Robo-Advisors may be just what we need!

Should you really fear Robo-Advisors?

Reading financial news, you see many posts warning of robo-advisors, telling you how you really need a human advisor, how you can robo-proof your investment business, or how robo-advisors are merely a fad and will die off when everyone realizes how evil they are.

All these posts have it backwards. They are apologists for entrenched firms attempting to protect their turf when individuals need help.

Shift from pensions to 401(k) plans hurt individuals

Last century, many large employers provided pensions as a benefit. These were large portfolios that could hire good advisors and thus performed well. However, by the end of last century, retirement funds had shifted to 401(k) and similar plans, where individuals managed their own portfolios.

Institutional portfolios hire great managers so many are able to beat their various market indices. In contrast, individual investors historically achieve less than half the returns of their related indices.

Poor performance by individuals managing their own retirement funds is a key factor in the current crisis facing Boomers who are under-funded for retirement. (Note to Millennials: don’t just speak to your parents, do your own planning so this doesn’t happen to you!)

Why do individuals invest poorly?

Individual investors are seen as a contrary indicator:

  • If they are buying, then the market is near its peak and it is time to sell; and
  • If they are selling, the market has reached its bottom and it is time to buy.

Here is a case in point:

We saw the regret and pride response in action beginning in March 2000, the largest purchase of mutual funds in the history of the stock market. Fast forward to 2008, just before the “Great Recession” market downturn, and stock prices were falling, but investors refused to sell at a loss. As the market continued to fall, investors held off until they simply couldn’t take it any longer. Many sold their stock near the bottom and missed the following upswing that began March 2009. Forbes – Why average investors returns are so low.

To summarize, individual investors perform poorly due to these factors:

  1. Lack of access to good investment advice; and
  2. Investment psychology. For more on the psychological factors to which individuals fall prey, see Seven deadly sins of investing to avoid.

There is a third factor: High expenses in form of commissions and other fees.

Robo-advisors address all three factors. 

  • First, automating advice permits good advisors to offer services to small investors. Betterment with automated rebalancing and tax-loss harvesting is a good example.
  • Second, automation lowers costs, so fees charged can be reduced. Combine that with use of ETFs and you have dramatically reduced expenses.
  • Last, robo-advisors are immune to greed and fear so their performance will not suffer the way performance of individuals may. No robo-advisor would wait until the market hit bottom to sell, as in the case of 2008 summarized above.  

Bring on the Robos!

What is my conclusion? Not only are robo-advisors here to stay, they may be just what individual investors need so they can retire well!

Should we use Robo-Advisors? I don’t know, let’s ask Siri!

robot-507811_640

Any web search for “robo-advisors” (or robo-advisers, robo-planners, etc.) produces an interesting spectrum of content, from “for” to “against,” with a fair share of “undecided.”

Some posts are ready to embrace new technology. See Robo Advice? Bring it on, it will be great for business by Tony Vidler. He says robo-advisors:

will be good for business for those advisers who provide real value and are smart marketers. The Robo’s will probably kill off the bottom-feeders in the business, together with those who have no genuine advice-based value proposition. Perhaps that is an unfortunate consequence, but then, maybe it isn’t.

We also like Neil Wood’s post “Are You Prepared For the Tidal Wave Of Assets Going Into Robo-Advisor Programs?” He says:

Remember the stock jockeys of the 1970s-1990s that refused to embrace financial planning? Many call them dinosaurs that died with a change in the way our industry did business. There will always be new competitors in our industry. People want faster, cheaper, better, improved, more powerful and a so-called better mousetrap.

But many posts are threatened by new technology. For example, the title alone in the post by Sara Grillo puts robo-advisors in a derogated status: Why a Robo-advisor is Like Getting Financial Advice at a McDonald’s Drive Through. More on Ms. Grillo in a minute ….

