Wealthfront Investing: What Are The Potential Risks?

Investing in Wealthfront comes with a variety of risks. The company itself outlines several of these on its website, including market risk, advisory risk, software risk, volatility and correlation risk, liquidity and valuation risk, credit risk, legislative and tax risk, tax-loss harvesting risk, potentially high levels of trading risk, foreign investing and emerging markets risk, ETF risks, inflation, currency and interest rate risks, and college savings account risks.

Other risks of investing in Wealthfront include a minimum deposit of $500, no access to human financial advisors, and the fact that Wealthfront does not buy fractional shares of ETFs for its automated investing service.

Market risk

• Macroeconomic Environment: External economic factors such as inflation, changes in interest rates, or shifts in government policies can impact the value of investments. Inflation, for example, can reduce the purchasing power of future returns and affect the value of fixed-income investments.
• Unpredictable Market Sentiment: Market sentiment refers to the overall attitude and emotions of investors towards a particular security or market. Positive or negative market sentiment can influence investment values, and it is challenging to predict or control.
• Economic Developments: Economic factors such as economic growth, recession, or unexpected events like the COVID-19 pandemic can impact the performance of investments.
• Interest Rates: Changes in interest rates can affect the cost of borrowing and the attractiveness of certain investments. For example, higher interest rates may lead to a decline in stock prices as businesses and individuals have higher borrowing costs.
• Regulatory Changes: Changes in government regulations, such as tax policies or industry-specific rules, can impact the profitability and value of investments.
• Political, Demographic, and Social Events: Domestic or foreign political changes, demographic shifts, or social events (e.g., natural disasters) can influence market sentiment and investment values.

It is important to remember that market risk is inherent in investing, and it is challenging to predict or control all these factors. Diversification and long-term investing are often recommended as strategies to mitigate market risk.

Advisory risk

• There is no guarantee that Wealthfront's investment approach will produce the intended results. The company's investment strategy may not always perform as expected or disclosed, and there is a possibility of software malfunctions or other issues that may impair access to their financial advisory services.
• Wealthfront's financial advisory services are entirely software-based. While they rigorously design, develop, test, and monitor their software, there is still a chance that it may not perform exactly as intended. This means that the software may not always execute trades or provide advice that aligns with your specific needs and goals.
• Wealthfront and its representatives are not responsible for any losses to clients unless caused by Wealthfront breaching its fiduciary duty. This means that if losses occur due to factors outside of Wealthfront's control, such as market volatility or software issues, they may not be held liable.
• In the event of computer equipment failure, loss of internet access, viruses, or other technical issues, you may experience impaired access to Wealthfront's software-based financial advisory services. This could potentially lead to missed investment opportunities or delays in executing trades.
• While Wealthfront continuously strives to monitor and correct any software issues, there is always a risk of unforeseen problems that may impact the performance of their platform. It is essential for investors to understand that software-based advisory services depend on the reliable functioning of technology, which is inherently susceptible to occasional malfunctions or disruptions.

Software risk

Although Wealthfront rigorously designs, develops, and tests its software before putting it into production, it is still possible that the software may not always perform as intended. Wealthfront continuously strives to monitor, detect, and correct any software that does not perform as expected, and it is their policy to ensure that any clients who suffer financial harm due to software issues are compensated.

However, it is important to be aware of the potential risks associated with software-based financial advisory services. These risks include computer equipment failure, loss of internet access, viruses, or other events that may impair access to Wealthfront's services. In the event of any of these issues, Wealthfront and its representatives are not responsible for any losses unless they are caused by Wealthfront breaching its fiduciary duty.

Volatility and correlation risk

Wealthfront's investment approach is based on historical data and probability projections, but it is important to remember that past performance is not a guarantee of future results. The volatility and correlation risk associated with investing through Wealthfront means that there is no assurance that your account will perform as expected or that you will achieve your desired financial goals.

During periods of high market volatility, the price changes in different asset classes may be more closely correlated than usual. This can result in a higher level of risk for your investment portfolio. In some cases, the impact of volatility and correlation risk may be mitigated by diversifying your investments across multiple asset classes. However, even a well-diversified portfolio may be subject to volatility and correlation risk during periods of market-wide upheaval or high volatility.

It is also important to consider the impact of fees and expenses on your investment returns. Wealthfront charges a management fee of 0.25% for its automated investment service, and the funds used to build your portfolio will also carry expense ratios. These fees and expenses can affect your overall investment returns, especially over the long term.

In summary, volatility and correlation risk are inherent in investing with Wealthfront, and there is no guarantee that your investments will perform as expected. The impact of these risks may be mitigated by diversification, but it is important to carefully consider the potential impact of fees and expenses on your investment returns.

Liquidity and valuation risk

Wealthfront's executing broker-dealer may encounter challenges in finding buyers for certain securities, which can result in a delay in selling or the need to sell at a discounted price. This situation can occur due to high volatility or the lack of deep and active liquid markets for a particular security. In such cases, Wealthfront may be forced to accept a significant discount to the market value, impacting the overall return on investment.

Additionally, the valuation of securities held in Wealthfront accounts relies on reasonably available exchange-traded security data. However, there is a risk of receiving or using inaccurate data, which could adversely affect security valuations, transaction sizes, and the resulting advisory fees paid by clients.

To mitigate these risks, Wealthfront rigorously designs, develops, and tests its software before deploying it with actual client accounts. They also continuously monitor the software's behaviour after deployment to detect and correct any issues that may arise.

It is important for investors to carefully consider liquidity and valuation risks when making investment decisions, as they can impact their ability to sell securities and the accuracy of valuations, ultimately affecting their investment returns.

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