Financial advisors have often heard the warning that their investment management services are going to become commoditized – so often, in fact, that you can forgive them for ceasing to pay attention. But if you don't believe that an online algorithm can replace the sophisticated advice offered by a flesh-and-blood advisor, then check out the Wealthfront USA website.
Wealthfront is among a new class of on-line tools that are being marketed directly to consumers, and in many cases their business plans explicitly envision them threatening to disrupt the traditional advisory business models. Some are pure technology platforms – offering the promise to fully automate the planning and investing functions – and others are positioned as a combination of on-line tools and personal advice, directly from an advisor.
I’ll offer my thoughts on the threats these developments pose to advisors – and how you should position your practice to best take advantage of what they offer. But, first, let’s look at the field of services, beginning with Wealthfront.
Depending on how they score on a risk-tolerance measure, Wealthfront's customers are invested in one of ten model portfolios, which are made up of low-cost index ETFs drawn from 11 different asset classes. An algorithm determines the most efficient deployment of assets between taxable and non-taxable accounts, and another algorithm is constantly measuring the tracking error of each of the component ETFs against their benchmark indices; too much error, and the ETF is replaced by a more reliable peer. Another algorithm harvests tax losses opportunistically as they arise during the year, working in conjunction with a related algorithm that automatically rebalances portfolios when they get more than 5% out of tolerance.
These portfolios will be adjusted periodically as capital market assumptions and correlations change in real time. The Wealthfront website publishes a set of current capital market assumptions – real net-of-fees, after-tax, after inflation returns and standard deviations – based on capital-asset pricing model calculations, the Black-Litterman model and an internal composite forecast created by Wealthfront chief investment officer Burton Malkiel (author of A Random Walk Down Wall Street and The Elements of Investing), in conjunction with a team of advisors that includes Stanford University professor of finance Paul Pfleiderer, Ph.D., Meir Statman, Ph.D. of Santa Clara University, and Larry Cohen, who chairs the Brown University investment committee.
Cost? The first $10,000 is managed for free. After that, the cost is 25 basis points a year – and Wealthfront eats all trading costs, rather than passing them on to its customers. "That was one of the most interesting things about it," said Andy Rachleff, the Stanford professor of entrepreneurship and venture capitalist who founded the company. "Clients are so poorly conditioned by the bad behavior of some financial advisors that they immediately expect the worst when they hear the word 'commission,' whether we get them or not. When we decided to eat the commissions, our growth rate accelerated."
Crowded space
Wealthfront is not alone. Since 2008, online financial service providers have appeared on the web like mushrooms after a spring rain, with a variety of business models from which to choose. Betterment is the most similar to Wealthfront. It charges between 15 and 35 basis points a year to manage ETF portfolios, depending on the size of the portfolio, and, like Wealthfront also offers automatic opportunistic rebalancing if holdings shift more than 5% from the target allocation. Betterment's investment team includes Geert Bekaert, professor of finance and economics at Columbia, University; Steve Lockshin of Convergent Wealth Advisors; and Saman Majd, former vice chairman of Deutsche Bank Asset Management.
The most sophisticated online planning tool is Goalgami, started by BARRA founder Andrew Rudd. The site invites consumers to input their household income, assets and debt, and they can specify their future goals in a particularly user-friendly interface: by moving icons onto a graphical representation of their life's timeline. This generates a household balance sheet, and shows the probability of achieving specific goals in a meter-like affordability indicator that looks surprisingly like the goal achievement meter that MoneyGuidePro users are accustomed to using. Consumers can even do limited what-if analyses such as the impact on future goals if they lose their job or receive a bonus. Social Security and pension benefits are factored into the calculations – and the site is free.
Bank Simple, whose motto is "replace your bank," not only organizes a customer's expenditures (like, for instance, Mint), but also encroaches on traditional advisor turf by tracking progress toward future financial goals that the online user defines.
FutureAdvisor invites people to link the site into their 401(k) and taxable investment accounts (in read-only format), whereupon an algorithm will compare the current portfolio holdings with various investment models and make specific recommendations of index funds. Customers receive monthly performance statements – and, for now, the service is free.
Other sites combine online portfolio management with access to a consultant or advisor over the phone. EverBank Wealth Management, a subsidiary of the EverBank online banking platform, offers a series of model portfolios that are integrated with the online customer's goals. Fees range from 1% a year (first $500,000) down to 55 basis points a year for customers with more than $3 million to invest.
