Every investor feels the pain and pleasure of stock price moves. Even the smallest move up or down can lead otherwise rational people to trade based more on emotions than facts. While a few disciplined investors stick to objective rules, the vast majority impulsively react to market swings. The key to successful stock market investing is to be one of those disciplined investors. 

Systematic investing is a time-proven method of extracting money from the stock market. Logical, established systems for making buy/sell decisions remove an investor’s emotions from the equation. Systems can range from simple calculations used by individuals to the ultra-complex, computer-driven algorithms employed by hedge funds, institutions, and professional traders.

While financial advisors and other money managers have used algorithmic decision-making software for some time, it has only been since 2008 that regular individual investors have been able to access this software on their own.

Known as robo-advisors, these automated investing platforms for the masses have become wildly popular over the last few years. Depending on your own susceptibility to impulsive trading, robo-advisors may make sense for a portion or even your entire portfolio.  Here are three things you need to know about robo-advisors.

#-ad_banner-#​1. They Are Not A Get-Rich-Quick Machine
Everyone dreams of having an automated money-making machine. Just pushing a button and watching the profits roll right in is a beautiful thought. Unfortunately, nothing like this exists. While robo-advisors are automated and create profits, they are far from a get-rich-quick machine. 

In fact, in 2016, the S&P 500 returned 11.74%, and corporate bonds produced averaged 5.8% returns. Using a standard 60-40 allocation ratio between these two would give an overall gain of 9.36%. Out of a dozen major robo-advisors, only one beat this benchmark, and it was by less than 2% after fees. Many individual and professional investors crushed these market-matching returns over the last few years. 

While no one knows what the future holds, robo-advisors have historically matched or underperformed the overall market. 

2. Robo-Advisors Are Limited By Their Algorithms
The primary reason robo-advisors match or underperform the market is due to being based on modern portfolio theory (MPT) and the efficient market hypothesis (EMH).

MPT teaches that diversification is the key to long-term profits in the financial markets.  This idea is built on the theory that asset classes are not correlated to each other, and therefore diversification balances out the ups and downs of the market. 

While this would seem to make sense, there are several major flaws in the theory. First, volatility is not predictable as markets cannot accurately price risk. Second, market correlations are not consistent. All we need to do is look back at the 2008-2009 financial crisis when both bonds and stocks declined in value rather than moving in opposite directions as their historical correlation would predict. 

The second theoretical underpinning of robo-advisors, the EMH, teaches that all available information is already baked into the price of the stock. Therefore, it is impossible to consistently beat the market. Obviously, with EMH as a backdrop, a robo-advisor’s unspoken goal is to simply match market returns. However, asymmetrical information flow, speed, and a host of other factors cast doubt on the EMH. 

The theoretical underpinnings of robo-advisors lead to the massive use of ETFs in their portfolios. ETFs are great to quickly gain diversified exposure to sectors and the entire market. But by primarily trading ETFs, robo-advisors miss out on the benefits available in individual stocks. 

3. They Can Help With Fees And Tax Management
Robo-advisor fees are usually much lower than human investment advisors charge. Lowering fees and costs in your portfolio can be a key to improving overall performance. 

One of the most appealing aspects of robo-advisors is that they implement a tactic known as tax-loss harvesting. Tax-loss harvesting is an IRS-approved tactic used to lower capital gains taxes. The strategy works by systematically reporting previously unrecognized investment losses to offset other gains and income. The cash created from the tactic is reinvested to increase the portfolio value.

Robo-advisor Wealthfront states that tax-loss harvesting could add over $76k to a $100k portfolio over the next two decades. The wealthy have been using this tactic for many years, and now robo-advisors make it easy to use for everyone. 

Risks To Consider: Robo-advisors have not experienced actual bear market conditions. Once the bull market ends, it remains to be seen how they will manage the changing market environment. 

Action To Take: If you struggle with your emotions when investing, consider allocating a portion of your portfolio to a robo-advisor. The harder time you have with your emotions, the greater amount of your portfolio to allocate to robo-advisors. Everyone is different in this regard, so conduct a little self-analysis to clarify where you stand. 

Editor’s Note: You know how in sports, some players unintentionally signal what they’re about to do next. Like when a pitcher accidentally lets a batter see his grip on the ball before he throws it. Well this kind of “tell” doesn’t only happen in sports… but in the stock market too! And if you can spot this subtle sign… you’ll know exactly what a stock will do… before it makes its move. Here’s how you can spot it too.