Wealthfront: Winning at Wealth Management
The wealth management industry is stodgy, slow to adopt new technology, highly profitable, and ripe for disruption as Wealthfront is doing just that.
The wealth management industry is stodgy, slow to adopt new technology, highly profitable, and ripe for disruption as Wealthfront is doing just that. For years wealth managers have collected fees for services like financial planning, portfolio construction, and manager due diligence despite the widespread belief (at least in academia) that markets are efficient and cannot be outperformed. Individuals sought out “their guy” from Merrill Lynch, J.P. Morgan, or another brokerage firm for their advice. Why is this? Asymmetric information. The vast majority of Americans don’t know how to think about financial planning, how much to allocate to equity or fixed income, or what investment funds to select.
Wealthfront is challenging the need for wealth managers altogether by automating the financial planning process. They launched in December of 2011 and over the last four years have raised over $2.6 Billion in assets under management.
Value Creation: Value creation for wealth managers and Wealthfront is fairly similar. Both create value by interviewing the customer to understand their risk tolerance, cash needs for spending, investment time horizon, and goals for retirement and then use this information to create the optimal portfolio (allocation between domestic and international markets, equity and fixed income, and other asset classes). Both also select the investment funds for each asset class and trade customer accounts.
They differ, however, in how they provide this service. Wealth managers have developed the “right” portfolio for their customers by asking pre-set questions and then selecting from one of the many off-the-shelf investment portfolios. Wealthfront differs from other wealth managers because they utilize technology to automate this process. Using survey questions and algorithms to determine the appropriate portfolio and exchange traded funds as the underlying investment, Wealthfront is able to offer a low-cost, automated solution to tax-efficient investing.
Value Capture: Value capture between traditional wealth managers and Wealthfront varies. Both capture value by charging customers an advisory fee for their services, although Wealthfront’s fee is much lower at .25% of the portfolio vs. 1.0%+ for traditional managers. In addition, traditional wealth managers can collect fees from trading or revenue sharing with the fund managers they select. This represents a conflict of interest as traditional wealth managers are incentivized to trade client accounts often or select fund managers offering the highest revenue sharing agreement.
Wealthfront provides access to the wealth management services that were previously only available to the wealthy and at a much lower cost. They are currently targeting millennials who tend to be tech savvy, like automation, and prefer low-cost investment offerings. By focusing on millennials, Wealthfront can lock in this growing market the way Charles Schwab concentrated on baby boomers. They can then start to shift up-market by offering additional services and start competing directly with traditional wealth managers. As more and more Americans have lost trust in Wall Street, I think Wealthfront will win the wealth management game.
Totally agreed that Wealthfront and its competitors like Betterment are doing a great job competing against the “brick and mortar” incumbents. This is especially evident in the user-facing part of the wealth management experience. But, I wonder how much is different between Wealthfront and traditional players in the “back-end”, namely the algorithms and portfolio decisions that translate a user’s preferences into actual trades and portfolio allocations.
In some sense, if Wealthfront/Betterment replicate the same portfolio decisions as Charles Schwab, then perhaps what they’re doing is just a new marketing play: they’re using a digital platform to reach more users and “democratize” a product that used to be targeted more towards the wealthy. However, this makes me nervous that competition against Wealthfront and Betterment will become fierce and that “digital wealth management” will become somewhat like a commodity – the actual financial performance of Wealthfront and Betterment won’t be any different, and instead it’s all about who has the most marketing (i.e. VC) dollars.
I think this speaks to a powerful consequence of a digital revolution. Whereas previously geography and brick and mortar locations used to be a source of advantage, a digital product knows no geographic bounds. It might become harder for companies in certain industries to differentiate themselves against competitors, but this could mean better outcomes (e.g. lower wealth management fees) for consumers as certain products become commoditized.
Responding to both the original post and the previous comment, I believe that Wealthfront is a digital winner and low end disruption to the wealth management business. However, there are some differences between traditional wealth management and services like Wealthfront/Betterment that are worth adding to the conversation.
First, looking at portfolio allocation, Wealthfront offers a set portfolio (VTI, VEA, VWO, etc) and the percentage mix of each is determined by an individual’s risk tolerance on scale of 1-10. I believe the brick and mortar wealth managers will find their value (and it’s arguable if the difference in fee will be totally justified) in the additional diversification of other asset classes available to their clients. There is also the effect of individual attention and a wealth manager’s ability to understand what their client truly wants out of their portfolio (risk tolerance beyond a 1-10 rating, expected return/required return, etc). Any brick and mortar wealth manager that doesn’t highlight their value added through services beyond the allocation of assets to standard funds/asset classes will lose significant market share to Wealthfront.
Another interesting development at Wealthfront is the recent change to the required account minimum (previously $5,000 to open, now only $500). They are very clearly moving to unserved markets, as a private wealth manager would never be focused on a $500 account. With the digital infrastructure now well established, the marginal cost of adding new accounts to Wealthfront is very small.
Great post. Eventhough I dont know in detail Wealthfront, I believe is a winner here, and traditional Investment/Wealth Management companies should, at least, carefully analyze what companies like this one is doing. They are creating value not only by lowering significantly the transaction costs, but also, focus their customer relationship towards more value to their portfolios, rather than mantaining commercial relationships!