Roboadvisers: a Primer

According to Business Insider, the term roboadviser was first coined by a reporter in 2002, before really entering into use in 2011 and 2012.  However, the term itself is terrible, because nobody knows what it means!

So in this piece, I’m going to define the roboadvisers, summarize how the various roboadvisers differentiate themselves, compare each roboadviser’s Assets Under Management (AUM), and finally discuss the profitability of the industry.

Definition: If you want to invest money or manage your personal finances, you can hire a portfolio manager or financial adviser to help you.  However, these services are not only costly, but often give bad advice.  To solve this problem, the roboadvisers use computers and algorithms to understand people and give better financial advice.

For instance, let’s say you wanted to invest for retirement.  A simple roboadviser might ask your age, the amount of money you have saved up, and ask how you feel about risky investments.  Based on this information, it would then invest in a portfolio, usually Exchange-Traded Funds (ETFs), that matches your investment style.

And while there are a lot of robo-advisers, they all have different business models, and solve different problems.  Here are some interesting factoids:
– Vanguard’s Personal Advisor roboadviser, which only became available to the public in March of 2015, holds $75 billion in AUM – twice as much as all other roboadvisers combined.
– The most well-funded startup, Betterment, raised $205 million in fundraising and has $5 billion in AUM.
– The roboadvisers charge very different fees, from free to 1% of AUM to a monthly fee.

Different Roboadvisers, Different Business Models and Problems Solved

While the number of roboadviser startups is exploding, they all fall into one of four categories:
1) 401k and retirement investing, for businesses
2) Retail roboadvisers, selling directly to investors
3) Roboadvising as lead generation for banks and financial advisers
4) Roboadviser software sold to financial advisers

401k and retirement investing, for businesses

Most businesses want to provide retirement 401k plans to their employees, but there are often two problems preventing this.  First, they’re too expensive, especially for small and medium sized businesses.  Second, they’re really confusing, and often limit one’s investing choices to high-fee mutual funds.  The startups in category aim at solving both problems, by charging low fees, providing access to low-cost ETFs, and creating an easier way for employees to invest.

The problem:
401k plans are expensive.  According to FiduciaryNews,  plan fees cost large companies an average of 0.5% of AUM (50 basis points), but it costs medium-sized businesses 90 basis points, and small businesses 140 basis points.  And that’s in addition to the actual cost of the mutual funds, which may add another 100+ basis points.

Even if employers were willing to pay the extra cost, many small and medium businesses are unable to provide 401k plans to their employees not because it would be too expensive, but simply because they’re too small for large financial services companies to talk to.

Then, even if these employers were able to get 401k plans for their employees, the interface of many 401k providers is also notoriously hard to understand.  How would you choose from the following?
401k investment choices

How are roboadvisers solving this problem?
The roboadvisers are doing two things: lowering the fees, and making it easier for employees to select a plan.  For example, Guideline charges employers a flat $500 setup fee, then charges a flat $8/employee/month reoccurring fee, plus an ETF fee of 3 basis points.  This is a fraction of the traditional cost.

Once an employer signs up, each employee then goes through the roboadviser process – being asked about their age and investment style, before receiving a recommendation for portfolio of ETFs.  This is much easier (and wiser) investing than having to choose from a list of 200 mutual funds!

In conclusion, traditional 401k advisers are expensive, and offer too many choices, confusing investors.  The 401k for roboadviser services offer few financially-sound choices, removing the paradox of choice.

Retail roboadvisers, selling directly to investors

There are a lot of people who have money to invest, but either don’t invest, or invest badly.  Many people are not financially literate enough to invest, or fall prey to bad investments.  The retail roboadvisers want to solve this problem, and so sell directly to individual investors.  While there are many companies in this category, they all differentiate themselves by offering slightly different services, targeted at different demographics.

The key differences in these services are:
High-touch & high-cost vs. pure automation: some robos are fully automated to drive down costs, others are adviser-assisted for a higher-touch but higher-fee service.
ETFs vs active investments: most robos use active ETFs, but some offer mutual funds and other customized portfolios.
Plans and features: Some robos offer vanilla 401k and IRA plans, others offer a wider range of services such as 529 college savings plans, or additional features such as tax-loss harvesting.  These additional services and features can help investors save even more money.

