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.

How Much Stock Should You Own?

asset allocation dog
(Click above for full size image)

The Wall Street Journal directed that question to retirees Monday. It’s really a good question not just for retirees, but investors of all ages. Research shows that asset allocation accounts for more than 90% of investment returns.

Let’s start with retirees. The old “wisdom” was that you subtracted your age from 100 and that was how much of your portfolio should be allocated to stocks. The balance was suggested to be in fixed income. So, this rule of thumb would conclude that most investors age 70 would have 30% allocated to stocks and 70% allocated to fixed income. That’s likely the wrong allocation today for three reasons:

  1. The equity allocation may be high or low.
  2. The fixed income allocation is likely too high these days.
  3. There are no alternatives in the allocation.

For retirees and investors of all ages, the answer lies not in the age of the investor but their risk profile. Our regular readers know that risk has three components:

  • Risk Tolerance – Are you a risk taker? This is typically reviewed through use of a questionnaire.
  • Risk Capacity – How much money can you afford to lose? This is typically reviewed by estimation of worst case outcomes in relation to your net worth.
  • Risk Perception – This is a subjective judgment people make about a given risk at a point in time.

Every investor has their own unique characteristics as far as goals, income, expenses, net worth, legacy wishes, expected longevity and risk profile. We have clients in their 60s, 70s and 80s with a “growth” or “aggressive” risk profile. They may or may not be working, don’t withdraw a large percentage annually from their portfolio, are comfortable with risk overall, have enough net worth where they can afford to lose an expected given portion of their assets and they have a low perception of danger of a given risk. Hence, based upon their unique characteristics, their asset allocation might be 60% equity, 20% fixed income, and 20% liquid alternatives. A far cry from 30% equity and 70% fixed income based on their age alone.

Conversely, we have some young clients who don’t like risk and have a “defensive” or “conservative” risk profile. Their asset allocation could be 30% equity, 35% fixed income and 35% alternatives. Everyone is different.

Another rule of thumb that needs review is the 60/40 portfolio. The traditional “balanced risk” portfolio is 60% stocks and 40% bonds. Some financial advisers recommend this 60/40 portfolio to their clients of all ages and all risk profiles. To them, the mix is what Goldilocks would say is “just right.” They recommend you “set it at 60/40 and forget it.” Unfortunately, it hasn’t worked well since 2000. Many of their clients should have had less allocated to stocks and more to bonds through 2011. And, now with the bond bull market seemingly over, they face the prospect of reducing the bond allocation but don’t want more in equity.

These first five weeks in 2014 remind us that the stock market doesn’t always go straight up and diversification is key. It’s no surprise that we continue to see more and more industry literature suggesting investors and advisers consider liquid alternatives for a portion of their portfolio – something we’ve been doing for ourselves and our clients for over seven years. Instead of a 60/40 portfolio, the DWM allocation for an investor with a balanced risk profile these days might be 50% stocks, 25% bonds and 25% alternatives.

Lastly, risk profiles change over time. Many risk profiles are different today than they were in early 2008. We live in a different world today than six years ago and it’s always changing. That’s why we are continually monitoring and managing the investment environment and meeting with our clients to help them with their financial goals and review their risk profiles. That’s what we call Total Wealth Management or “TWM.”

Beware of advisers that rely on antiquated rules of thumb (such as using your age for your asset allocation) or suggesting a 60/40 set-it-and-forget-it portfolio. Identifying and maintaining the appropriate asset allocation requires a lot more work. It requires a robust financial planning and investment management process like DWM’s TWM. If you’d like more information please give us a call.

What’s Next for the Economy and Markets?

crystal-ballTough question. A more relevant question would be: “How do I obtain long-term investment success?” We’ll discuss both today.

First, the economy and the markets are not correlated over the short-term. Last week’s overall market selloff again demonstrates this. Yes, over the long-run, there is a correlation between GDP growth and corporate earnings. But data demonstrates that over the short-term, there is no correlation.

Second, it is imperative to filter the noise of the media and put the current situation in broader context, than to guess about the future. Our economy is still recovering from the 2008 credit crisis. Similar crises were followed by weak GDP and job growth. The Fed confirmed last week that we are following this historical pattern. Since September 2012, when the latest QE program started, the unemployment rate has fallen from 7.8% to 7.6%. The Fed expects GDP to increase 2.3-2.6% this year. Inflation is up only 1.05% year over year.

Of course, these results, and the stock markets, have been influenced by easy money policies. Since 2008, the fed funds rate has been near zero. Hence, the Fed has employed additional policies to boost the economy. The most significant has been QE. The Economist on Friday described Chairman Bernanke’s tough assignment: “In a zero-interest rate environment, the central bank can influence monetary conditions more through words than through actions.” Mr. Bernanke’s comments last week, which pointed to the path that actions were “data dependent” were interpreted (perhaps incorrectly) by many investors to mean greater “hawkishness” (tapering was about to start). Virtually all markets tumbled.

The economic data doesn’t support a change in the bond-buying policy. Unemployment is still at 7.6%, labor participation rates are near 29 year lows, inflation expectation are falling, and perhaps, most importantly, there has been no substantial improvement in job growth:


Yet, despite the weak pace of overall growth, the recovery in the last four years seems to be getting smoother. The housing market is up, the energy sector is booming, auto sales are improving, household finances are looking healthier and consumer confidence is at a five-year high. The Fed has increased its 2014 growth forecasts to 3% to 3.5%, from a March forecast of 2.9% to 3.4%. So, we’re making progress, but will it continue? And, if so, when will tapering start?

We agree with Yogi Berra, who said: “It’s tough to make predictions, especially about the future.” We humans are not so good with making accurate predictions. However, these days, you can generally find an opinion to confirm almost any point of view. In fact, studies have shown that the most confident, specific forecasts are a) most likely believed by readers and viewers, and b) least likely to be correct.

We prefer to focus on the long-term. People seem to lose sight of their financial future in the midst of all the noise. Most of us have a long-term investment horizon- perhaps 20, 30 years or more. During that time, we can expect bull and bear markets, volatility and short-term market swings. Emotional reactions to short-term events and media noise can cause you to miss market rallies and doom you to long-term investment failure.

You need a disciplined investment strategy and perhaps a full-time professional investment adviser to help you with it. Your asset allocation needs to represent the three asset classes; stocks, bonds and alternatives, with further diversification within each asset class. Your portfolio needs to be reviewed continually and rebalanced regularly. You need to make your capital work for you all the time, and not leave money sitting in cash. Over time, asset allocation, diversification, rebalancing and mean reversion will all work in your favor.

So, we won’t focus on predictions. Instead, what we will do is to help you establish and maintain a long-term probability-based investment approach that should reap dividends and investment success for you for years to come. Give us a call. We’d be happy to chat.