Robo-advisors: The Latest “Inexpensive” Product

RoboadvisorWhen Brett was little, he worked, saved his money, and bought a three wheel ATV. He needed a helmet to keep his head safe while he was riding merrily through the neighborhood. We investigated and settled on a Bell Helmet since it was the best. Their slogan said it all: “If you have a $10 head… buy a $10 helmet.” In my opinion, the same applies to your financial future. If your financial future isn’t worth much to you, use a robo-advisor. It’s like the $10 helmet: it’s cheap, better than nothing, yet provides little value.

Robo-advisors are making the news. They are a low-cost, computerized asset-allocation software application. Folks like Betterment, Wealthfront, Vanguard, and now Schwab have been getting into the game. Users are asked to provide a number of inputs such as:

  • How much are you investing?
  • What is your risk tolerance?
  • What is your goal?
  • How long do you have to invest?

Then proprietary algorithms process the inputs and provide a “tailored” investment plan. The provider implements that plan using their recommended funds.

Here’s what people who use robo-advisors are generally not getting:

  • Appropriate diversification. Use of all three asset classes: equities, fixed income, and liquid alternatives is generally not available with the robo-advisors. Studies have shown that adding non-correlated assets, aka alternatives, to a portfolio can improve return and reduce volatility.
  • Wide fund selection. Robo-advisors not only get their asset management fee from customers, they typically also receive all or part of the operating expenses of the funds for the funds they recommend. Lack of independence in fund selection is a key point here since the robo-advisor’s overall income is impacted by the funds they recommend. Hence, while the asset allocation percentages may be appropriate, the specific investment choices may not be, which can lead to underperformance.
  • Monitoring. Investment management is a process. “Set it and forget it” doesn’t work, particularly in the current investment environment.Regular monitoring and periodic rebalancing is required in order to continue to adapt and improve portfolios.
  • Commitment to protecting your money. Let’s face it, the robo-advisors were developed and exist to collect assets and make money for their company. If there is a big market swing, like we had in 2008, don’t expect the robo-advisor to cushion the downfall. A firm like DWM is focused on your money, not ours.We’re here to help protect first and then grow your assets. Our clients are familiar with what we did in 2008 to contain their losses by reducing equity exposure and the use of alternatives.
  • Guidance. Some robo-advisors do include some assistance with financial decisions in their service. Most of the advice will be generated automatically by the firm’s computers and delivered online. Compare that with a firm like DWM. Brett and I have over 60 years’ experience helping clients. In addition, as you know, we’re CFP® practitioners, CFA charterholders, and I am also a CPA. You want a sounding board that is experienced, competent, thoughtful, and sensitive to your particular personal situation, not a robot simply doing calculations and spitting out answers.
  • Fiduciary care. Robo-advisors don’t sign an oath, as Brett and I have, to always put the client’s interest first. We are also Accredited Investment Fiduciary (AIF®) certificants. Robo-advisors are the latest “fad” for collecting assets and have no legal responsibility to put their client’s interests first. Their principal goal is to make as much money for their company as they can.
  • Proactive advice. Don’t expect that from your robo-advisor. DWM clients know that we believe “Wealth Management is a Process, not a Product.”We have processes in place to review and monitor on a regular basis and review with our clients such important topics as financial independence, education funding, income taxes, estate planning, insurance and other matters. We have saved families hundreds, thousands, and millions of dollars by providing proactive suggestions for them in many different ways. In addition, we have collaborated with their other advisers to implement changes to help secure and protect them.

Ultimately, it’s all about what price you put on your financial future. If you want a seemingly inexpensive product (a computerized calculation of an asset allocation) and you believe that will provide you and your family future financial success, then a robo-advisor may be for you. If, on the other hand, your family’s financial future is of key importance to you and you wish to have financial “peace of mind” with an independent, competent, experienced, proactive financial advocate that employs processes in both investment and financial planning areas devoted to helping you and your family and is committed to protecting and growing your net worth and legacy, then I suggest you do your due diligence and opt for the best, not the cheapest.

What is NAPFA?

NAPFAElise recently helped me change the artwork in the office. Added some, moved some, and removed a couple. The best addition was a map of Sanibel Island signed by our kids and grandkids, and now, thanks to Elise’s help, it includes pics of everyone. Sanibel has always been a special vacation place for our family. Great memories.

