The Promises and Pitfalls of Robo-Advising

46 Pages Posted: 20 Apr 2018

See all articles by Francesco D'Acunto

Francesco D'Acunto

Boston College

Nagpurnanand Prabhala

The Johns Hopkins Carey Business School

Alberto G. Rossi

Georgetown University

Multiple version iconThere are 2 versions of this paper

Date Written: February 21, 2018

Abstract

We study a robo-advising portfolio optimizer that constructs tailored strategies based on in- vestors’ 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: D140, G110, O330

Suggested Citation

D'Acunto, Francesco and Prabhala, Nagpurnanand and Rossi, Alberto G., The Promises and Pitfalls of Robo-Advising (February 21, 2018). CESifo Working Paper Series No. 6907. Available at SSRN: https://ssrn.com/abstract=3165339

Francesco D'Acunto (Contact Author)

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Nagpurnanand Prabhala

The Johns Hopkins Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States
+1 410 234 4532 (Phone)

Alberto G. Rossi

Georgetown University ( email )

McDonough School of Business
Georgetown University
Washington, DC 20057
United States

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