The big retail roboadvisers are:

Betterment has a number of product lines – not only a retail robo, but a “Betterment for Business” 401k for SMB arm, as well as an institutional arm for partnering with banks.
FutureAdvisor is a retail robo, but also has a white-label product for partnering with banks to allow banks to offer their own roboadvisory services.
Wealthfront is the most technologically advanced, offering features such as security-level tax-loss harvesting and direct indexing, and only offers retail services.
Personal Capital and LearnVest have simpler roboinvesting features than Wealthfront, but also offer personal finance tools like budgeting and expense tracking as well as access to human advisers.
Hedgable is a robo that focuses on more active investing, instead of passive ETFs like Betterment, Wealthfront, and Personal Capital.
Ellevest is a retail robo built and targeted at women, with more options on setting and changing investing goals.
Motif is a investor-directed robo, allowing investors to create their own custom ETF investments.
Rebalance IRA is a retail robo with that provides more access to professional advisers than other roboadvisers, at higher cost.
WiseBanyan is a new retail robo that is experimenting with a “freemium” revenue model.
Acorns is a retail robo that focuses on automating saving, with small savings accounts being invested in ETFs.

In conclusion, there are a large number of retail roboadvisers, and they all serve different investors and demographics by offering very different products.

Roboadvising as lead generation for banks and financial advisers

Banks and financial advisers can provide a lot of valuable services: tax planning, retirement planning, and customized investment plans, among others.  However, not everybody needs or wants these services – yet.  Specifically, there are a lot of Millennials and younger investors who have a small amount of money to invest, and don’t need complicated planning.  The roboadvisery algorithms are perfect for these people.

While roboadvisery services are much less profitable for banks than traditional financial services, they allow banks to attract customers while they’re young.  And as these customers grow in their careers, accumulate wealth, get married, and start buying insurance, the banks can slowly start selling more profitable and customized services to these customers.

For this reason, many of the big banks and financial institutions are offering roboadvising services – either by building them internally, or buying a roboadviser startup.
– Companies building roboadvisers: Schwab, E*Trade, Fidelity, Vanguard, Capital One
– Companies buying roboadvisers: BlackRock, Northwest Mutual

Similarly, some financial investors previously required a high initial investment ($1 million+) in order to invest with them, but are creating a separate roboadvisery service people with less to invest to access their funds.
– The Edelman Group and Ritholtz  Wealth Management both launched roboadvisers to allow low-cost access to their mutual funds.
Asset Builder provides access to DFA mutual funds, which are otherwise unavailable to individual investors.

In conclusion, roboadvisery is a way for banks and financial institutions to serve customers who would otherwise be unable to afford their services, and to build brand loyalty so that customers come back and buy more expensive services later on in their life.

 

Roboadviser software sold to financial advisers.

Not everybody wants to build or buy their own roboadvisery software, and so there’s a market for companies to build roboadvisery software and license it out to other companies.

This can be done as a white-labeled retail roboadviser, such as Upside Advisor, which Ritholtz Wealth Management used to create its own product.  Alternatively, this can also be done as a back-end tool such as Jemstep, which allows financial advisers to spend more time with clients by spending less time doing asset allocation.

Finally, no discussion of the roboadvisers is complete without mentioning Financial Engines, a publicly traded company which started 20 years ago as the predecessor to the roboadviser, working with 401k providers to help customers with financial planning and asset allocation.  Nowadays, the company provides financial planning, investment planning, and other financial services through a network of retail advisers that uses Financial Engines’s software.

I’m classifying Financial Engines as a robo-like since its business model is too different from the other roboadvisers, and excluding it from the charts below.  However, it’s important to note that  the company holds $113 billion of AUM across 932,089 accounts as of 9/9/2016.  The company has more AUM than any other company listed below, and is a profitable 20-year-old public company.

 

Roboadvising Compared: Assets under Management

The follow charts shows how the roboadvisers compare in terms of AUM.

401k and Retirement Investing, for Businesses
Company Status Funds Raised Fundraising Round Snapshot Date Assets Under Management Accounts Average Account Size
Honest Dollar Acquired – Goldman Sachs $3,000,000  Seed 6/17/2016 $147,278 605 $243
Captain401 $3,500,000  Seed 6/22/2016 $3,409,136 621 $5,490
ForUsAll $12,840,000  Series A 3/28/2016 $4,967,000 100 $49,670
Guideline $9,000,000  Series A 8/9/2016 $120,692 26 $4,642
blooom $4,000,000  Series A 8/25/2016 $359,286,848 3,995 $89,934

As shown, Blooom is the undisputed leader in AUM, with Captain401 and ForUsAll a very distant second.  Some of this is due to strategy – blooom and ForUsAll target larger companies, and hence have larger average account sizes when compared to Captain401.

