26 Jun The skinny on robo-advisors

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Q. What do you think of “robo-advisors?” I am 48, and married with two kids. I have $900,000 in three 401(k) plans and a brokerage account worth about $450,000. A financial advisor manages the brokerage account for .06 a year, and he advises me on the 401(k)s. My 401(k) offers automatically-generated free advice. I get an A for fee efficiency and tax efficiency, but an F for performance and a D for diversification, saying I’m missing out on $1.5 million of lost growth, and I should have 39 percent in emerging markets. My advisor doesn’t trust the robo-advisor. What do you think?

A. While it’s nice to get second opinions, there are some things a machine or a software program simply can’t do.

And while you may think paid live human advisors have a vested interest to be anti-robo-advisor, it’s not just about their livelihoods. It’s about the quality of what you get from a robo-advisor compared to a real person — something NJMoneyHelp.com agrees with 100 percent.

Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown, isn’t a big fan.

He said traditionally, financial advisors work like other professionals. You go to the professional’s office and meet with them. They provide you a professional service (a tax return, a will or a financial plan) and you pay them a fee.

But with the advent of the internet, we are starting to see more and more professional services being offered online, Kiely said.

“Turbo Tax will prepare and e-file your income tax returns,” he said. “Legal Zoom will prepare your will or incorporate your business.”

And now there are several companies that will manage your accounts online. Robo-advisors.

Kiely said the main benefit of these online services is they all provide a professional service for a fee that is a lot less than if you visited a local professional. But, he said, there are plenty of downsides.

For starters, when you deal with a robo-advisor or other online service, you are not working with a real live person.

“Turbo Tax guarantees the accuracy of their returns. By accuracy, they mean mathematical accuracy. The figures add up and the tax calculations are correct,” Kiely said. “They don’t guarantee that your income, deductions and dependent exemptions are correct.”

Plus, he said, Turbo Tax will not go to an IRS audit with you. If you are audited, you are on your own.

Then there’s Legal Zoom, which will prepare your will for you.

“But no one will sit down with you and ask a lot of questions,” he said. “No one will understand you and your family. Every family is different; we all have our own unique quirks.”

But a real human attorney will understand and work with your family’s unique quirks, Kiely said, such as if nee of your children is a spendthrift or has an addictive personality. If that’s the case, maybe leaving substantial money outright may not be a good idea. Possibly that child’s share should go into a trust upon your passing, Kiely said.

“Will a robo-attorney pick up on that? Who knows? Buy the way, in Legal Zooms ads they say they are not a law firm. Why is that?”

Kiely said he’s had clients who have formed corporations without really understanding the legal consequences of doing so. There are tax filings, worker’s compensation insurance issues and annual registrations.

Kiely shared the story of a client who once formed a corporation in the state of Delaware. He formed it online, but his business operated exclusively in New Jersey. Kiely asked why the client did that, and the client couldn’t give a satisfactory answer.

And that was a big problem, Kiely said.

In New Jersey, a New Jersey corporation is called a “domestic corporation.” An out-of-state corporation is known as a “foreign corporation.” Foreign corporations operating in New Jersey must register with the Secretary of State in Trenton and they must ask for permission to operate in New Jersey, Kiely said.

“This guy was operating his business illegally. This could have caused him problems if he was ever sued,” Kiely said. “It’s possible he could lose the legal protections of a corporation the moment he really needed those protections. He formed the corporation on the cheap with no professional guidance.”

Now, the robo-advisors. They will manage your investments for a very small fee. But you don’t get to sit down and talk to a real live person.

Kiely said besides managing client’s investments for a fee, companies like his provide other services.

“I help them establish realistic financial goals. We discuss strategies for saving for their kid’s college; how to manage their debt. We help them make their quarterly estimated tax payments. We discuss Social Security benefit strategies,” he said. “I represent them at IRS audits. I educate them on investment topics. I explain to them why now is not the right time to buy 30-year U.S. Treasury Bonds.”

