Robo advisors, a computerized alternative to human financial advisors, are taking on Wall Street. Their algorithms pick investments for customers, taking on the likes of Fidelity and Charles Schwab, whose employees have been dispensing advice about stocks and mutual funds for decades.
Wealthfront and Betterment are two of the venture-backed startups leading this emerging pack.
Wealthfront, in particular, has been growing fast with over $2 billion in money managed as of earlier this year compared with $500 million, 12 months earlier. Led by Adam Nash, a former Apple, eBay and LinkedIn engineer, Wealthfront has been outspoken with its view that financial robo advisors will become the norm in the next decade.
Nash has also been critical of his competitors, including calling out competitors Betterment and the robo advising service launched by Charles Schwab a few months ago for charging uneccessary fees. Although Wealthfront says that it has saved its customers nearly $10 million in fees that they would have incurred from traditional advisors, it has also drawn criticism for its own fee structure.
Fortune sat down with Nash to talk about how Wealthfront is different, the company’s fees and more.
(The following has been edited for length and clarity)
Fortune: What makes Wealthfront different as a company than the Fidelitys of the world?
Nash: Unlike a retail brokerage like Fidelity, Wealthfront is built as a software company and designed for a new generation of investors. Over 60% of our clients are under 35. We have focused on providing a completely automated investment service, eliminating the cost of retail locations and sales teams. When you walk into our office in downtown Palo Alto you’ll see engineers, designers and PhDs alongside executives from companies like Facebook, LinkedIn and Twitter. It’s a different vision for financial services.
Explain to me the value your service offer clients that they can’t get in say a Vanguard Target Date fund, for instance.
Well, I’d say that if you do find yourself in a Vanguard Target Date fund you’re much better off than most retail investors. We’re huge fans of Vanguard’s products as well as their company culture. Our own chief investment officer, Dr. Burton Malkiel, was a director at Vanguard for 28 years, so our investment philosophies are very much aligned and we use many Vanguard ETFs in Wealthfront’s portfolios.
In the end, however, a target date fund is simply a product that is based only on your age. It’s not personalized to your financial situation, it doesn’t know if it’s in a taxable account or an IRA. For instance, a 30-year-old making $70,000 a year with $10,000 in debt would be put into the same target date fund as a 30-year-old making $200,000 a year with $40,000 in savings. Just by taking into account these two additional data points it’s clear that these two 30 year olds have very different financial situations.
This is why Wealthfront takes into account the details of your personal financial situation like income, net worth as well as how you feel about money to assess your risk tolerance, and allocates your investments across a wider array of investment options, optimized to the type of account you are opening. After you take our risk assessment quiz we show you exactly the portfolio we would put you in and you can see both your taxable and non taxable account mix.
Additionally, Wealthfront offers strategies like tax-loss harvesting [tax-loss harvesting is a way of minimizing taxes you owe on a portfolio by selling shares at a short-term loss, when you can, and replacing them with another investment that keeps your portfolio diversified] and Direct Indexing platform [lets you own the US Equity market directly using stocks, rather than buying an index fund] to taxable accounts. Together, tax loss harvesting and direct indexing can add as much as 2.03% to your after tax return on an annualized basis.
The value of Wealthfront’s service is in the automation of all the behaviors and strategies that investors should be doing on a regular basis, but frankly aren’t. Great investing is a marathon and not a sprint and little things like dividend reinvesting, rebalancing and tax-loss harvesting add up to very large amounts over long periods of time. We’ve been able to take services that typically only the ultra-wealthy have access to and deliver them directly to consumers in software at an extremely low cost.
I noticed Wealthfront recently lowered its minimum to $500 to open an account and it is free under $10,000. How does your business model allow for free accounts?
One of the biggest problems in the traditional industry is the perverse pricing that charges investors with smaller accounts the highest fees and then gives the best deals to the ultra-wealthy. One of the things I love about software is its ability to scale. Because Wealthfront is automated, our incremental cost of adding a new client is very low and we can avoid both the high minimums of the traditional industry, as well the high costs. As a result, we don’t need to make money off of those investors who can least afford it. We should be encouraging young people to save and invest for their future, not penalizing them as many of the big banks do.
You say that millennials want a different type of brand and a different type service, specifically in financial services. Why?
There’s a recent Viacom study that shows millennials rank the existing financial services brands poorly and overwhelmingly want to see financial services from technology companies. It’s important to remember that millennials have lived through not one, but two market crashes. They are incredibly cynical about the sales pitch that they will find easy money in the markets, and they are painfully aware of the gotchas and gimmicks employed by the traditional industry. This may be the first time in history where having a hundred year old brand in financial services triggers resentment, not trust.
A recent report from CB insights shows that the amount of money poured into the fin-tech space last year nearly tripled from 2013 to $12 billion. Why is this happening now and what does it mean for the future of financial services?
I am glad that investors have recognized that it will take an enormous amount of patient capital to impact real change on the banking and financial services industries. My only hope is that these new crop of companies really do impact meaningful change that benefits the client.
It may not be obvious when companies are small, but the choices their founders and CEOs make when deciding where and how to take revenue are magnified over time. If this new crop of companies really want to avoid repeating the mistakes of the past, they have to build their businesses differently.
How do you think about Wealthfront’s pricing and how is it different from competitors? Is the percentage fee in the best interest of consumers?
Historically Wall Street has put up many barriers to investing that include high minimums and high fees. At Wealthfront, we are free for accounts under $10,000 and then charge an annual management fee of just 0.25% thereafter. This is a tiny fraction of the 1%+ that Wall Street typically charges. As a result, we are the least expensive option for investors just starting out.
Our pricing model is very similar to the way most software companies build their businesses – they create value for their customers, and then charge a small fraction of the value they create. Oracle charged per server, eBay and Airbnb charge per transaction, and Facebook charges per ad. Wealthfront charges per dollar, because the value our service creates grows with every dollar investors place with us.
It’s the same pricing model that has served Vanguard well over the past 40 years, and we’re happy to follow in their footsteps.
Charles Schwab is now also offering a robo advisor. Does it validate the space?
When you’re right about technology, you expect others to copy you. I’ve been very vocal about the fact that I think in the next decade we’ll see everyone using some form of automated investment service. Having the computer watch your money 24/7 and do all of the little mundane tasks to keep you on track makes too much sense.
Young people who are in the beginning stages of saving and investing don’t want to walk into a branch office and talk to a salesperson who uses investing jargon and then hands them pages of confusing fees. They want to take out their smartphone, link their account and rest easy knowing they are in a fully diversified portfolio of index funds that is constantly being monitored so they can live their lives.
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