Here is another, where the title of the article by Craig Iskowitz sounds as if he thinks robo-advisors are a passing fad: Dead Robo Walking: Why Wealthfront is Doomed. However, he provides real analysis of the new technology and differentiates the growing field of robo-advisors, calling out Wealthfront as an advisor he believes failed to prepare and execute well. Wealthfront may not do well, but Mr. Iskowitz sees it as losing out to other investment firms, both robo or traditional. (Also see Robo-Advisors may be just what we need!)

Finally, there are some who purport to be threatened but may in fact be carving out their own turf in the robo-advisor space. Ron Lieber believes that is what JP Morgan is doing. See “Jamie Dimon Wants to Protect You From Innovative Start-Ups.

As I said in What is a financial plan?, that those who insist that robo-advisors will not replace individual, human planners comprise the “There’s no app for that” group.

Hold on, Steven. This is Siri. What about me? Where do I fit in?

Well Siri, you are a robo-voice, not an advisor.

But you ask me questions all the time!

Yes, I do. But I don’t count on you for life-changing decisions!

I’m hurt!

Enough! As promised, back to Sara Grillo. In the end, she thinks robo-advisors “are a good way to get financial advice for those who have no emotion attached to their money, a long time horizon, and simple requirements.” However, if you need more attention, then she expects you to pay a human for advice, despite the $500,000 portfolio minimum threshold barrier.

Should that be the cutoff? You have to already be wealthy to get good advice? We think it shouldn’t.

Imagine that, as a financial planner, CFP or other advisor, robo-advisor technology frees up more of your time. You could use that time to provide more advice to clients or to advise more clients. Just like the introduction of word processing and desktop computers in offices decades ago, technology brought efficiencies and created a massive shift in how we use time.

Or Imagine that we can create a robo-advisor website that will provide the sort of advice that a human would, even encompassing the issues Ms. Grillo suggests: “complicated trust and estate issues, a need for cash flow planning.” This is my hope for the website we are building, that we can make the essence of human financial planner advice accessible to those who made need it most, who have not amassed great wealth – yet.

Technological change comes in many forms and constantly evolves – that is a constant in our lives. Those who resist are often buried in the process – Neil’s dinosaurs. Those who would adopt and adapt fare far better.

Don’t you agree Siri? Siri?

I’m not talking to you until you apologize

Oh boy.

China’s economy, the stock market and politics


(worried about investing?)

So far this year, checking your investment account balances could lead to an upset stomach, or worse. You are better off watching the historically unusual 2016 presidential campaigns. That way, you have enough to distract you from making a bad investment decision … even if Donald Trump or others upset your stomach.

What would a bad decision be? Here are several worries you may have, stated as “oh no,” along with a description of the potential bad investment decision:

“Oh no, stocks are too risky, I’m moving my money over bonds instead” – a.k.a., changing your portfolio allocation

If you (and your advisors) constructed a good long-term portfolio, then stick to the allocation in your portfolio. At present, the return on most bonds is less than the rate of inflation, after income taxes. The return on money markets is even less. So, unless you have amassed huge sums, you need the stock market returns to reach your financial goals.

That means you have to stay in stocks, and ride out the current downturn.

“But does that work?”

Let’s take the last big market dive of 2008 as an example. Measuring stock performance from 2008 through 2012, “the S&P 500 generated a cumulative return of 8.6 percent.”   See Went to Cash? Here’s the next Big Mistake You’ll Make.

Have you seen any bonds paying 8.6%?

“No.”

I didn’t think so.

True, there are alternate investments, such as hedge funds, precious metals, commodities and raw materials, which could perform better than bonds. However, each has different risks and expenses, and some of these have high barriers to entry. If any of these investments do belong in your portfolio, they are there to balance your other investments, which must still include stocks.

“Oh no, investing is too risky, I’m putting my savings in cash for now” – a.k.a., attempting to time the market

Pulling out of the market when it goes down and then putting all that cash back in just before it goes back up sounds great. However, the problem with market timing is no one can do it. Looking at 2008 through 2012, “If an investor missed the 36 percent drop in the S&P 500 in 2008 — or even worse, bailed on the markets mid-carnage — they probably also missed the 26 percent gain in the S&P 500 in 2009, and the next three positive years for the index that followed. See Went to Cash? Here’s the next Big Mistake You’ll Make.

