Since the financial crisis, digitization has disrupted the traditional wealth management industry with new startups gaining market share and incumbents forced to revisit their business models in the face of increasing competition and pricing pressure. Betterment has emerged from this wave of innovation as the leading player.
Founded in 2008 by Jon Stein, a Harvard University graduate, Betterment is the largest independent robo-advisor managing over $5.6 billion in assets under management across more than 185,000 customers1. Robo-advisers like Betterment are online, automated services that use an algorithm to provide investors with wealth-management advice. Betterment was named to the CNBC Distruptor 50 list in 2014 and 2015. In the article, Founder and CEO, Jon Stein was quoted as saying, “We’d like to put target date funds, annuities and mutual funds out of business. There’s no good reason for them to exist anymore.”2
Figure 1: Betterment Mobile Application3
In addition to disrupting traditional investment funds, robo-advisors like Betterment have had a significant impact on the traditional wealth management industry. Traditional wealth managers like Merrill Lynch have come under scrutiny from their clients in recent years for several reasons: (i) high required minimum account balances, (ii) high fees, (iii) inability to produce differentiated investment returns, and (iv) a lack of technology solutions that facilitate ease of use and information transparency. Robo-advisors have attempted to create solutions to address these issues.
Betterment’s business model creates and captures value by offering a simple, transparent digital interface that produces optimal investment returns at a lower cost and is accessible to everyone. Betterment’s platform offers clients access to its platform for a tiered annual fee between 0.15%-0.35% depending on investment amount with no minimum investment. This compares to traditional wealth managers who have a minimum account balance requirement of $250k or more and charge 1%-2% annual fees. On a $250k account, this translates to a Betterment client saving $2,125 in annual fees prior to considering any impact from return performance and compounding over time4.
To deliver on this promise, Betterment’s operating model: (i) provides investment diversification based on Nobel Prize winning research, (ii) invests in low cost investment funds reducing the fees clients pay at the fund level, and (iii) employs a tax harvesting strategy to maximize the tax efficiency of each client’s investing strategy5.
What does this all mean? In short, there will be continued disruption in the wealth management industry. In a recent survey administered by Investopedia, 78% of financial advisors in the U.S. indicated that they believe technology will greatly impact their practice in the next five years6. A.T. Kearney estimates that robo-advisors will grow from $300 billion (<1% of assets) in 2016 to $2.2 trillion (~6% of assets in 2020)7.
Figure 2: Estimated U.S. Robo-Advisors Assets Under Management ($ in Trillions)7
Some traditional wealth managers such as Charles Schwab, Vanguard, BlackRock and Fidelity8 have attacked the proliferation of robo-advisors head on by acquiring robo-advisory firms while other such as Bank of America Merrill Lynch9 and Morgan Stanley10 have announced plans to build in-house robo-advisor capabilities. In a worst-case scenario, robo-advisors could take significant business away from traditional wealth managers. At the very least, robo-advisors should put pricing pressure on traditional wealth managers – estimated by A.T. Kearny to decrease industry revenues by at least $8-$12 billion over the next five years7.
However, the impact of Betterment and its peers should not be all bad for the industry. Booz & Co published a presentation in 2013 that opined on how the industry can use digitization to its advantage: (i) creating new technologies that enable enhanced interaction between advisors and potential clients and (ii) enabling advisors to reach a broader base of potential clients. In my opinion, this last point is the most important11.
In the short-term, Betterment and other robo-advisors should continue to attract new clients to their platform as well as partner with large corporations (such as Uber12) to be their low-cost retirement provider. However, to build a sustainable long-term business, I believe that robo-advisors should partner with large wealth management platforms as part of a customer segmentation strategy. Nearly all large traditional wealth managers are moving towards their own robo-advisor solution that will increase competition with Betterment. Inevitably some of these will fall short in their offering, however, partnering with traditional providers to manage their robo-advisory platform should be a win-win for all parties. There will always be a need for customized financial advice for wealthy individuals and that will require professional, human advisors for the foreseeable future but a customer segmentation strategy that expands the opportunity for professional wealth management strategies to a broader audience of consumers is a compelling value proposition and one that can be facilitated by Betterment.
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1 Betterment. 2016. Betterment Announces the Latest Breakthrough in Tax-Smart Investing: Tax-Coordinated Portfolio™. [ONLINE] Available at: http://www.prnewswire.com/news-releases/betterment-announces-the-latest-breakthrough-in-tax-smart-investing-tax-coordinated-portfolio-300334678.html. [Accessed 18 November 2016].
2 CNBC.com staff. 2016. Betterment 2015 Disruptor 50. [ONLINE] Available at: http://www.cnbc.com/2015/05/12/betterment-disruptor-50.html. [Accessed 18 November 2016].
3 Listen Money Matters. 2016. Acorns vs Betterment vs Wealthfront: Epic Robo-Advisor Battle . [ONLINE] Available at: https://www.listenmoneymatters.com/acorns-vs-betterment-vs-wealthfront/. [Accessed 18 November 2016].
4 Betterment. 2016. Our Pricing – Betterment. [ONLINE] Available at: https://www.betterment.com/pricing/. [Accessed 18 November 2016].
5 Betterment. 2016. Our Portfolio – Betterment. [ONLINE] Available at: https://www.betterment.com/portfolio/. [Accessed 18 November 2016].
6 Investopedia. 2016. Nearly 80% of Financial Advisors Expect Robo Technology to Upend Wealth Management Industry. [ONLINE] Available at: http://www.prnewswire.com/news-releases/nearly-80-of-financial-advisors-expect-robo-technology-to-upend-wealth-management-industry-300326916.html. [Accessed 18 November 2016].
7 Teresa Epperson, Bob Hedges, Uday Singh, Monica Gabel. 2015. Hype vs. Reality: The Coming Waves of “Robo” Adoption . [ONLINE] Available at: https://www.atkearney.com/documents/10192/7132014/Hype+vs.+Reality_The+Coming+Waves+of+Robo+Adoption.pdf. [Accessed 18 November 2016].
8 For Investors: 7 Things You Should Know About a Robo-Advisor | The National Association of Active Investment Managers – NAAIM. 2016. For Investors: 7 Things You Should Know About a Robo-Advisor | The National Association of Active Investment Managers – NAAIM. [ONLINE] Available at: http://www.naaim.org/for-investors-7-things-you-should-know-about-a-robo-advisor/. [Accessed 18 November 2016].
9 Lisa Beilfuss. 2016. Merrill Lynch Unveils Plans to Launch Robo Adviser – WSJ . [ONLINE] Available at: http://www.wsj.com/articles/merrill-lynch-unveils-plans-to-launch-robo-adviser-1475610410. [Accessed 18 November 2016].
10 Business Insider. 2016. Morgan Stanley’s digital strategy relies heavily on robo-advising – Business Insider. [ONLINE] Available at: http://www.businessinsider.com/morgan-stanleys-digital-strategy-relies-heavily-on-robo-advising-2016-7. [Accessed 18 November 2016].
11 Kunal Vaed. 2013. How Digitization is Transforming Wealth Management. [ONLINE] Available at: http://cdn.americanbanker.com/media/pdfs/Mobile13-Vaed.pdf. [Accessed 18 November 2016].
12 Betterment. 2016. Uber and Betterment Drive Together Toward Better Financial Management – Betterment. [ONLINE] Available at: https://www.betterment.com/resources/inside-betterment/uber-and-betterment-drive-together-toward-better-financial-management/. [Accessed 18 November 2016].