Between Oct. 9, 2007 and March 9, 2009, Kiely said, the S&P 500 stock index lost over half its value — 51 percent in 17 months.

“I calmed my clients and reassured them. I prevented most — not all — of them from buying at the top and getting out at the bottom,” Kiely said. “Most investors who were on their own panicked, got out of the market and never got back in.”

Kiely said the value he adds is just more than managing their money, and for all of this, his firm charges 1 percent of what it manages.

Now on to your robo-advisor’s comments.

You said you received an A for fee efficiency, an F for performance and a D for diversification.

“I find this alarming because someone gave them access to your private 401(k) account information,” Kiely said. “Did you grant them access? Or did your employer? If your employer did without your permission, they violated their Fiduciary obligation which is against ERISA’s rules.”

The robo-advisor says you’re leaving money on the table by not taking its advice, including having 39 percent of your funds in emerging markets.

Kiely said for the 27 years ending Dec. 31, 2014 emerging markets have had an average return of 16.65 percent. That’s not bad when you consider the S&P 500 was up 12.21 percent. But there’s more to consider.

“When emerging markets are up they are way up and when they are down they are way down. In 2008, emerging markets were down 53.18 percent,” Kiely said. “Because of that, most investors in emerging markets sold at the bottom and swore never to get back in. The next year, 2009 emerging markets were up a whopping 79.02 percent. If you got out, you weren’t in to get the 79.02 percent, were you?”

He said emerging markets are simply too volatile for his clients, but that’s not a conversation a robo-advisor will have with you.

The robo-advisor also said you are out $1.5 million because you didn’t follow its advice. Kiely said it makes this claim because it “back tested” your account.

“When you back test, you apply your new strategy to an account. You then compare what happened to that account to what actually happened in the past,” Kiely said. “The problem with back testing is that the strategy is influenced by history. Of course you would have beaten the market because you know exactly what happened in the past. You would have won the last war, but the question is: Will you win the next war?”

Kiely said if the robo-advisor is a newer service, it’s never been in a bear market, so you have to take on faith that it would make the correct decisions for your lifetime savings.

The cost of investing — the fees you pay — is another important issue here.

“One might say a penny saved is a penny earned, but in this case I see this as more of, ‘A fool is a man who knows the price of everything, but the value of nothing,’” said Brian Power, a certified financial planner with Gateway Advisory Group in Westfield, quoting Oscar Wilde.

He said advisors, including the robo-advisors, can bring plenty of value to the table. The issue is whether someone is willing to pay for or see the value in what is being offered.

“If risk management is important to you as an investor, then having an advisor help you is very valuable,” Power said. “There are many ways to help manage risk that most individual investors don’t have the time or discipline to implement properly.”

He said there are some basic risk management strategies that should be considered.

First, you should have a properly diversified portfolio to help provide the best performance within a certain risk range, he said. This includes how many asset classes should you own and how your should combine them together in the right way to give you the most efficient portfolio, Power said.

Then, Power said, you should rebalance on a consistent basis.

“This is when you make sure that your investments are consistently in line with your original asset allocation,” Power said. “If you let winners run too long, you can have too much of your money invested in one area and when that area corrects, you’ll most likely experience downside that you’re not comfortable with.”

He said advisors can help rebalance regularly without you having to think about it.

Plus, an advisor can help you be sure you own the top performing investments within each asset class — something an advisor will always be updating.

An advisor will also help you keep a long-term perspective.

“Chasing performance by owning what is always working now can have serious downside consequences to your portfolio,” Power said. “Just ask the folks still licking their wounds from owning all of those tech stocks during the tech bubble years. Advisors keep you disciplined.”

And finally, don’t mistake a bull market for brains.

“The markets will go down again and you will want to have risk management when it does,” Power said. “Advisors have a fiduciary duty to manage the risk in their client’s portfolios. Over the long run, an advisor should be able to earn their fee by giving your investments a smoother ride on your way to obtaining your goals then you can do on your own.”

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This story was first posted in June 2015.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.