So, you are thinking that 2008 to 2012 is an aberration.

“Yes, I still want to move to cash.”

 Then consider 1970 to 2016, where, if you missed just the best 25 days out of 11,620 trading days, “your returns would have gone from 1,910% to 371%, or [from] 6.7% a year to 3.4%. To give you an idea of how lousy that is, 1-month U.S. T-bills returned 4.9% over the same period.” See How missing out on 25 days in the stock market over 45 years costs you dearly.

The challenge of timing the market is capturing the best days. However, Nobel laureate William Sharpe “found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors.” See Why you should stay in the stock market.

Are you that lucky?

“No.”

“Oh no, China is a total mess, this time is different, I’m am getting out of stocks forever” – a.k.a., attempting predict the future

True, the slowing of the Chinese economy is causing economic problems worldwide. But, in terms of the impact on stock markets worldwide, that is not dramatically different from the 1987 crash, only then it was Japan.

“Yes, but my friends are selling stocks …”

Did you know that the individual investor is a contrary indicator for the stock market?

“What does that mean?”

Historically, when individual investors are selling, that is a market low, a good time to invest. Similarly, when individual investors are putting everything into the stock market, that is a market peak and a time to sell the over-priced stocks.

By the time you realize that you are mistaken, you will have missed much needed performance. For emphasis, consider this:

From 1990 to 2005 a $10,000 investment would have grown to $51,354 had you just sat tight from beginning to end. However, if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you’d be looking at a mere $15,730. Why you should stay in the stock market.

Oh no, investing is too risky, I put my savings in cash” a.k.a., thinking short-term, another argument for going to cash

he stock market has to be risky, otherwise there would be no reward for investing.

“But I like cash!”

Cash is not volatile, but it is still “risky” – the return on cash – the interest earned – is less than the rate of inflation. Over time, investing only in cash puts you far behind, while long-term investing reduces the risks of stocks. The key is, you have to withstand the downturns to gain from the upturns:

A study by SEI Investments reviewed all the bear markets since World War II. According to the study, reported in The Wall Street Journal, stocks rose an average of 32.5% in the 12 months following the bear-market bottom. Yet, if you missed the bottom by just a week, that return fell to 24.3%. Waiting three months after the market turned cut your gain to less than 15%. Why you should stay in the stock market.

“Oh no, I need money to buy a house” – a.k.a., having the wrong investment strategy

What was your short-term investment doing in the market in the first place?

“I need my money to double so I can buy my dream house!”

Sorry, if you need that much then your dream is wrong.

For the stock market, anything less than 5 years is “short term.” If you have money set aside for a vacation, new car or other major purchase, like a house, those funds need to be invested more conservatively, taking less risk. Otherwise, while you could double your money in a couple of years, you could also end up with much less.

“Oh yes!” a.k.a., the conclusion, an important message – don’t forget it:

After watching investors for several decades, I know this to be true: you must create a good investment strategy and stick to it for it to work.

Even if do not have an optimum strategy, your investments will perform far better than someone who keeps altering their strategy.

“But the fund I have didn’t do as well as another fund last year, so I am selling ….”

Chasing after the last year’s star mutual fund usually works out poorly. You sell your current fund, paying fees and taxes, to buy the star fund, only to watch its performance return to the mean. Disappointed, you then sell the new star fund to chase another star performer, only repeat the same mistake with fees and taxes. After you repeat this a few times, you could end up with negative returns while someone who simply a bought and held a mediocre fund will have substantial gains.

If your investment strategy is better than mediocre, and it includes stocks, stick with it!

“Okay, I will.”

Good, the future you, sitting on a beach sipping drinks with paper umbrellas, will be so glad you did!