Another nice addition was my NAPFA acceptance letter, related Fiduciary Oath signed by me, and the recent Accredited Investment Fiduciary (AIF®) certification I received. Brett has these three items in his office as well. We’re often asked by clients and others for more information on NAPFA and AIF® so we thought it might be worth an explanation.

NAPFA (pronounced ‘Nap-Fah’) stands for the National Association of Personal Financial Advisors. NAPFA and its members are all about bringing integrity, honor, and trust to its clients and to investors in general. Its members are strictly fee-only, independent, Registered Investment Advisors just like DWM. NAPFA vets its candidates very carefully, including credentials, experience, peer review of a sample comprehensive financial plan, and signature and adherence to NAPFA’s Fiduciary Oath.

The AIF® designation is awarded by the Center for Fiduciary Studies, the standards-setting body for fi360, the first full-time training and research facility for fiduciaries in the country. AIF® is a very select group. There are only 6,000 AIF® designees currently, as compared to 70,000 CFP® certificants. AIF® designees are the only recognized professionals trained to perform fiduciary assessments, which measure how well investment professionals are fulfilling the fiduciary duties required of them by the applicable investment legislation, case law, and regulatory opinion letters. AIF® designees, like Brett and myself, are able to use the knowledge and resources they have gained through their training to better organize, formalize, implement and monitor their processes and procedures. Studies show that a prudent process improves investment results.

There is a tremendous investor movement away from large brokerage firms to smaller, fee-only independent firms such as DWM. In my opinion there are two key reasons for this: results and trust.

According to the WSJ, “Investors are Fleeing Active Stock Managers.” Actively managed stock and bond mutual funds are the building blocks used by many large institutional wirehouses. The operating expense of an actively managed mutual fund is generally a minimum of 1% more per year than a passive, low cost mutual fund or ETF. Actively managed funds have a lot of expenses a passive fund doesn’t have. These can include research (to try to beat the market), trading, marketing, upfront fees, sales fees and others. Of course, the institutions that promote these actively managed funds to investors receive part of those operating expenses as “revenue sharing.” The investor comes out the loser in this format, since studies have shown time and time again that actively managed stock and bond funds over time don’t “beat the market”, but rather they consistently underperform the benchmark indices. And, that underperformance is usually by about 1% or more, just about the same amount as the “excess fees” over passive investments. The extra 1% in expenses goes right to the bottom line, especially these days when diversified stock returns are more likely in single digits than double digits. A 1% drag on a $1 million portfolio would reduce the appreciation over 20 years by $600,000 or more. It’s no surprise that many large institutions don’t even provide performance results with their statements. The reports can be 100 pages long and yet there is no performance data provided (i.e. time-weighted return calculations). The WSJ article puts it this way, “U.S. active managers destroyed the trust of individual investors and financial advisers, neither of whom want to pay up for active management that can’t beat an index.”

So, many large brokerage institutions have tried to gain the public’s trust (and their money) by advertising themselves as fee-only and fiduciaries. While there may be a small portion of their offering that does qualify to use these terms, their overall business model is generally focused on making money for the institution and its employees. They may charge a client a percentage of asset fees for managing money. That’s not all they get. They often receive “revenue sharing” from mutual fund companies they promote to clients and receive commissions for selling annuities and life insurance contracts.

Have you seen the recent Charles Schwab “Why” TV Commercial? The ad revolves around a boy who quizzes his father about the real value the family’s financial advisor provides. It suggests that most children can see that the wirehouse business is stacked in favor of the advisor, not the client. These days, both children and their parents are really questioning what they are getting and paying these brokers. True fiduciaries put their clients’ interests first and disclose any potential conflict of interest. They hold themselves accountable for results and make full disclosure to their clients. And, they provide additional value-added services and transparency. The general public, I believe, is recognizing that the wirehouses just don’t do that.

NAPFA and its members are gaining a lot of traction. Investors looking to move from the old wirehouse paradigm can contact NAPFA and use its website, to find vetted financial advisers in their area who might be a good fit for them. DWM gets communication, prospects, and ultimately clients from our association with and link to NAPFA. No money changes hands between us. Like DWM, NAPFA is all about doing the right thing; bringing integrity, honor and trust to its clients and investors in general. That’s why we are proud to be members of NAPFA® and AIF® designees.

