In recent years, a line was drawn in the sand between on-line advisers and human advisers. The on-line community staked out their turf by suggesting that human advisers will die out like dinosaurs. That’s not happening. Human advisers and on-line advisers both have qualities and both are gaining assets. I believe the line in the sand will wash away this year and vertical advisers will appear.
On-line advisers have figured out that human advisers offer services to a different clientele and more affluent segment of the marketplace. At the same time, human advisers understand the importance of brand recognition and are trying to figure out how to offer on-line services for a future affluent on-line audience. A practical solution is the vertical adviser – one company that does it all.
I’m a human adviser. My company’s investment specialists speak one-on-one with all our clients to set investment policy and assist with other personal financial matters. It’s a great model that offers high profit margins, but there are challenges. First, one-on-one advice creates a natural ceiling in the number of relationships per investment specialist. Second, it’s not a model that works well when an investor has less than $500,000 in assets.
The business model of an on-line adviser is quite different that the human adviser. Their goal is to bring asset management to the masses by letting computers do the talking. It’s Wall Street’s equivalent of Ask Siri.
Look under the hood of most on-line investment management firms and you’ll find a VC funded software company that has an investment overlay. The employees are mainly of software engineers sprinkled with a few investment specialists.
Two firms I’m most familiar with are Betterment in New York City and Wealthfront in Palo Alto, California. Betterment is run by Jon Stein, a former bank consultant who has an economics degree from Harvard, a finance degree from Columbia Business School and a Chartered Financial Analyst (CFA). Wealthfront is run by Andy Rachleff, a well-known venture capitalist and tech entrepreneur who has a BS from the University of Pennsylvania and an MBA from Stanford University.
I’ve been to both Betterment and Wealthfront and know their CEOs. I’ve met the management teams and the staff. My view is that both firms are well run, have dedicated people, and are extremely focused on delivering high quality, low-cost on-line investment management services to the masses.
On-line companies also have challenges. Their immediate challenge is cash flow. A secondary challenge will be client retention in the years to come.
Cash flow can’t yet sustain the business of on-line firms. Based on SEC ADV filings, the average client asset holdings at on-line advisers is well below $100,000. I calculate that the average client is paying less than $50 per year in fees. It’s going to take a lot of clients to generate positive cash flow using this model.
The second problem is client retention. This is an issue on two fronts. First, nervous investors want to talk with someone during difficult times in the markets. It isn’t known yet if a computer will be able to keep clients calm when the next bear market hits. There could be a lot of terminations. Second, on-line advice may not suffice as clients become more affluent. I believe many affluent investors will pay more to talk with a real human being rather than a computer. This could lead to terminations down that road as clients’ accumulate assets in their accounts and become lucrative to the on-line firms.
Here is where the vertical adviser idea comes in. A well run human adviser firm has positive cash flow and one-on-one services. What’s needed today is better back-office technology to be more profitable, and better brand recognition with the next generate of affluent investors. On-line advisers have technology. What they need today is more cash flow, and they need the mechanism to retain clients in the future as those clients gain wealth.
I believe human advisers and on-line advisers should erase the line in the sand and form alliances. I see unbounding opportunity for more client choices, increase profitability through productivity, and increase cash flow across the entire business model. It’s a natural next step for the adviser industry.