China’s currency devaluation, the stock market correction and Powerball

Recent news headlines could drive you crazy:

China’s currency devaluation and fears of slower worldwide growth lead to a stock market correction;

North Korea claims to have detonated an H-bomb, but the US says “we don’t believe you”; and

Powerball hits a record $1.5 billion prize.

However, just as the record size of the Powerball jackpot is no cause to buy lottery tickets, the January jolt to stocks is no cause to deviate from your long-term investment plan … although it is wise to brace yourself for what is likely to be a choppy market ride in the new year.

Abby Joseph Cohen, president of Goldman Sachs Group Inc.’s Global Markets Institute says, this is “the S&P 500’s worst-ever start to a year [sending] the index down 7.5 percent in 2016, near lows seen during a rout over the summer.” See “Goldman Sees 11% Upside in S&P 500 After ‘Emotional’ Selloff” in Bloomberg News, January 14, 2016.

Ms. Cohen goes on to say, “What is happening is really very much an emotional response … We need to put things into perspective. Stocks are probably the best place to be.”

I agree. Predictions of a US major recession, let alone a full market collapse, have not come to pass.

In fact, US GDP has grown for all but one quarter since the end of 2011 and unemployment is down to 5%; US Dept. of Labor consumer price index is near 0% – as a measure of inflation. CIT Voice of the Middle Market, where 59% of the middle market corporate managers think that the best way to judge economy is to observe economic stability of their community, says that its 71% of the group say their companies are strong and 57% say they doing better than last year.

Yes, China’s growth is cooling down to a still very robust 6.5%. But China probably had to devalue currency to continue that growth.

Its stock market should have seen the stimulus as favorable but so many market investors in China are individuals with a short-term horizon that they could have been more concerned with buying power of their wealth and sold off their holdings. The more important long-term issues are the impact of China’s increasing debt and the impact of China’s devaluation on emerging markets.

Meanwhile, the US dollar remains strong, keeping gold prices down, and US corporate balance sheets are healthy, many having cash to raise dividends.

We remain in the third longest bull market in US history. And everything I read, from very optimistic articles to predictions of a crash, ends with something like “stick with high quality holdings.”

Some authors say this because they seek dividends, for income. But, with the Powerball in mind, I translate this to:

Short-term plays in the stock market are purely speculative, so if you want to grow your portfolio, stay out of that betting game.

You can buy a lottery ticket if you want to be speculative.

I conclude with these reminders you can chant as you read headlines on the stock market or watch TV news:

News headlines are not about me,

I won’t panic because I have a good investment plan, and

I will maintain a long-term perspective and stick to my plan

That worked well in 2008. Sticking to a long-term plan meant you participated when the market shot back up almost 10% in January of 2009.

Let me know if you want to share your comments and concerns.

What to watch out for in 2010 – investing, taxes and more

With a new year begun, now is a good time to take stock of your finances. Below are a series of areas to address. If you have questions or comments, please let me know Contact Us

Investing

The markets were up in 2009, some by over 70%, especially low grade stocks and bonds or what some have called a “junk rally”. Should you expect the same for 2010? Is there “a new normal” to which you need to respond?

If you have read any of my Newsletters, you know my response: last year’s winners usually perform poorly in the following years; many individual investors buy these investments anyway, making it more difficult for fund managers to produce results (it is harder to find good investments when you have a great deal more to invest); individual investors also often sell investments that historically go up; any thesis about a “new normal” tends to either ignore long-term lessons of history or be a flashy way of pitching a tactical move that could make sense, but only if you know when to sell as well as when to buy; and what is out of favor usually returns to favor, so that the more stable stocks and bonds that seem too boring to buy could be the right investment to be making now, as so often investment returns track back to the norm over time.

