- Family situation spouse’s salary and professional situation. Number and age of children.
- Other income besides salary or business income such as rental properties.
- Tax bracket and other relevant tax information.
- Whether the client and spouse are making maximum IRA contributions.
- Whether either or both of the heads of household works for a company with a 401k plan whether it has a company match (and how much) and what the balance is and how much is being contributed annually.
- How are the 401k assets invested and what are the investment choices.
- If the clients are self employed do they have a SEP IRA or individual 401k…and how would they determined if they should set one up.
- If they are saving for college does a 529 plan make sense, if so which plan should they choose and how should they allocated the investments.
- Does either of the clients have a pension
- What are the “savings goals” in all likelihood they include things other than retirement: purchase of a first or trade up or vacation home. College education, or starting a business would be some examples.
Thursday, February 5, 2015
Should you use a Robo Advisor ? Part One: Why they Give Too Little to the clients
So called robo advisors where one uses a web based service to have one’s investment portfolio managed seem to be gaining traction. The largest of these Wealthfront has the backing of prestigious academics such as Burton Malkiel and $1.8 billion in assets under management. The other major player Betterment has extensive VC backing and says it already has $1 billion in assets under management with 60,000 customers. Some articles by advocates of these robo advisors say it will “crush” the business of independent investment advisors…like me.
I think it is great that investment advice is getting more accessible and everyone should have to justify the price they charge for their services and give fair value. But after giving Betterment and Wealthfront a test drive I have concluded that when more is needed in advice Betterment comes up short and when less Is needed they probably come up with too much.
I will explain what I mean in two posts.
The major problem with these Roboadvisors has actually nothing to do with the asset allocations it proposes but with the fact that those asset allocations are produced without getting to know the customer.
The asset allocation gets spit out based on a few questions: age,for what and when do you need the money, current assets, salary and a couple of “risk tolerance ‘ questions.
There are major problems with this in fact here are just a few
Since Betterment and Wealthfront (like the less thorough flesh and blood advisors) are only interested in the assets it can capture under management they never seek to gain a full financial picture of its client. Answer a short set of questions on the website click the mouse and you have an asset allocation”that meets you circumstances” ready for them to invest for you.
A good advisor would offer a consultation asking these along with many other questions. Only after that review could the advisor put together an investment strategy and in all likelihood in which the allocation of any assets to be directly managed by the advisor is actually one of the least important parts of the investment decisions.
Here are some basic questions robo advisors doesn’t ask:
A good advisor would give a consultation and offer a full for fee consulting service on portfolio allocation even if it would not generate “assets under management” for an ongoing asset management fee.
A proper investment consultation would first of all make sure the investment strategy maximizes the potential for the best after tax returns. This is far more dependent on proper placement of assets and use of tax advantaged investment accounts than on the choice of asset allocation.
Here are the areas a thorough investment consultation should review:
Make sure the client’s first savings go into tax deferred accounts
IRAs or Roth (and explain the advantages of each)
For those with a 401k their first savings should go into the maximum contribution to the 401k plan most certainly the amount that generates the largest employer match.
Assistance with the asset allocation in the 401k or 401ks for a couple taking into account allocations in other accounts.
For the self employed review of the various tax deferred accounts available: individual 401k, Sep Ira and defined benefit plan and assistance with asset allocation.
It doesn’t ask basic questions such as about the spouses salary and occupation, whether the client has a 401k available to him, whether he is saving for more than one purpose (i.e. college and a new house and retirement), how many children in the family and what ages and whether either of the heads of household is self employed
For those saving for college review of the benefits of 529 plans assistance in choosing a plan and generating asset allocation.
Betterment spits out either a taxable account allocation which includes a national municipal bond ETF in the bond allocation or a tax deferred allocation which includes taxable bonds. But it never integrates the two and gives an allocation for the most common situation: someone with both a tax deferred account like a 401k and a taxable account.
Without an integrated allocation the client will wind up with a tax inefficient allocation. To give the most basic example: as much as possible of the bond allocation of a portfolio should go into the tax deferred account to avoid current tax on the bonds same for instruments like REITs that generate current income. Stocks which will be held for the long term and subject to what in most cases are lower capital gains taxes should be placed in the taxble accounts.
In sum Betterment is “too simple” in simply producing an asset allocation for the assets the client intends to have Betterment manage without actually learning anything about the client.
The difference between the investment strategy based on a thorough knowledge of the clients financial situation and the one based on a simple questionnaire has far more consequence for the long term growth of a portfolio than the specific allocation and portfolio management which Betterment provides.
Even if one chooses Betterment to manage investment assets it would be money well spent to have an investment advisor provide a consultation to cover the issues above.
In my next post I will examine the “too complicated” part of Betterment’s service…the asset allocation.