 

Roboadvising as Lead Generation
Company Status Snapshot Date Assets Under Management
Charles Schwab Intelligent Portfolios Started by Charles Schwab 7/18/2016 $8,200,000,000
E*TRADE Adaptive Portfolio Started by E*Trade New June 2016
Fidelity Go Started by Fidelity New July 2016
Vanguard Personal Advisor Services Started by Vanguard 7/21/2016 $75,354,792,068
Capital One Advisor Connect Started by Capital One New June 2016
Edelman Online Started by Edelman Group 7/19/2016 $14,880,000,000
Liftoff Started by Ritholtz Wealth Mgmt 8/15/2016 $411,449,549
Asset Builder 3/2/2016 $670,913,627

Immediately, a couple of insights stand out:
– Vanguard is by far the biggest player in the roboadviser industry, with $75 billion of AUM, more than everybody else combined.
– Most of the big banks and financial advisers are rushing to create their own roboadvisers, with E*Trade, Fidelity, and Capital One entering the market in the past couple of months.  Interestingly, Fidelity had partnered with Betterment before, but is now starting its own service.

 

Direct-to-Customer Retail Roboadvisers
Company Status Funds Raised Fundraising Round Snapshot Date Assets Under Management Accounts Average Account Size
Betterment $205,000,000.00  Series E 8/2/2016 $5,104,843,616 215,402 $23,699
Wealthfront $129,500,000.00  Series D 8/10/2016 $4,021,496,689 80,975 $49,663
PersonalCapital $175,300,000.00  Series E 8/2/2016 $2,853,461,487 19,522 $146,166
FutureAdvisor Acquired – BlackRock $21,500,000.00  Series B 3/28/2016 $808,179,549 10,835 $74,590
LearnVest Acquired – Northwestern Mutual $72,130,000.00  Series D 6/30/2016
Covestor Acquired – Interactive Investors $23,850,000.00  Series B 8/8/2016 $11,576,534 205 $56,471
Hedgeable $1,850,000.00  Seed 4/20/2016 $50,587,840 1,100 $45,989
SigFig $60,000,000.00  Series D 7/25/2016 $93,737,000 1,814 $51,674
Rebalance IRA 7/28/2016 $403,000,000 950 $424,211
WiseBanyan Unknown  Seed 3/29/2016 $49,020,424 9,437 $5,194
Ellevest $10,000,000.00  Series A 5/12/2016 $136,185 40 $3,405
Motif $126,500,000.00  Series E 3/18/2016 $119,000,000 159 $748,428
Acorns $61,960,000.00  Series D 7/19/2016 $197,000,000 917,000 $215

Since there is a lot of diversity in strategy for the retail roboadvisers, there are also huge differences in AUM:
– Wealthfront, Betterment, and Personal Capital are the leaders, each with more than a billion dollars under management.
– Instead of growing their own roboadvisery services, many financial institutions choose to acquire a roboadviser startup.
– Some companies, e.g. Acorns, which is more of a saving service than an investing service, will naturally have lower account sizes.
– In addition, the different roboadvisers target different groups – individuals, high net worth individuals, pension funds, charity investments, etc.**

**Client breakdown available on demand – see end of document.

 

Robo-Advising Tools
Company Status Funds Raised Fundraising Round
Upside Advisor Acquired by Envestnet $1,200,000.00  Seed
Jemstep Acquired – Invesco $15,000,000.00  Series A
MarketRiders $200,000.00  Seed

Finally, there are a number of companies making roboadvisery software, which is sold to roboadvisers or financial advisers.  This is a brief and non-exhaustive list.

Are Roboadvisers Making Money?

This is the million dollar question.  The short answer is no, the roboadvisers are not yet profitable – but that doesn’t matter.

401k and retirement investing, for businesses
Blooom, with its $359 million of AUM, charges between $5 (accounts less than $20,000) and $99 per month (accounts more than more than $500,000) for its 4,000 accounts – equivalent to about 30 basis points.  Calculated out, Blooom earns approximately $1,000,000 in revenue per year.

On the expense side, Blooom currently has 26 employees, so if they have expenses of $150,000 per employee (salary + office + operating costs), they would have expenses of $3,900,000 per year – for a net loss of $2,900,000 per year.  The conclusion?  Blooom is not profitable.

Honest Dollar, which was famously acquired by Goldman Sachs at SXSW 2016, charges $5/user/month, but only had $147,000 under management across 605 accounts.  Hence, revenue was incredibly low – approximately $36,000 per year.

