Some observers have suggested that robo advisors based on algorithms might be in trouble when the market starts to slide.
So, in this recent correction, what happened to investors who’ve turned decision-making power over to an automated advisor?
Among our SigFig managed account holders, six times as many investors added funds than took money out of their accounts. In the weeks prior to the correction, these investors were only four times as likely to add funds — meaning that our managed account holders were 1.5 times more likely to add funds to their managed account than they were to draw down, compared to the months before the correction.
Our data shows that in the broader investing public, very few investors buy when stocks are down — less than 1% — but investors who used our robo advisors are more likely to find themselves in that group.
A focus on long-term, passive investing helps investors do the right thing when stocks are down. Investors whose portfolios are properly diversified and risk-balanced will find it easier to sit tight and avoid panic-selling in weeks like the one that recently passed.
Unfortunately, some investors do exactly what they should not do when stocks are down: they sell. As China experienced what many dubbed a new “Black Monday,” our data shows that 72% of retail investors did nothing. However, that still means that more than 1 in 5 investors sold stocks.
Most who did so, sold less than 10% of their holdings, but 5% of investors sold between 10% and 30% of their portfolios, and 1% sold between 30% and 50%.
We saw a similar pattern during the correction of October 2014: 78% of investors stayed put, while about 1 in 5 investors sold some stocks. Again, most investors who sold made small moves, selling 10% or less of their total holdings. But a few investors panicked and sold large amounts of stock. Our data shows that 27% more investors panicked this week than did in October 2014.
It may be that these panicking investors were over-exposed to stocks in the first place. Our data has shown that many individual investors have not properly diversified their portfolios: investors of all ages are overweight in stocks and underweight in bonds, and 1 in 4 investors who track their portfolios with us hold at least 23% of their portfolios in a single stock. Portfolios like these tend to be volatile, experiencing big losses when markets dip, which leads investors to overreact to short-term corrections.
Investors who do react to downturns like the one we experienced are more likely to underperform. The more investors have historically sold during a downturn, the worse their returns have been.
Investors who did nothing in response to this correction had a median trailing 12-month return of a loss of 4.6%. Investors who sold 10% to 30% of their portfolios experienced a median loss of 6.3%, and those who sold 30% to 50% of their holdings experienced a median loss of almost 10%.
Overreaction to a correction creates the very problem investors are trying to avoid. Our data further shows that less wealthy investors are more likely to sell during downturns, so it’s the investors who can least afford it who are suffering the most.
Our data proves that the best thing to do during a correction is to do nothing, and that’s exactly what investors using our SigFig managed accounts have been encouraged to do.
Note: SigFig has over 800,000 investors who use its product to track, analyze, and manage their investments. This specific analysis included a sample size of 250,000 synced users in taxable accounts only. The reason the firm examined non-IRAs and 401(k)s, it adds, is that most investors don't actively manage those accounts.
Mike Sha is CEO and co-Founder of San Francisco-based automated investment platform SigFig.