February 3, 2012
A shakeout has been expected for years.
Some would say it began over a decade ago, as the number of licensed securities salespeople started to dwindle. Others would say it has manifested itself in fee compression. Or in the fact that key aspects of the financial professional's advice have been commoditized. Or they would point out that online wealth management applications have been growing in sophistication and number.
Meanwhile, an intellectual and academic assault on the value added by financial advisors is taking shape. Twice this week, from totally different places, I came across academics from major educational institutions bashing advisors.
The most notable episode involved behavioral economist Dan Ariely, the James B. Duke professor of behavioral economics at Duke University's Fuqua School of Business. Ariely, who is widely quoted as an expert source in advisor publications and has been the keynote speaker at major conferences for wealth managers, recently wrote in the Harvard Business Review, "Highly trained monkeys could do the same basic job" as a financial advisor.
But the incursion on the turf of advisors by Wealthfront, an online investment app, is more worrisome. Wealthfront represents a highly sophisticated long-term commitment by super-wealthy Silicon Valley venture capitalists to create an online investment advice business that ultimately replaces advisors.
Wealthfront is the latest in a series of incarnations of a wealth management platform funded by investors such as Netscape founder Marc Andreessen and Jeff Jordan, the former president of PayPal. With each new version, the company is learning from its mistakes and refining its business model.
I first wrote online about Wealthfront after seeing it reviewed in TechCrunch. While researching the company, I called CEO Andrew Rachleff, who is also a partner at the venture capital firm Benchmark Capital and a professor at Stanford University's Graduate School of Business, where he teaches a course on entrepreneurship. Benchmark has invested in more than 150 startups and manages nearly $3 billion in committed capital, and Rachleff has interests in such companies as AOL, eBay, Ariba, Juniper Networks, Red Hat, MySQL, OpenTable, Second Life, Yelp Inc., Zillow, 1-800-Flowers, Ebags.com, Friendster, Palm Computing and Seeking Alpha.
Interviewing Rachleff left me with a chill, a concern about the growing likelihood of a dramatic shift in the financial advice business. This column will explain Rachleff's business plan at Wealthfront and explain the central but subtle role his product and similar Web-based investment apps could play as the industry changes.
Rachleff was gracious in a voicemail after my first story about his company appeared. "I just wanted to compliment you on the quality of your reporting when it came to Wealthfront," he said. "You figured us out better than anyone who has ever written about us, be it analyst reporter, you name it." He added, "And I especially got a kick out of your response to a comment quoting [Harvard professor] Clayton Christiansen because Christiansen is the inspiration for almost all of what we do at Wealthfront and no one had ever gotten that before you."
While intoxicating (I haven't erased the message), Rachleff's praise had a double edge because he believes he knows something that advisors do not. "Usually," he said in an interview, "the people who are being disrupted don't know it's happening to them."
Rachleff, with academic precision, described a cycle he is certain will stealthily unfold, stressing that its impact might not be noticed by advisors for many years even as the competitive threat gains strength.
"I sit on the board of the University of Pennsylvania's endowment fund," Rachleff says. "I'm vice chairman. What Wealthfront is trying to do is to bring the same quality of investment advice that the endowment gets to the masses, because it has always struck me as wrong that only the wealthy have access to high-quality investment advice."
Wealthfront, Rachleff explained, is targeting customers advisors do not want. The customers it seeks, for now at least, are limited to 25- to 35-year-olds working in Silicon Valley, where the company is headquartered. These people do not meet the minimum investment of $500,000 or $1 million required by an established financial advisor. These are not your clients.
So advisors probably don't care that Wealthfront is free for the first $25,000 an investor puts on its platform. That's right, it's free. Investors pay 25 basis points only on assets of more than $25,000.
Wealthfront adjusts portfolios to an investor's risk tolerance and rebalances them. The application essentially replaces the highly trained monkey derided by Ariely. To advisors building portfolios using low-cost index funds or ETFs, the investment methodology will sound familiar.
"Wealthfront, an SEC-registered investment advisor, offers an online service that makes it possible for everyone to access sophisticated financial advice," says the company's brochure.
What Wealthfront is describing is a cycle of "disruptive innovation" first articulated by professor Christiansen, who writes on his Web site, "Disruptive innovation is a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves 'up market,' eventually displacing established competitors.
"An innovation that is disruptive allows a whole new population of consumers access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill."
According to Christiansen's process of disruption, innovative businesses in their initial stages are often characterized by lower gross margins, smaller target markets and simpler products and services that may not appear as attractive as existing solutions when compared with traditional performance metrics. But they eventually win.
When Rachleff says Wealthfront is pursuing customers advisors do not want, it would seem to be no threat. But he knows that if he does his job right, eventually advisors would be "displaced," according to Christiansen's theory.
Rachleff says he and the other luminaries funding Wealthfront are using an iterative process articulated in Eric Ries' best seller The Lean Startup. The approach to building a company assumes startups will build something, learn from it and make it better.
In Wealthfront's case, that's meant drastically altering the company's investment advice solution several times in the last three years. Wealthfront started off as "kaChing," a product for managing individual securities. When Rachleff was brought in to run the company, he changed its name and its solution to offer models of diversified portfolios managed by separate account managers for fees of 50 to 200 basis points. Rachleff says its young target clients objected to the high fees, so the solution was revamped again with an innovative pricing model.
Offering a free investment solution to early adopters of technology is ingenious. These young investors will have much more than $25,000 to invest in a few years, and Wealthfront is grooming them to be clients for the next 50 years. The company is also putting assets on a platform that will be refined over time.