Personal Capital, started by former PayPal and Intuit CEO Bill Harris (Charles Goldman, formerly of Schwab, Fidelity and Advizent is on its board of directors) calls itself the "Next Generation Financial Advisor." The service combines mobile apps and online portfolio reporting with telephone consultations with CFP advisors who appear to be mostly former employees of Fisher Investments. Cost: 95 basis points a year for the first $250,000, with a $100,000 minimum.
LearnVest, an online advisory platform created specifically for women investors, provides a model very similar to Personal Capital – an in-house staff of CFP advisors plus an online platform that tracks progress against a budget, and downloads balances from online banking and investment accounts. Women who simply want to create and monitor a household budget can pay a one-time fee of $89 for an advisor's assistance. At the high end, the site assesses a one-time fee of $599 for investment advice and a recommended portfolio.
NestWise, a new subsidiary of LPL Financial Holdings, also provides online customers with phone access to in-house financial planners, although some of their credentials strike me as sketchy (CFO of a technology company, realtor, neuroscience graduate who "aided in research with a leading economist at UCLA," product manager at Microsoft). Customers pay $250 for a financial plan, plus $40 a month for ongoing access to the advisor, plus 1% of assets under management.
Covestor actually uses flesh-and-blood portfolio managers for its online offering, and unlike most of the other sites mentioned here, it openly professes belief in active portfolio management. In an early iteration, the company allowed professional and do-it-yourself investors to share their portfolios online and trade advice back and forth. Now, Covestor gives online consumers the option of "mirroring" any of 134 portfolios managed by the investors who compiled the best track records over the company's six years of existence. The fees are set by those managers, ranging from 50 to 200 basis points a year. The list includes traditional planning firms like Mosaic Financial Partners in San Francisco and Fletcher Wealth Management in Johnson City, TN, but most appear to be hobbyists, such as the vice president of a construction company and a 20-something independent systems engineer at Cornell University.
Underappreciated threat
Online investment technology has finally, after years of ominous warnings and many false starts, come of age. Indeed, many mainstream professionals might wish their own desktop systems included the portfolio management algorithms built into Betterment or Wealthfront. At the same time, with the broad spectrum of services and varying degrees of involvement with a professional over the phone, online asset management providers are clearly still searching for their optimal business model.
Should advisors be worried? How much of a threat are these emerging online services to the advisor who may be rebalancing portfolios once a year using a spreadsheet?
"The threat of online providers is greatly underappreciated in our profession," said Dennis Stearns, of Stearns Financial Group in Greensboro, NC.
Stearns is a regular speaker – most recently at the FPA Retreat, FPA Experience and, in November, at the Insider's Forum Conference – on how to use scenario analysis to anticipate and prepare for the future. However, in this case, he doesn't have to invent probabilistic scenarios when the future is staring him in the face. "The things that are being worked on now at Google and the Palo Alto Research Center, and even Apple's new Siri that will come out with their iPhone 6 – all of these things make a system smarter than anything we've experienced before," he said. "We're going to see an explosion of these capabilities in the next five years," he predicted.
Who is most vulnerable? "Those who are not doing particularly creative things with their clients, who are just doing a plan and figuring out an asset allocation, should be paying especially close attention," Stearns continued. "Maybe their magnetic personality and relationship will keep this trend from disrupting them. But I think even those of us who are offering pretty robust extra services need to keep an eye out and be concerned about this."
Negative impressions
Advisors who are unworried about online competition are making an assumption that has reliably held true in the past: that people will always want to talk with a real person about their finances, and they will prefer that conversation to be face-to-face. Some of those boundaries are already being blurred, as Skype, Facetime and GoToMeeting create digital face-to-face interactions that advisors are using with their own out-of-town clientele.
The comfortable assumptions may also break down along generational lines, as younger customers look for a different advisory relationship than their parents had – or no relationship at all. "The thing that is most off-putting to a traditional financial advisor about us is their belief that people need to have their hands held," said Rachleff. "I think that may be true for 50-70-year olds," he conceded, "but I can tell you with great confidence that it is definitely not true for 20-year-olds, and maybe not for 30-somethings. They actually prefer never to talk to someone."
In fact, Rachleff believes that online algorithms are even proving to be superior to traditional advisors at the moment when advisors believe clients need them most: when scary market gyrations are driving hordes of investors stampeding to the sidelines. "That's what the data are telling us," he said. "Granted, it is only 16 months and we haven't had a steadily down market," he added; "but we have had a number of significant downdrafts during that time period, and we have had no churn. It's amazing. Our churn has been less than 1%."
