portfolio rebalancing software

Who Can You Trust When Buying Portfolio Rebalancing Software?

“As you all know, first prize is a Cadillac Eldorado. Second prize is a set of steak knives. Third prize is you’re fired.”   — Alec Baldwin as Blake in Glengarry Glen Ross

No one likes high pressure salesmen, no matter what they’re selling. Whether it’s a car, a cell phone or computer software, you do not want to be on the receiving end of a snake oil sales pitch. P.T. Barnum said, “There’s a sucker born every minute,” but you don’t want to be it.

As part of my consulting work helping asset managers, broker-dealers, banks, and RIAs, I have been on the receiving end of hundreds of sales pitches from vendors of every facet of wealth management software; proposal generation, risk profiling, new accounting opening, portfolio management, performance reporting and billing.

One of the areas that is most complex and often requires the lengthiest sales cycle is portfolio rebalancing software.

I was interviewed for a recent article in Financial Planning magazine about buying portfolio rebalancing software. When the article was posted, I was concerned that it was implying that vendors were making inaccurate claims about their software and that this might lead to end investors being impacted.

I do not believe that this is common practice in our industry.

As I pointed out in the article, “I have not heard [of] any that intentionally make inaccurate or misleading claims.”

I think that software vendors in our industry can be trusted and that they want clients to purchase their products based on straight up comparisons with their competitors. No snake oil required.

That being said, it is incumbent on every wealth management firm to invest the time and effort to ensure that they understand their reasons for buying new software, what their business priorities are and what the determining factors are when comparing very similar products from multiple vendors.

At Ezra Group, we have developed a proprietary methodology that we train our clients in to enable them to make the best technology decision.  Without this advice, many firms wind up selecting products that are not the optimal choice for their requirements.

But making choices that meet less than 100% of your requirements is not the same thing as being misled by a vendor to choose their product.  As I said, in my experience, I have not seen this happen.

The article mentioned three “claims” that vendors of portfolio rebalancing software are supposedly making.

Free Lunchportfolio rebalancing software

I have a great amount of respect for Sheryl Rowling, who is now Head of Rebalancing Solutions at Morningstar after they purchased her portfolio rebalancing software firm, Total Rebalance Expert, back in 2015.  She is both a successful entrepreneur and successful financial advisor having run her RIA, Rowling & Associates, for decades.

Rowling was the guiding force behind the Total Rebalance Expert (tRX) application and successfully sold it to hundreds of RIAs, primarily on its tax awareness functionality. tRx is consistently among the top five products in our annual review of portfolio rebalancing software.  (See Advisor’s Guide To Choosing The Best Portfolio Rebalancing Software)

As a Morningstar employee, Rowling has a vested interest in the success of her company’s software and is, naturally, a biased source.

As a creator and user of portfolio rebalancing software, Rowling said that marketers of such software often make inaccurate claims about what their product can do. Among the chief claims that advisers should recognize as a likely overstatement: The software is free.

“There is no such thing as a free lunch,” Rowling said.

This is a knock that we often hear against software provided by custodians, especially against TD Ameritrade and their  popular iRebal application.  Custodians can offer their software “for free” since they are making so much money off the custody of the underlying assets.  So, technically, you are paying custodial fees, but you have to pay them anyway (unless your firm is self-clearing) whether or not you use their rebalancing software. (See TD Ameritrade Rides the RoboAdvisor Wave with Latest iRebal)

This type of competitor bashing is to be expected when you have to sell software for real dollars while someone else is offering it for no cost as part of another service.  Microsoft is still selling their Office Suite even though Google gives their Docs away for free.  Microsoft has to keep adding features and innovating to stay ahead of the free offering.

As I noted in the article:

“Software marketers are no different from those in other industries. They know they have to accentuate the positive and minimize the negatives in order to help sell their product.”

If you choose to use iRebal or any other custodian software, you will be limited to only working with accounts that they are holding.  If you are multi-custodial, you will have to pay for rebalancing software, either a standalone product, like tRx, or something that is part of a wealth management platform.

As far as portfolio rebalancing software goes, there is such a thing as a free lunch, but you have to be able to handle the limitations that come with it.

Avoiding the Taxmanportfolio rebalancing software

The article continued on the offensive with, “Another suspect claim: The software is 100% tax-efficient.”

I’m guessing this came from Rowling since she is always quick to tout her software’s tax efficiency. However, in my experience, I have never heard any portfolio rebalancing vendor say this and I have heard a lot of claims and drilled down into a lot of software’s tax capabilities.  (See What’s New in Portfolio Rebalancing Tools?)

Often, the rebalancing is missing key functions in the tax analysis.

I’m going to disagree with Rowling on this since all of the top products have all of the key tax functions (otherwise they wouldn’t be the top products!).

Advisers should look for software with location optimization and household level rebalancing, tax loss harvesting, tax gain harvesting, short-term gain avoidance, and capital gain distribution avoidance, Rowling said.

Here I’m able to agree and also point out that all of the above features are now table stakes in the rebalancing space.  The areas of differentiation are narrowing as products become more mature.  Client decisions often come down to very specific functionality such as the ability to customize tax efficiency ratings for location optimization, availability of APIs or the ability of the tax loss harvesting algorithms to recommend the best tax lots to sell.

