There are no real risks with using Wealthfront by itself. They exist, but are unlikely to happen Wealthfront simply buys stocks automatically for the user. It automates buying to keep the cost of investing low for the investor and to save them time…
Financial institutions can get scary when they are doing all sorts of silly things with loans, derivative and other financial instruments!
Wealthfront doesn’t do anything like this!
• It is very possible that one of the banks/brokers that Wealthfront uses could go belly up. Depending on the insurance threshold on these accounts, you might little or a lot depending on each individual brokers rules. I would say though:
Never overlook the small print. Read every document and ask a financial professional to look at every possible financial risk. There is a saying that Only The Paranoid Survive. Losing money on investments, especially if they concern your pension, can be absolutely fatal! Do your due diligence!
The Real Issue Is The Culture Of Investing That Wealthfront Supports
To explain this, I will have to go back tot he basics.
Investing in stock market means allocating capital to companies. Investors use their own methods to decide whether a stock will increase in value after they buy it. If it goes up - good times! If it goes down - bad times!
Picking stocks used to be easier in 50s and 60s - no one knew how the market functioned. But today, everyone knows how the market works and its become harder and harder to beat it.
This means that many fund managers cannot beat the market, but they charge their investors huge fees!
Investors are losing twice here. Firstly, they are not getting average performance from their fund managers. Secondly, they are being charged the earth for this lack of performance!
That’s where Vanguard comes along. Index funds allow an investor to hold all the stocks in the market, instead of picking stocks. Investors do not choose stocks based on value, instead they hold all the stocks in the index at a low-cost. They hold the market. Problem solved?
Holding index funds is fine in the stock market. But this strategy relies on traders who are not passive investors. If everyone started investing passively, no one would allocating capital to companies efficiently.
But that’s a long way off right?
Well, no. Vanguard has been the fastest rising fund manager since 2008. This means that a lot of investors have been piling in to Vanguard funds without even valuing the companies inside it.
is this process continued, the price of index funds would move out of sync with the underlying and it could form an enormous bubble. If a bubble did form and people realised the stocks were over-valued, the value of the investment could collapse…
There Is No Right Approach
A lot of people like Warren Buffett say index funds are the gospel. I think they work if you believe in the philosophy and hold on to them during downturns. Buffett himself is a conservative investor and his portfolio has been drawn down by nearly 50% a few times in his life!
If you want to invest with a fund manager, you might feel comfortable with them manager your money and you may be less likely to sell during downturns (the most fatal mistake). If you are using fund manager though, make sure to look at their fees and accept that its very possible that the manager will underperform the market average!!