Whether or not the online service providers actually provide superior service, they will impact advisory practices in other ways. As a group, they are boldly questioning the traditional advisor's fee structure and value proposition, and, wherever possible, creating a relentlessly negative portrayal of their entrenched flesh-and-blood competition.
There are two themes to these assaults on traditional planning. The first is visceral. Betterment, Wealthfront and many of the other sites are remarkably consistent in how they decorate their website's homepages: they show montage photos of their customers, who all appear to be hip, attractive and decades from noticing their first gray hair. The pictures imply that the younger generation is much smarter and savvier than their parents, capable of mastering the new online investment world.
The other line of attack is more troubling: piggybacking on the post-2008 exposures of the worst excess of the brokerage model, the sites suggest that all flesh-and-blood advisors are really brokers. They routinely offer blanket statements about fees and conflicts which might apply to a top-of-the-table asset-gatherer at one of the wirehouses, but which bear no relation to the practices of most AUM-compensated advisors.
For example? Betterment created some controversy last year when it posted a blog post pointedly titled "Financial Advisors Are Bad for Your Wealth" – which includes an unflattering graphic of a pig with an advisor's face photo-shopped onto it. The text of the blog referenced in detail a mystery shopper survey by the National Bureau of Economic Research which found that brokers were encouraging frequent trades and moving customers into high-fee funds.
That blog was eventually modified, with an explanatory disclaimer at the bottom, after Josh Brown (who calls himself "The Reformed Broker" on his own blog) and Mike Alfred from Brightscope pointed out that the brokers' behavior would have been just as abhorrent to fee-compensated advisors as to Betterment customers. But the company's website still makes some exaggerated comparisons between Betterment's service model and a hypothetical "Investment Advisor:"
Minimum balance?Betterment: not here. Investment Advisor: how deep are your pockets?
Fees?Betterment: 0.15%-0.35%. Investment Advisor: An arm and a leg… at least 1%.
Simplicity?Betterment: Super simple. Investment Advisor: And you thought relationships were complicated.
Access to Money?Betterment: Anytime. Investment Advisor: With a fight.
In their public statements, the executives of online advice providers are, for now, careful not to awaken the financial advisory profession to the competitive threat they represent – not, at least, until they've achieved a measure of scale. In our interview, Wealthfront's Rachleff drew a fine distinction among startups. A new market disruptor – the category in which he places Wealthfront – merely finds a way to profitably serve customers who are not economic for existing providers to support. He contrasted this with a low-end disruptor, which creates a new business model or platform to profitably undercut the pricing of the existing providers. Rachleff added that Wealthfront is not aiming to take market share from traditional advisors; the goal, instead, is to provide advice to the unwealthy masses that advisors aren't interested in servicing.
However, Wealthfront's website tells a different story. The front page offers a calculator where the interested prospect can enter in the size of her portfolio, the annual fee she is paying her current financial advisor (the default setting is 1.31% a year, which prejudices the results against the typical fee-only advisor), and what she predicts the annual return on her portfolio will be over the next 20 years. The site then helpfully calculates the terminal wealth of the portfolio managed by that expensive financial planner vs. a portfolio achieved by Wealthfront's leaner 25 basis point annual fee. (On a $1 million portfolio, assuming 5.5% annual returns, the difference comes out to $509,956, including inflation.)
On another page, the site calculates how investors can improve their portfolio performance using the various algorithms provided by the Wealthfront platform:
2.1% a year improvement using index funds over actively-managed mutual funds (a significant exaggeration);
1% a year improvement from opportunistic tax-loss harvesting (supported in a back-tested report on the website);
50 basis points a year improvement from "optimal" allocation between taxable and nontaxable accounts;
40 basis points a year improvement from automatic rebalancing; and
60 basis points annual improvement from diversifying across 7-8 asset classes vs. just three.
Total: Additional returns of 4.6% a year!
Meanwhile, Rachleff sometimes, during our interview, talked much more like a low-end disruptor than a new market one. "Our belief is that there is a tremendous amount of money in the hands of people who are, by their nature, delegators, but who can't qualify for a financial advisor," he said. "We enable you to open your account online, fund it online and have it traded electronically, which means essentially zero marginal costs," he added. "If you have zero marginal costs, you can price your service at a fraction of the fee of the incumbents, and you can offer your service at a minimum that is three orders of magnitude below a private wealth manager."
