn’t actually troubled by this. The brokerage industry knows how to open an account and obtain enough information to ascertain a customer’s investment objectives and risk tolerance.  It is a task that the industry performs every day.

Where the report was most enlightening was in its side by side comparison of the portfolios that seven robo-advisors would have constructed for a hypothetical 27 year old who was investing for retirement. The disparities are enormous. The amount of equities purchased ranged from 51% to 90%; the amount of foreign issues from 22% to 48%. One portfolio contained 5% in gold and precious metals; another 14% in commodities. The rest had no investments in either category.

Presumably these allocations would not change over the next 40 years as the customer added to the account every year. The FINRA report defines re-balancing as maintaining the target allocation.  I would assume that risk tolerance declines with age, but the FINRA report makes no mention of how that money would be invested in the future.  Even if the allocations were static, the end result would vary greatly platform to platform.

So what, you say? The end result of a 40-year investment portfolio is going to vary greatly if you compare the portfolios prepared by live advisors as well.  True, but the difference is that live advisors are looking at the real world and absorbing real information.  The algorithm that is at the core of a robo-advisor, once set, may never be modified and never looks at real world events.

I have read a lot of articles about robo-advisors.  Few actually try to evaluate the algorithms of one versus another. The FINRA report suggests that member firms need to effectively govern and supervise the algorithms that they use. An algorithm is a mathematical formula. Exactly how does the investment committee at a brokerage firm supervise it?

The FINRA report gives passing acknowledgement that many of the robo-advisors are based in Modern Portfolio Theory (MPT) and gives a shout-out to Prof. Harry Markowitz who first proposed it and later won the Nobel Prize.  I went back and re-read Prof. Markowitz’ article that was published in 1952.  The math was over my head.

Markowitz was a theoretical mathematician who applied his theory to economics, specifically to investment portfolio construction. He theorized that investors would want to maximize their investment returns while at the same time minimizing their risks.

He accomplishes this by theorizing that a diverse portfolio of non-correlated assets will perform better than a portfolio of concentrated assets.  He creates a series of mathematical formulas (algorithms) to show that it is possible.

As a practical matter it is the idea that the various assets in the portfolio are not correlated to each other that is at the core. As oil prices come down for example, we know that it has a negative effect on the profit of oil companies but a positive effect on the profits of airlines and trucking companies. Higher interest rates are good for banks, but not so good for home builders.

Now go back and look at the categories of equities that make up the robo-advisor portfolios; large, mid sized and small cap domestic securities, developing and emerging foreign markets.  How are these non-correlated?  Haven’t builders, large and small in all countries been helped by low interest rates? Aren’t airlines of all sizes in all countries going to be negatively affected if oil prices shoot back up?

MPT necessarily looks at the effect that interest rates and commodity prices have on portfolio securities. I realize that those 5 categories of equities, large, medium and small cap, developed and emerging markets have become standard in some quarters but in a global economy they are less and less non-correlated.  That correlation is even higher if you use baskets of securities (ETFs) because some number of the securities in every basket will be affected by changes in macro market conditions.

Markowitz’ formulas are based upon what he believed investors should want; good returns with less risk. The “efficient frontier” that evolved from his equations is a point on a graph, not a place on a map.  It is a hypothetical goal.

The algorithms that support the robo-advisors are the same, hypothetical. They do not look at the real world, nor are they concerned with it.  They just tell you, if you do X, Y should happen.  That might be true is the world were stagnant, but it isn’t.

One difference between Markowitz and the new generation of algorithm writers is that Markowitz published his equations in a peer reviewed journal. The robo-advisors will never let anyone see what is behind the curtain.

The fact that FINRA can demonstrate the wide disparity between the portfolios that various algorithms would create makes shopping for a robo-advisor all the more necessary while at the same time demonstrating that it is an impossible task.

If you hire a human investment advisor you can sit down and talk to them first. You can ask them what they know and what they think. You can ask them about the markets and about the future. Chances are because they deal with a lot of people they have heard the same questions before and have had an opportunity to consider their answers.

Robo-advisors are a fad. They are popular because they are cheaper. They are sold by disparaging human investment advisors who some people think cannot do any better than average. That begs the question that I have asked before: why would anyone want to hire an average investment advisor?



