Betterment is a FinTech startup that provides investment management services to individuals of all types. By leveraging software and automation, the team has drastically reduced the cost structure of investing and disrupted a well-protected and inaccessible industry.
Americans are poorly invested because the existing infrastructure for creating and maintaining savings plans is difficult to navigate and expensive to administer. According to techcrunch, “30.9% of the population has no retirement savings or pension plan. For millennials, many of whom were late to the job market thanks to the financial crisis of 2008, those numbers are actually just above 50%.”
Technology has enabled Betterment to automate portfolio allocation based on easy to understand preferences such as investment horizon and risk tolerance. Replacing portfolio managers as the gate keepers with crystal balls, Betterment simply creates diversified portfolio (then adds on a few fancy features like tax loss harvesting) and takes its hands off the wheel.
Betterment offers better net returns (+4.30% vs. DIY investor according to the company), more accessible investing, and less human bias. They are able to offer better net returns (vs. avg. DIY investors) for several reasons. First, they are able to charge less because their service is highly automated so marginal cost per dollar invested is very low. Second, they provide automated services that most portfolio managers simply can’t offer, such as automatic rebalancing. Rebalancing has historically been high touch and slow. Slow rebalancing can be costly because it causes suboptimal risk-adjusted returns. And lastly, betterment gives much broader diversification that most portfolio managers. This diversification can only be accomplished using automation.
Next, Betterment makes investing more accessible. Historically, individuals have been given options for investing amongst a list of funds administered by Fidelity, Vanguard, etc., these funds charge higher rates yet don’t provide clarity on the investment objectives. For someone who doesn’t know much about finance (or even someone who does) this process can be overwhelming. Betterment asks simple questions about the investors objectives and designs a custom allocation based on those preferences.
Betterment introduces less human bias into the investing process. Portfolio mangers’ objectives are not aligned with those of the investor. They are driven to take risky bets in order to compete for investment dollars. Betterment has created a unified algorithm that doesn’t make bets based on “instincts” but rather on fundamentals.
Betterment is a winner because it has broken into a $5.5 trillion industry with a small team and a simple mission. Their use of technology directly supports that mission and provides real value to the customer. This investing strategy may have broader implications for the economy (where investment is less correlated with news/earnings), but for the early adopters who gain cheap access to investment in a much better pool of assets – Betterment will do great things.