ACTIONABLE ADVICE FOR FINANCIAL ADVISORS: Newsletters and Commentaries Focused on Investment Strategy

The Most Underappreciated Threat to the Advisory Business

April 30th, 2013

by Bob Veres

Bob Veres

Financial advisors have often heard the warning that their investment management services are going to become commoditized – so often, in fact, that you can forgive them for ceasing to pay attention. But if you don't believe that an online algorithm can replace the sophisticated advice offered by a flesh-and-blood advisor, then check out the Wealthfront USA website.

Wealthfront is among a new class of on-line tools that are being marketed directly to consumers, and in many cases their business plans explicitly envision them threatening to disrupt the traditional advisory business models. Some are pure technology platforms – offering the promise to fully automate the planning and investing functions – and others are positioned as a combination of on-line tools and personal advice, directly from an advisor.

I’ll offer my thoughts on the threats these developments pose to advisors – and how you should position your practice to best take advantage of what they offer. But, first, let’s look at the field of services, beginning with Wealthfront.

Depending on how they score on a risk-tolerance measure, Wealthfront's customers are invested in one of ten model portfolios, which are made up of low-cost index ETFs drawn from 11 different asset classes. An algorithm determines the most efficient deployment of assets between taxable and non-taxable accounts, and another algorithm is constantly measuring the tracking error of each of the component ETFs against their benchmark indices; too much error, and the ETF is replaced by a more reliable peer. Another algorithm harvests tax losses opportunistically as they arise during the year, working in conjunction with a related algorithm that automatically rebalances portfolios when they get more than 5% out of tolerance.

These portfolios will be adjusted periodically as capital market assumptions and correlations change in real time. The Wealthfront website publishes a set of current capital market assumptions – real net-of-fees, after-tax, after inflation returns and standard deviations – based on capital-asset pricing model calculations, the Black-Litterman model and an internal composite forecast created by Wealthfront chief investment officer Burton Malkiel (author of A Random Walk Down Wall Street and The Elements of Investing), in conjunction with a team of advisors that includes Stanford University professor of finance Paul Pfleiderer, Ph.D., Meir Statman, Ph.D. of Santa Clara University, and Larry Cohen, who chairs the Brown University investment committee.

Cost? The first $10,000 is managed for free. After that, the cost is 25 basis points a year – and Wealthfront eats all trading costs, rather than passing them on to its customers. "That was one of the most interesting things about it," said Andy Rachleff, the Stanford professor of entrepreneurship and venture capitalist who founded the company. "Clients are so poorly conditioned by the bad behavior of some financial advisors that they immediately expect the worst when they hear the word 'commission,' whether we get them or not. When we decided to eat the commissions, our growth rate accelerated."

Crowded space

Wealthfront is not alone. Since 2008, online financial service providers have appeared on the web like mushrooms after a spring rain, with a variety of business models from which to choose. Betterment is the most similar to Wealthfront. It charges between 15 and 35 basis points a year to manage ETF portfolios, depending on the size of the portfolio, and, like Wealthfront also offers automatic opportunistic rebalancing if holdings shift more than 5% from the target allocation. Betterment's investment team includes Geert Bekaert, professor of finance and economics at Columbia, University; Steve Lockshin of Convergent Wealth Advisors; and Saman Majd, former vice chairman of Deutsche Bank Asset Management.

The most sophisticated online planning tool is Goalgami, started by BARRA founder Andrew Rudd. The site invites consumers to input their household income, assets and debt, and they can specify their future goals in a particularly user-friendly interface: by moving icons onto a graphical representation of their life's timeline. This generates a household balance sheet, and shows the probability of achieving specific goals in a meter-like affordability indicator that looks surprisingly like the goal achievement meter that MoneyGuidePro users are accustomed to using. Consumers can even do limited what-if analyses such as the impact on future goals if they lose their job or receive a bonus. Social Security and pension benefits are factored into the calculations – and the site is free.

Bank Simple, whose motto is "replace your bank," not only organizes a customer's expenditures (like, for instance, Mint), but also encroaches on traditional advisor turf by tracking progress toward future financial goals that the online user defines.

FutureAdvisor invites people to link the site into their 401(k) and taxable investment accounts (in read-only format), whereupon an algorithm will compare the current portfolio holdings with various investment models and make specific recommendations of index funds. Customers receive monthly performance statements – and, for now, the service is free.

Other sites combine online portfolio management with access to a consultant or advisor over the phone. EverBank Wealth Management, a subsidiary of the EverBank online banking platform, offers a series of model portfolios that are integrated with the online customer's goals. Fees range from 1% a year (first $500,000) down to 55 basis points a year for customers with more than $3 million to invest.

Personal Capital, started by former PayPal and Intuit CEO Bill Harris (Charles Goldman, formerly of Schwab, Fidelity and Advizent is on its board of directors) calls itself the "Next Generation Financial Advisor." The service combines mobile apps and online portfolio reporting with telephone consultations with CFP advisors who appear to be mostly former employees of Fisher Investments. Cost: 95 basis points a year for the first $250,000, with a $100,000 minimum.

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