Worse, advisers unwittingly using imperfect software can ding clients’ returns.

“Choosing software without full tax functionality means clients will not get optimal tax benefits,” Rowling said.

When advisers attempt to make up for the tax functionality gaps of such software and rebalance by manual means that leads to less-than-maximum tax savings, she says.

The claim that some advisors are “unwittingly using imperfect software,” implies that there is such a thing as “perfect” software, which is impossible.   Since we have already established the fact that all of the top rebalancing applications have “full” tax functionality, it comes down which software has “the best” tax minimization functionality.

Unfortunately, there is no known process for doing this.  It is impossible to know which portfolio rebalancing tool would save an advisor’s clients the most on their taxes due to the amount of variables involved. Of course, advisors who deal mainly in retirement accounts would see little to no benefit since it only helps if you have taxable accounts.

Only one vendor I know, Smartleaf, publicly announces the amount of tax savings they have generated for their clients. And while our evaluations have shown that they have one of the best rebalancers on the market, this number needs to be taken with a grain of salt since it is created by comparing against accounts that are managed without any tax efficiency, which is unrealistic.

Rebalancing Danger

There were a few questions that did not make it into the article.portfolio rebalancing software

What is dangerous for financial advisors about not recognizing those [claims] as inaccuracies? And how might that lack of recognition hurt their clients?

There’s nothing “dangerous” about this software. We’re not talking about software that manages air traffic control or a nuclear power plant. No one is going to die due to the results of a portfolio rebalance.

I think a better question would have been, “how would clients be hurt if an advisor buys rebalancing software that is missing some features they need?”

The answer is that there shouldn’t be any impact at all to their clients.  Financial advisors are fiduciaries and have a responsibility to manage their client’s assets in their best interests.  This is true whether the orders are created from an Excel spreadsheet, calculations on pen and paper or from automated rebalancing software.

The primary benefits of rebalancing software is improving firms’ operational efficiency.  If an RIA buys software that doesn’t have all the features they thought it had, then the primary impact is only to their own internal efficiency.

Using the examples I noted above, if an RIA buys rebalancing software and they expect it to be able to generate orders for options, but it can’t, there should be no impact on the clients.  The firms’ operations staff would just have to generate options orders manually.

There are some studies that claim that rebalancing can improve portfolio performance, by small amounts.  But there are other studies that claim that portfolio rebalancing hurts performance and clients would be better off if nothing was done.

The bottom line is that there is nothing dangerous about portfolio rebalancing software, either for advisors or their clients. It is just a tool that can help advisors to run their business more efficiently.


Should advisors share with clients the risks of an over dependency on portfolio rebalancing software and what are the top three risks?portfolio rebalancing software

This is a leading question. “Over-dependency”?  Almost every industry is dependent on some kind of software.  The advisory business is no different.  Where exactly do you draw the line between dependency and over-dependency?

And why should details of advisory software need to be shared with clients? Other industries don’t bother their clients by explaining all of the technology they might be using.

Should accountants share the risks with their clients of relying on tax preparation software?  Should lawyers share the risks with their clients of relying on case management software?  Should digital marketing companies share the risks of using advertising management software with their clients?

There are risks in using any investment software.  Portfolio rebalancing tools do not execute trades, they only present the advisor with a list of orders.  It is up to the advisor to decide which ones, if any, to execute.

Most rebalancing tools have options that allow them to be configured to match the firms’ processes.  If an RIA doesn’t take the time to understand the configuration options and/or isn’t properly trained on how the software works and/or blindly approves orders without any oversight, it could result in unexpected impact on the performance of their client’s portfolio.

But this has nothing to do with any issues of the rebalancing software itself.  It would require negligence on the part of the advisor.

No Snake Oil

What do you tell your clients about your portfolio rebalancing software to keep them aware but not misled?

In general, clients don’t care about the rebalancing software their adviser uses.  They care about the relationship their advisor builds with them, the guidance they receive and whether or not they feel their financial concerns are being addressed.  The software an advisor uses is rarely of any concern to a client.



One Response

  1. Craig: Great post, which I think gives a clear-eyed perspective on rebalancing.

    With that being said, I hope you don’t mind if try to clarify one point. You write that Smartleaf “publicly announces the amount of tax savings they have generated for their clients”. While we’re very proud of our Taxes Saved Report, these reports don’t measure the amount of the amount of taxes we have saved our clients. They measure the amount our clients have saved *their* clients (investors) in taxes, relative to the same account being managed without tax sensitivity. Our Taxes Saved Report doesn’t (can’t) tell you how much Smartleaf contributes to this — the advisor might have been able to do just as well with manual processes or by using a competitor’s product. Our main innovation is to give advisors the tools to quantify the value they’re providing.

    {That being said, we have independently measured whether we help our clients become more tax efficient relative to whatever process they were using beforehand. The answer is yes. On average, we help our clients cut their clients capital gains tax bills by more than 60%.}



The Wealth Tech Today blog is published by Craig Iskowitz, founder and CEO of Ezra Group, a boutique consulting firm that caters to banks, broker-dealers, RIA’s, asset managers and the leading vendors in the surrounding #fintech space. He can be reached at craig@ezragroupllc.com