Door Number One, Door Number Two, or Door Number Three?

LetsMakeaDealRemember Monty Hall? He was co-creator and game show host for “Let’s Make a Deal”, one of America’s all-time favorite game shows. Contestants were asked to decide which door they wanted. Behind the three doors were some booby prizes and some very valuable items. Problem was- the contestants didn’t know what was behind the doors.

Today, we’re changing up the game. Money Hall is going to ask you to decide which door you want. Behind doors 1, 2, and 3 are three very different financial advisers, all of whom want to manage your money. But today you’ll have an advantage. Money Hall is going to open each door for you and give you a detail of the adviser behind each door before you make your choice.

Money Hall: “Ready, let’s open Door #1. Financial adviser #1, please tell us about yourself.”

Financial adviser #1: “I’m a broker with XYZ Bank. I’ll do my best to sell you the products and services of XYZ bank. However understand that my primary obligation is to my employer.”

Money Hall: “Let me add some other important information about adviser #1. Adviser #1 is paid based on fees and commissions he or she generates for XYZ. He or she is required to make “suitable” recommendations to investors. However, he or she has no obligation to put your interests first. Investments don’t have to be the most appropriate, merely “suitable.” The “suitability standard” favors the brokerage firm and its employees over the investor. It also creates a conflict of interest between the adviser and the investor. Finally, XYZ bank considers its’ compensation to be “fee-based”. This means it receives fees from customers, commission payments on annuities and insurance contracts, and revenue sharing payments from mutual funds it recommends to its customers. Adviser #1 is a CFP® practitioner.”

Money Hall: “Thank you, adviser #1. Now let’s open Door #2. Financial adviser #2, please tell us about yourself.”

Financial adviser #2: “I work for LMN Company, a Registered Investment Advisor. We don’t sell products. We are fiduciaries and put our clients’ interests first.”

Money Hall: “Let me add some other important information about adviser #2. Adviser #2 is required by law to act solely in the interests of clients and disclose any potential conflicts of interest. LMN is a fee-only RIA. Its only income comes from fees paid by clients. It receives no commissions or revenue-sharing. Adviser #2 is a CFP® practitioner.”

Money Hall: “Thank you, adviser #2. Now let’s open Door #3. Financial adviser #3, please tell us about yourself.”

Financial adviser #3: “I’m an owner of ABC Company, a Registered Investment Advisor. I have signed a fiduciary oath stating that I will always put our clients’ interests first. Our firm works hard and uses a systematic, prudent process in all areas to fulfill our fiduciary commitments to our clients.”

Money Hall: “Let me add some other important information about adviser #3. Adviser #3 is similar to financial adviser #2 in that he or she is required to act solely in the interests of and with undivided loyalty to their clients and disclose any potential conflicts of interest. In addition, though, adviser #3’s firm consistently uses a fiduciary quality management system (analogous to ISO 9000) to organize, formalize, implement and monitor the proactive financial planning and investment management it performs for its clients. ABC is a fee-only RIA. Adviser #3 has the CFP®, CFA, and Accredited Investment Fiduciary (AIF®) designations.”

So, it’s now your choice. Door #1, Door #2, or Door #3? Who will manage your money? Who do you want to be your trusted adviser? Who will always put your interests first? Who will always disclose potential conflicts of interest? Who has a proactive process to make sure they fulfill their fiduciary obligation to you? And, who has best demonstrated their commitment to you and excellence in their profession through their multiple credentials and experience?

Did you make your selection? We hope the choice was clear. If it was, you might be as happy as this couple:

LMADBTW, if the adviser behind Door #3 sounds like someone you know, it is. Brett and I are CFP® practitioners, CFA charterholders, and AIF® designees. DWM believes effective relationships between investors and advisers are built on trust. That trust is grounded by a commitment by the adviser to act solely in your best interests.

However, it goes beyond that commitment. It requires the application of a prudent process consistently applied, which we do every day. We value greatly our role as wealth manager and fiduciary with our clients as it puts us in a special relationship of trust, confidence and legal responsibility. It’s a role we don’t try to avoid, it’s one we cherish.