The Promises and Pitfalls of Robo-Advising

44 Pages Posted: 22 Feb 2018  

Francesco D'Acunto

University of Maryland - Robert H. Smith School of Business

Nagpurnanand Prabhala

University of Maryland - Robert H. Smith School of Business

Alberto Rossi

University of Maryland - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: October 10, 2017

Abstract

We study a robo-advising portfolio optimizer that constructs tailored strategies based on investors' holdings and preferences. Adopters are similar to non-adopters in terms of demographics, but have more assets under management, trade more, and have higher risk-adjusted performance. The robo-advising tool has opposite effects across investors with different levels of diversification before adoption. It increases portfolio diversification and decreases volatility for those that held less than 5 stocks before adoption. These investors' portfolios perform better after using the tool. At the same time, robo-advising barely affects diversification for investors that held more than 10 stocks before adoption. These investors trade more after adoption with no effect on average performance. For all investors, robo-advising reduces -- but does not fully eliminate -- pervasive behavioral biases such as the disposition effect, trend chasing, and the rank effect, and increases attention based on online account logins. Our results emphasize the promises and pitfalls of robo-advising tools, which are becoming ubiquitous all over the world.

Keywords: FinTech, Portfolio Choice, Behavioral Finance, Individual Investors, Financial Literacy, Technology Adoption.

JEL Classification: D14, G11, O33

Suggested Citation

D'Acunto, Francesco and Prabhala, Nagpurnanand and Rossi, Alberto, The Promises and Pitfalls of Robo-Advising (October 10, 2017). 8th Miami Behavioral Finance Conference 2017. Available at SSRN: https://ssrn.com/abstract=3122577 or http://dx.doi.org/10.2139/ssrn.3122577

Francesco D'Acunto

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

HOME PAGE: http://terpconnect.umd.edu/~fdacunto

Nagpurnanand Prabhala

University of Maryland - Robert H. Smith School of Business ( email )

4427 Van Munching Hall
College Park, MD 20742-1815
United States
301-405-2165 (Phone)
301-405-0359 (Fax)

Alberto Rossi (Contact Author)

University of Maryland - Department of Finance ( email )

Robert H. Smith School of Business
Van Munching Hall
College Park, MD 20742
United States

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