Wealthfront's current incarnation will not be widely embraced in the next year or two. First, Wealthfront will focus on serving those young Silicon Valley clients. However, the firm is setting itself up to lure a broad swath of other types of clients advisors don't want beyond Silicon Valley over the next ten years. Wealthfront and others of its ilk will learn from their mistakes and get better at providing investment advice.
You won't even notice it's happening. Until it is too late. The shakeout will occur gradually over the next decade, as such companies nibble at the fringes of the financial advisor universe. It won't be "Advisor Armageddon." Advisors who are great salespeople or highly trained professionals will continue to be valued and find success. But those who are not great salespeople and who lack professional designations and education will find it more difficult to compete. Fee compression will become more acute. The trend to professionalize the financial advice business will become stronger as the online advice incursion occurs over the next ten years.
What will be interesting to see is how online advice will affect the profession over the next generation or two. The financial advice business will not be decimated over the next decade, but two or three decades from now the ranks will have thinned.
"By the time a company like mine can make a difference is years away," says Rachleff, who admits that older clientele still want their hands held. Yet he is part of an avant-garde that is a real competitive threat.
"We're taking mean variance optimization, the foundation of modern portfolio theory, and putting a consumer interface on it so consumers can do it themselves," says Rachleff.
"Making airline reservations was expensive and the reservation system was only available to travel agents," Rachleff adds. "What Expedia and Kayak did with travel reservations, we can do with financial advice."
Editor-at-large Andrew Gluck, a veteran financial writer, owns Advisor Products Inc., a marketing technology company serving 1,800 advisory firms.
Missing the pointWealthfront, while interesting is essentially making the bet that their innovation is Price (25bps), Andrew seems to be going along with the idea that this is disruptive. It's not.
What would be disruptive is if they could match that price with low cost client acquisition. They haven't YET.
Making that work, further assumes that financial advice has a high price elasticity (sensitive to price). While it is elastic, price alone doesn't drive these consumer choices otherwise assets would have flowed far more quickly to Index Funds and ETFs.
Rachleff is very smart and they will be interesting to watch but they haven't cracked the code yet.
You All Don't Get It YetDan - I truly understand where you are coming from, but you need to understand that you are the exception, not the rule. A vast majority of "financial advisors" do little more than sell portfolio products.
The majority of the American public think that anybody who is a "financial advisor" is nothing more than a stock broker. Heck, that even applies to financial planners. How many times do I meet someone and tell them I am a financial planner only to have them ask me about the stock market or my best stock tips.
Even Andrew Gluck slips up here when he attributes Dan Ariely's comment to being about financial advisors. I don't know if that was the phrase Mr. Ariely used in his NYT piece or not, but it doesn't matter. To the public it is all the same.
The truth is, we've done it to ourselves. We rank ourselves internally based on AUM. We allow rags like F.A. and even JFP to focus on investment performance vs. other parts of the planning process ... and nobody holds Money, Bloomberg or any other main-stream media to task when they make the same erroneous generalization.
I love the airplane pilot analogy, BTW ... but how many travelers actually think that a computer flies the plane for the most part. If there is a malfunction, however, I'd rather have you or Sully in the cockpit than some damn machine. Same thing goes with my money (remember the HR block commercial about asking the box for answers?).
Are you kidding? 10 questions replaces a trustedIt would be useful for the article to narrow its definition of financial advisor, because I certainly don't see this as a threat to shaking out any of my business. Plus, I doubt if Andrew truly believes the 1800 Advisory Firms A4A services are no more valuable than highly trained monkeys, but please, speak up if that's how we should be categorized. If financial advice were nothing more than handing out asset allocations, then yes, it's a commodity. But it misses the boat by lumping all financial advisors into the "Key role" of being asset allocators. Maybe this puts me into the category of "those who don't know it's happening to them." But I couldn't take it seriously after going to Wealthfront's website. Ten questions? That's it? Ten questions on a website to replace what I do for my clients? You can't be serious? People make SERIOUS financial mistakes all the time - all generations, high and Low NW, high and Low incomes - optimized asset allocations and websites do not fix these problems or address human needs, people do.
I can't help but think Christiansen was never an advisor because trusted personal guidance is not a commodity and cannot be measured on the margin. And no matter how highly trained it is, a monkey will never understand a person's needs.
In addition to being a CFP professional I am a professional airline pilot, so I found it ironic Wealthfront compared itself to buying an airline ticket. I agree, if all a person needs is an asset allocation then get rid of the middle man. But selling the ticket and flying the airplane are two different matters. A professional advisor, in the true sense of being a professional (not just an asset allocator), doesn't sell the tickets, he flies the planes. They are the ones who get people safely from A to B, not the ticket.
Mean Variance Optimization FatigueI'm sick of the elite finance guys thinking they know what the public wants and needs from a financial advisor. They are often well-financed in their ideas, have a pretty cover, as they sneer with disapproval at pedestrian financial planners. But as long as they actually believe that people want investment mean variance optimization instead of financial advice, they'll fail.
There truly is a shift to bringing financial advice to the people who need it. But, Financial Engines with good GUI for Geeks isn't going to do it for most American families. As long as our profession keeps its collective heads in academic finance, MVO will be part of the solution, but only a small part. Technology and the evolution of consumer web behavior is re-defining financial advice, but the need for an understanding, trusted advisor is still paramount. These guys want to give the financial equivalent of a pill dispensing machine to replace a doctor/nurse.
Fill out your "symptoms" and we will dispense what you need. You'll like it better because it is smarter and more efficient. Bunk.