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.