With 20 employees, Honest Dollar was burning money when acquired by Goldman – and while the details of the acquisition are not public, we can guess that the acquisition was for Honest Dollar’s technology.

Retail roboadvisers, selling directly to investors
Wealthfront, with its $4,000,000,000 of AUM, charges 25 basis points with the first $10,000 of AUM per account covered for free for its 80,000 accounts.  Calculated out, Wealthfront earns approximately $8,000,000 of revenue per year.

On the expense side, with 150 employees at approximately $150,000 total costs per employee, Wealthfront has expenses of $22,000,000 per year – or a net loss of $14,000,000 per year.  With $130,000,000 of fundraising since 2008 but an increased customer acquisition cost (rumored to be approaching $1,000 per customer), Wealthfront has challenges ahead.

Personal Capital charges higher fees (89 basis points first million invested, cheaper afterwards) on its $2,800,000,000 of AUM, earning approximately $25,000,000 of revenue per year.

On the expense side, the company employees 250 employees – more than Wealthfront, due to the increased need for human advisers.  At $150,000 total costs per employee, yearly expenses would be $37,000,000 – for a yearly net loss of $12,000,000.

Acorns is focuses more in saving than investing, and so has a very different business model – with more than 900,000 accounts but averaging only $215 per account, Acorns charges $1 per month for accounts below $5,000, or 25 basis points above $5,000, with the service provided free to students.  Given these numbers, Acorns can be estimated to earn $8,000,000 per year.

With 120 employees and a cost of $150,000 per employee, the company’s expenses would be $18,000,000 per year, for an annual $10,000,000 loss.

WiseBanyan also has a different revenue model – freemium.  Since many of the other roboadvisers are competing on cost, WiseBanyan is charging nothing for its basic roboadvisery service, and instead charges for add-on services.  Since the company just started several months ago, there’s no solid revenue data yet.

In conclusion, while the retail roboadvisers are growing very rapidly, they’re still all unprofitable.  In the startup ecosystem, this isn’t a bad thing – it just means roboadvisers are still immature: we know that they solve a very important problem, and we know there is demand for these services, but we just don’t know what a profitable business model looks like yet.

Roboadvising as lead generation for banks and financial advisers
Since Vanguard Personal Adviser (VPA) and Schwab Intelligent Portfolios (SIP) are offshoots of Vanguard and Charles Schwab respectively, it’s hard to measure their exact impact.

From a pure numbers perspective, it’s easily measurable.  VPA has $75 billion of AUM, which at 30 basis points translates to $225 million of revenue per year.  In comparison, SIP has $8 billion of AUM, but charges no fees.

However, there are other considerations that make calculations tricky:
– A significant chunk of AUM might be cannibalized from existing services.  For example, many VPA clients were previously serviced by Vanguard Asset Management Services, paying twice as much (70 basis points).
– In addition, at the end of the day, these roboadvisery addons invest in the Vanguard (or Schwab) ETFs and funds, generating additional revenue.
– Finally, it’s difficult to independently track expenses, since these are not independent companies, but instead part of a larger financial services company.

In conclusion, while we may be unable to calculate exact revenue and expense numbers, we can see that all the major banks and financial institutions are either buying or building a roboadvisery service, to both generate revenue and generate leads.

 

Roboadviser software sold to financial advisers
Very little data is publicly available for this sector right now.

 

What are the conclusions?

There are a lot of different companies in the roboadvisery business, but they’re all united by the common thread of using computers and algorithms to understand people and give better financial advice.

Within the industry, the roboadvisers can be separated into four categories:

1) 401k and retirement investing, for businesses: while this category holds comparatively low AUM, it’s a rapidly growing sector that’s not only cutting costs for small businesses to provide 401k plans, but also promoting better financial investments.
2) Retail roboadvisers, selling directly to investors:  most roboadvisers fall into this category, and they all have their own unique way of approaching the market – fully automated vs. human adviser-assisted, simple ETFs vs. customized portfolios.  However, this market is still immature and not yet profitable.
3) Roboadvising as lead generation for banks and financial advisers: with massive amounts of AUM, most banks and financial institutions have accepted that they will need roboadvisery services as lead generation.
4) Roboadviser software sold to financial advisers: with the increased demand for roboadvisery services, many companies are buying 3rd party services, but the profitability of this category is unknown.

 

Disclaimer: data on this page was pulled from ADV filing (AUM and number of accounts), press releases, LinkedIn (employee count), and service websites (cost structure).

A complete spreadsheet with all the information above, plus additional information such as client breakdown, can be found at the following link: robo-adviser-comparison

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