The lesson of Long Term Capital Management

Over the years I have marveled at the fact that some of the most intelligent people in the financial markets repeatedly get blindsided by market action. Frequently it is because in the real world the markets do not act in accordance with their view of how the markets should act.

A great many intelligent people lost money when the markets crashed in 2000 and 2008 because in each instance they did not see the crash coming. Many fall back on “nobody” can predict the market when what they mean is that “they” failed to predict the market.

A great deal of the advice given by the Wall Street firms is conflicted. Even simple tools like asset allocation are grossly misapplied. Finding a better than average financial adviser can be hit or miss.

Many people agree that investing requires time, information, analysis and discipline. There is logic that suggests using computers and mathematics to make investment decisions has merit. Computers will certainly analyze more information in less time and can trade any account subject to a rigid discipline.

Success should be dependent upon analyzing the right information in the right way. Hiring really smart and accomplished people to decide which information to collect and how to analyze it would seem to enhance the chance of success. Except that it does not always work.

The most outrageous example may be the case of Long Term Capital Management (LTCM), a Connecticut based hedge fund that lost about $4.5 billion of investors’ money in 1998 and almost brought the markets down with it. The investors were some of Wall Street’s biggest banks and many of the individual executives who managed them.

LTCM was started in 1993 by Lee Meriwether, a very accomplished trader who had made substantial profits for Salomon Brothers. Showcased members of the team were Myron Scholes and Robert Merton, two economists who had devised a mathematical model for pricing options. Merton and Scholes won the Nobel Prize in Economics for that model in 1997 just before the downturn that wiped out LTCM.

LTCM performed arbitrage with its investors’ money. They looked for small discrepancies in the price of the same or similar instruments in different markets. They assumed that the markets would always efficiently close those gaps.

LTCM created sophisticated mathematical tools to identify those discrepancies and to evaluate the greater markets so they could estimate how those gaps would close. No one has suggested that LTCM’s math was wrong; it is just that the events that occurred were not in the database that they were analyzing.

In 1997 the government in Thailand devalued its currency. The ensuing defaults roiled the markets in Asia and caused a serious decline in the equity markets. Credit markets in Japan, a major US trading partner and the most important capital markets in Asia tightened significantly. It did not help that Russia defaulted on its own sovereign debt shortly thereafter.

Importantly, LTCM did not lose money when the devaluation occurred in 1997 but a year later. The LTCM fund was very profitable into 1998. Losses started to mount up when its mathematical models could not account for the shifting market conditions caused by the devaluation. They were useless to predict the effects of the often conflicting ways in which other Asian governments and central banks would deal with it.

The lesson to learn from LTCM is quite simple. Even the best mathematical models created by the smartest people should not be relied upon to tell us what the markets may do. No computer program can accurately predict the price of securities one month or one year from today.

Despite this fact, there are currently a multitude of “quant” firms that are developing and using ever more sophisticated mathematics to do just that. Most are focused upon making predictions of what will happen in the markets today not next month. I wish them luck but I would not give them any of my money to invest.

The markets will continue to evolve, globalize and expand. Developing mathematical models based upon how the markets have acted up until today will be less and less accurate and have less and less utility going forward.

Millennials think otherwise and are expected to invest trillions of dollars with robo-advisers who use mathematics in the same way. A substantial percentage of those funds will be lost the next time the market turns down.

Then the market”professionals” and pundits who currently sell and endorse robo-adviser programs will remind the millennials that “nobody can predict the market” because some things about the markets never change.

7 Reasons Why Robo-Investing Will Not Work. Millennials – Wake Up

Robo-investing is the next really big, really dumb thing. Millennials are expected to pour enormous amounts of money into these programs in the next few years. That would be an enormous mistake.

Robo-investment programs promise to help users to set up investment portfolios now and then to help manage those portfolios for the next 25 or 30 years. The portfolio with which you will end up, all those years down the road, is likely to be a disappointment.

I looked at a number of the websites and advertisements for these programs as I was writing this article. One proposes that a”moderate risk” portfolio would have 90% held in stocks. Another has a member of their investment team who takes a “holistic” approach to financial planning. That may be fine for some people but is not a serious approach to managing your money as far as I am concerned.