Later in the interview, talking about Wealthfront's automated tax-loss harvesting algorithm that pounces on losses as soon as they show up, he said: "We think this is a feature that a physical advisor cannot offer."
Cyborg approach
While Wealthfront and Betterment rely on the assumption that consumers don't need a flesh-and-blood advisor, services like Personal Capital, LearnVest and NestWise have hedged their bets by making limited phone access to an advisor a part of their service platform. Which will prevail? Stearns, putting on his futurist hat, believes that the eventual winners could be advisors who view the rise of the machines as an opportunity rather than a threat.
"A combination of the advisor and online tool might be where the future is going," he said. "It would provide a huge upside for the profession because the very same efficiencies that are built into these online platforms could be harnessed to make it more economical for today's advisor to work with middle market and even below-middle-market consumers. I think having good human advice combined with wonderfully-enhanced technology tools could be the killer app."
Interestingly, the most sophisticated online planning platform – Goalgami, created by Advisor Software – actually views itself in exactly this way: as an adjunct to an advisory practice. Call it the cyborg approach to planning, where the online platform becomes a strategic part of an advisory firm's service model. And Neal Ringquist, president of Advisor Software (Goalgami), thinks that this marriage of human and algorithm could be just as disruptive as the pure online offers.
Advisor Software was born out of Rudd's experience at BARRA, helping institutions evaluate their portfolios on a much deeper level than was possible before, and later out of creating behind-the-scenes technology in the brokerage world that automated much of the analysis and portfolio development for asset-gathering brokers. "We built the platform for Citibank back in 2008," said Ringquist. "That was a bad time to be launching any financial technology, but especially in the brokerage world."
The company's tools also create the portfolios that are generated on the EverBank website. They do essentially the same thing for do-it-yourself consumers who go to TD Ameritrade's Amerivest system.
The online Goalgami platform, which is free to the general public, is closely paired with an advisor version called Goalgami Pro, currently priced at $495 a year. "The Goalgami workflow experience is meant to engage and entertain consumers, and help them learn about goal planning," said Ringquist. The Goalgami Pro quick planning experience for advisors is the opposite. It's designed to get the advisor through the site to generate a report as quickly as possible to maximize efficiency."
The professional version allows clients to input their basic data, connect to their online account statements and set their goals and timelines through a portal called Collaboration Connect. The advisor can then run the planning report, and – using its own online algorithms – Goalgami Pro creates an appropriate portfolio that the advisor can accept or modify. "It takes roughly eight to ten minutes to generate a quick plan," said Ringquist, adding that much of the input work is handled by the consumer. "We think this addresses that gap in the marketplace between a calculator and a comprehensive planning program," he added. "There are a lot of potential clients who advisors aren't serving right now – people who don't need a hand-crafted plan with a lot of complexity in it."
Playing field convergence
Will advisors – cyborg or otherwise – prevail in this interesting contest with online platforms? Will the ancient, never disproven, assumptions about clients needing a face-to-relationship continue to hold under the threat of sophisticated new algorithms? We probably won't know for at least a decade, and it's certainly possible that there is room for all in the profession. Armed with Goalgami Pro and similar tools that will evolve in the future, advisors will be fully prepared to battle for market share in the middle market, which the Wealthfronts and Betterments now call home.
Wealthfront and Betterment, meanwhile, are flying in the face of one of the most oft-cited trends in the profession, which say that Generation X and Y consumers want a more collaborative relationship with their advisory-service provider.
However, there is almost certainly a segment of the marketplace that is increasingly comfortable with having a website manage their portfolios. Will that cohort become larger as wired consumers become more sophisticated?
The unknown factor is how much evolution the competitors will undergo as they start to collide in the marketplace. There seems to be a bit of hubris on both sides of this interesting new battleground. Advisors dismiss the online technologies as mere “calculators,” and maintain that the face-to-face interactions are crucial. On the other side, Rachleff seems to believe that advisors are unable to evolve, reinforcing the image of a stodgy profession of old people who charge too much and deliver too little. "One of the differences between us and the physical advisor," he said, "is that unlike a physical advisor, a software-based advisor constantly improves. You can keep on improving your software. We can keep on adding features that help you in bad environments. They just look at us as we are today, not as we will be."
"And," the writer asks, "how will you be?"
"You'll see that over time," Rachleff answers with detectable confidence in his voice. "I'm highly confident that the quality of our service will only get better."
Bob Veres's Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com. Or check out his Insider's Forum Conference (September 17-19 in Dallas) at www.insidersforum.com.
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