The Role Of The Robo-Advisor

Editor’s note: This is part of a series of interviews with thought leaders on the future of the wealth management industry.


Hurley: What will determine the winners and losers among robo-advisors?

Stein: Partly timing. The winners are probably already in business today and it’ll become increasingly difficult to enter over time.
There are many little companies that are trying to get some traction but offer only marginal improvements. We will be the biggest, and ultimately will dominate the space.

Hurley: Why?

Stein: Because we’ve invested in a vertically integrated platform. We are doing custody as well as the front-end advice piece. We have a lower cost to serve the customer, and we can provide a better user experience.

Look at the great modern companies. Many of them were vertically integrated. Carnegie Steel: the mines, the smelting plants and the rails to deliver products. Carnegie could ship steel cheaper than anybody else could and nobody had his pricing power.

Hurley: It also helped being a monopoly.

Stein: It did. But Carnegie had all of the means to deliver from beginning to end, and that was huge. Apple has a different sort of vertical integration. They do the hardware, the software and the retailing, and they’re able to provide a better user experience as a result.

We have all of those advantages. We have price advantages, cost advantages, and we have the user-experience advantage. We do everything faster, seamlessly, more delightfully than anyone else in this space. Every survey by users of the various products today unanimously says that Betterment has the best service.

Hurley: You are competing with Schwab, Fidelity and Vanguard: massive technology platforms with great brands, thousands of clients and large 401(k) programs. How can an independent firm such as Betterment win?

Stein: We have some incredible advantages. First, Vanguard is not a technology company. They are a mutual fund company.

Schwab and Fidelity have a lot of legacy baggage. Building an investing company today is fundamentally different than 20 or 30 years ago. Whereas companies of that era thought about a ticket and a trade, we think about portfolios, aggregating individual trades into bigger trades with fractional shares with much greater liquidity. These legacy firms really struggle with these changes and are trying to staple a new service onto dated technology.

Three other trends provide us with advantages. One is cheaper diversification. It used to be very expensive and difficult to diversify a portfolio. Today, because you can get very cheap ETFs, diversification is almost free.

Secondly, in earlier years firms like Fidelity, Vanguard, Schwab had a competitive advantage to have asset manufacturing in-house because they could bundle it with other services. Today, customers want independent advice.

The third trend is the shift away from defined-benefit pensions and toward defined-contribution plans. It is a good idea that individuals are now accountable [for their long-term financial well-being] and that [financial obligations] are off corporate and government balance sheets. But most people don’t have the tools to conceptualize saving over 30 years. Without any great advice or obvious default settings, they really struggle.

If you were to build an investing company today in this defined contribution world, you’d start from a place of advice. Advice is core in what we do.

Hurley: What is the advice you provide?

Stein: I sometimes make the comparison between driving and life planning. Everyone can very clearly see that self-driving cars are taking off. It is a very complex problem to make a self-driving car, but they’re doing it; they’re solving those problems. I have a 1-year-old daughter, and I sometimes wonder if she’ll ever have to learn how to drive.

People have much less imagination about where life planning is heading. My daughter will not have to think about how much to save for retirement, how much of her paycheck to put away each month or where to put it, because it’ll just be managed for her by technology.

Hurley: Why are you so certain your technology will provide the right answers?

Stein: Because we can take account of everything that goes on in her life, monitor it in real time, compare it to what we’re doing for millions of other people and do it better than it’s ever been done before.

Hurley: You can build into technology the judgment necessary to help clients diagnose their problems, craft personalized solutions and also educate them so they can make intelligent decisions? You have immense confidence in technology.

Stein: Immense. I mean, do you believe that we’ll have self-driving cars?

Hurley: Driving a car does not involve any of the emotional issues that shape client decisions involving their money.

Stein: You think it’s more complicated to make a life plan, or to make a route plan for a car?

Hurley: A life plan.

Stein: Why?

Hurley: Because you’re dealing with human beings. At their core, advisors de-emotionalize money for the clients. Also the complexity of one’s problems changes both with wealth and age.

Stein: While advisors do a great job taking the emotion out of things, technology does it better because it has no emotion. It can hold to that even in emotional times. Technology is the emotionless investor.

Hurley: Long-Term Capital Management made similar arguments and it did not end well. How do you build technology that has the flexibility to account for potential irrationality, in particular, that of the people who use it?

Stein: LTCM was about investing in niche markets and that is not what we do. We take the same approach as any great wealth manager: globally diversify, rebalance, manage taxes, encourage clients to think about the long term and not worry about short-term ups and downs.

We also do a lot of things to help improve the behavior of our customers. We have a much richer data set than most advisors possess and we study our clients’ propensity to change their allocations and how they react to market events.

A small percentage of our customers do chase returns. We want to discourage them from doing that. For example, we’ve introduced a feature called “tax impact.” Before clients [make a change], we’ll show them its tax impact. When customers have seen that information, about two-thirds of them decide not to make the [change to their portfolios]. Advisors also love these types of features that we’ve built.