These computer programs do not have what it takes to intelligently construct a portfolio for you now or to manage it over a period of many years. Years from now, you will wish that you had a portfolio put together and monitored by a well trained and intelligent flesh and blood investment adviser. By then it will be too late.

Robo-investment advisers tout the fact that they cost less than a human investment adviser would cost. It does not really matter. Robo-investment advisers are inexpensive because they provide investors with little or no value.

If you have any doubt that these robo-investment adviser programs are less than worthless, here are seven obvious reasons why the actual portfolio that you will get from a robo-investment adviser program is likely to perform poorly.

Number One: It is not about your age.
One of the few personal questions that a robo-investment adviser program will ask is your age. If you are thirty the program will assume that you can afford to take on more risk than a person who is sixty. If it is suitable for you to take on more risk then your recommended portfolio will get more stock funds or ETFs and fewer bond funds and bond ETFs.

Investing based upon your age assumes that your age and the markets are somehow related. What you should or should not buy today is dependent upon the market, not upon your age. If you start down this path, what you will have bought or sold over the years that you stay with the program will have had nothing to do with what might have been a good investment at any time.

Number Two: Today might not be a good day to invest in either stocks or bonds.
Let us say that the program suggests that you create a portfolio that is 35% bond funds or bond ETFs and 60% stock funds or stock ETFs with 5% held in cash. In truth, it does not seem that most of these programs ever hold a lot of your funds in cash which always increases the portfolio risk.

If you begin investing this year when the stock market averages are making new highs it is reasonable to expect that next year or the year after the market might correct. It is very possible that five years down the road 60% of your portfolio will be worth less than it is today.

After seven years of forced low interest rates is this a good time to put 35% of your money into bond funds or ETFs? Savvy investors know that bond funds do not do well when interest rates rise. The computer will not adjust for the hike in interest rates that everyone knows is coming until after it happens and the portfolio has taken the loss.

Number Three: It is about the right math, the right data and more.
Robo-investment advisers claim to have sophisticated algorithms that will crunch the numbers and produce good results. The algorithms may be good but these programs look at the wrong numbers. A robo-investment adviser never gets past a limited set of gross market data. A robo-investment adviser never actually looks at any company’s balance sheet. They are an example of the GIGO principle of statistical analysis; garbage in, garbage out.

It is not only about the numbers. Before I would invest in any company I would want to know about products that the company might have in the pipeline, what its competitors were up to and what the CEO is thinking about. I am not alone. A robo-investment adviser is never interested in these things that most other investors would want to know.

Number Four: Investing cannot be done in a vacuum.
The computer program does not get a live news feed and would not know if Germany had invaded Poland so events leading up to any crisis that might affect the markets and the portfolio would necessarily be ignored. The program does not concern itself with current commodity prices, currency rates or international politics. Intelligent investors do.

To my mind, using a robo-investment adviser to construct and manage your long-term portfolio is the same as making all of your investment decisions from inside a small closet with the lights off and the door closed.

Number Five: The markets will not be static for the next 25 years.
The noted theorists upon whose works Modern Portfolio Theory and asset allocation are based were examining data from the markets prior to 1990. The financial markets have evolved significantly in the last 25 years. It is not just the speed or the technology. The markets are now global, there are a lot more participants and there is a lot more money in play. How the markets will continue to evolve and operate in the next 25 years is anyone’s guess and is certainly not built into any robo-investment program.

Number Six: The data that the program uses to select portfolios is based upon the past performance of the markets and past performance only. I should not have to tell you that past performance is an unreliable indicator of future results. If you invest with any one of these programs future results are exactly what you are trying to achieve. Why use data that is unlikely to get you there?

Number Seven: Human beings are actually necessary.
The sales pitch for these robo-investment advisers suggests that can do better than any human financial adviser. One company even touts that its program alleviates the risk of human error.

Using a robo-investment adviser will inevitably lead to portfolio losses every time the stock market goes down or interest rates go up. It will never tell you to avoid downturns or to get out of the markets all together before a crash. Likewise, the program never looks for new companies that might do very well or for any other investment opportunities that might make you money.

Severe market downturns can be scary. Investors are prone to panic. When your account value is dropping you are going to want someone to call. The robo-investment adviser will offer neither solace nor advice. That will only come from a knowledgeable human being. For that you have to pay a little more.