Studies show that, on average, mutual funds over decades fared slightly worse than their respective indices but individual investors did far worse. On the last point, there is a good article entitled “Stop Listening to Jim Cramer” found at Stop Listening to Jim Cramer. The point of this and some other authors worth noting is that prudent investing requires a long-term strategy, and with it the urge to resist trying to pick winners based on a fad, their most recent performance or some other short-term gauge (see The Biggest Mistake Investors Make). Investing in index funds is very boring, but the fees are low and these funds often do well over time.

So what do you do? First, create or update your investment allocation with a long-term view that does not respond to fads. This is essential. Second, rebalance at least annually, selling the excess of your winners to buy your under-performing funds. Historically, this is a way to sell high and buy low. Third, as a tactical move, consider funds investing in large cap US stocks, dividend paying stocks, and adding or increasing your allocation to international stocks. Also, use bond funds that have short-term durations and try to find bond or convertible bond funds that are buying or holding bonds that are discounted. Finally, consider adding commodities as further diversification, with the goal of obtaining gains from either new building, especially in foreign markets, or the chance that we have inflation instead of deflation.

Tax law changes

In my 2009 year-end tax planning Newsletters, I highlighted Roth conversions and other ideas that still apply in 2010. I also pointed out that, with the Bush tax cuts expiring and the need to cover deficits, counting on marginal income tax rates to rise is a safe bet. (Please see Three-year Planning for this year-end and Year-end Tax Planning – Tax Credits – Continued)

This means that you should maximize your contributions to your 401(k), SEP or 403(b) plans, use your HSA or FSA, avail yourself of the first-time home buyer credit and even sell stocks and bonds to reset the basis before the long term capital gains rate rises.

With respect to the Roth conversion, you get two years to pay the taxes for a conversion in 2010. However, the 2011 rate could be higher so this may not be an option worth taking.

In the end, we all need to follow what Congress does to update our strategies during the year.

Estate tax update

Congress is expected to reinstate the estate tax retroactively to January 1. However, instead of the $3.5 million credit and 45% rate, there are some pushing for $5 million and 35% who may win in a compromise. We will update you when we know more.

Also, remember to use your $13,000 annual exclusion for gifting strategies.

Credit – mortgages, cards, etc.

Check your mortgage rate against what you can get on refinancing now. Rates are still low so you may be able to save. Also, if your appraised value is less than the mortgage, there are government programs to help (see Making Home Affordable – refinance eligibility).

If you have not purchased a house, rates are low as are home prices, so this could be a good time to act. First time home buyers have the tax credit as an extra incentive (as mentioned above), if they can act in time.

There are actions to take regarding your credit rating and use of credit cards. Monitoring your credit score will let you know if you can qualify for good loans and credit cards, as well as alerting you to any potential identity theft.

Check to see what accounts are open and use them, reasonably. An account that is not used can be closed under the new banking laws, which has a negative impact on your credit score.

If you do have higher fees or rates imposed, fight to see if you can get your old terms back. Many notices are sent without real scrutiny of your particular situation so, if you have a good history, you may win this fight. Also, opt out of the overdraft fees ($39 per time you go over your credit limit).

If you are looking for a new card, consider credit unions, as their rates are capped, unlike other credit card issuers.

Finally, consider adding a child who is in college to your card, because the new law requires them to prove sufficient income to afford the payments.

Estate plan and life insurance

As noted above, we await action from Congress on the federal estate tax.

However, you still need to make sure that your current will/trust/durable power of attorney/medical directive/etc. work under state laws, have all the people you still want as your fiduciaries and reflect any other changes you have experienced. If not, you should update these documents.

Other financial matters

Do you have an umbrella policy? Did you buy or update your disability policy? Have you checked to see if you can get a better deal on your auto insurance? Would increasing the deductible make sense for your risk tolerance and cash flow?

There are many other items to review. Please check out Finance Health Day – your own financial planning focus

Conclusion

Even if 2010 is not a repeat of 2009 for investments, there are many steps to take to make certain that you are in an optimal position on all your financial fronts.

Let us know if you have questions or comments. Thanks,

Steven