The purpose of this article is not to reiterate what has been exhaustively discussed in professional publications regarding “robo-advisers.” Rather, I'd like to give you a road map on how to compete with and beat online investment management services using technology.
When looking at what robo-advisers (“RAs”) offer, it's quite simple: dirt-cheap portfolio management based on asset allocation with automatic re-balancing and tax loss harvesting. How can advisers compete when they charge more? The only way to win this game is to make what we offer more valuable than what clients can get online. That means we need to:
• Provide better investment management
• Provide advice and personal communication
In order to do this, we must embrace technology to a greater extent than what we are currently doing — and to a greater extent than what is offered by RAs. In other words, you have to be better and more efficient to survive and thrive through this age of online competition.
(Don't miss these 7 client services that robo-advisers can't provide)
Providing Better Investment Management
Most advisers struggle with re-balancing. It is typically the most time-consuming and error-prone part of the business. It is repetitive and requires consideration of multiple variables at once. Because of the complexity — even with using spreadsheets or basic custodian-provided re-balancing tools, advisers only re-balance clients' portfolios one to four times per year. Additionally, tax loss harvesting is usually done only once a year, at year-end.
If capacity was not an issue, re-balancing ideally would consider all of the following parameters:
• Minimizing transaction costs
• Avoiding redemption fees
• Minimizing gain recognition
• Avoiding short-term capital gains
• Avoiding wash sales
• Location optimization (household level re-balancing)
The RAs might be able to do some of this, but I doubt they offer all of it — especially location optimization. And it is location optimization that provides the greatest opportunity for short-term and long-term tax minimization.
How it works:
A client with several accounts, including taxable, non-taxable and/or tax-deferred accounts, can benefit from location optimization strategies. For example, rather than hold ordinary income-producing bonds in a taxable account (or possibly settling for diminished returns from municipal bonds), bonds can be held in an IRA (which ultimately will be taxed at ordinary rates). Likewise, rather than holding appreciating securities in an IRA, equities held in a taxable account may be subject to advantageous capital gains rates.
(See also: Ready to engage robo-shields. Make it so.)
Finally, locating high-return investments in a pretaxed Roth individual retirement or 401(k) account can achieve the most tax avoidance. Coordinating location decisions along with re-balancing transactions can be quite cumbersome, but the results have the potential for significant tax benefits.
Sheryl Rowling is chief executive of Total Rebalance Expert and principal at Rowling & Associates. She considers herself a non-techie user of technology.
