Should a Robot Run Your Retirement Portfolio?


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Betterment CEO Jon Stein and Wharton's Olivia Mitchell discuss robo-advisors as the future of wealth management.

Should you take investment advice from a robot? For Jon Stein, CEO of robo-advisor firm Betterment, the answer is a resounding yes. Robo-advisors are algorithms that recommend investments based on one’s investment preferences, risk tolerance and financial goals with minimal human interaction. Using this technology, robo-advisors cut the cost of traditional wealth management to the masses.

Stein talked about this rising trend in the investment management industry on the Knowledge@Wharton Show, which airs on Sirius XM channel 111. He was joined by Olivia Mitchell, executive director of the Pension Research Council, who is also director of the Boettner Center for Pensions and Retirement Research at Wharton.

 An edited transcript of the conversation follow.    

Knowledge@Wharton: When we’re talking about investing and people saving for retirement, would you say that we shouldn’t be surprised to see more use of robo-advisors and technology?

Olivia Mitchell: Absolutely. We have the software now, and most people have some access to the internet through phones or laptops or what have you. And these are hard problems: figuring out how much to save, where to invest, and what to do with your money in retirement. So we could use help.

Knowledge@Wharton: How quickly is the financial industry coming along right now with the use of technology?

Jon Stein: What we’re seeing is incredible growth. … We now manage over $8 billion for 240,000 customers. Our growth path over the past few years has been faster than the growth of mutual funds, faster than the growth of ETFs — even when those products were new, in their early days. This idea of technology-driven, smarter investing is really transforming the way that people think about what they do with their money. It’s taking off in a way that’s never been seen before.

Mitchell: Some of our listeners might not be terribly well versed in what the term “robo-advisor” means. It’s shorthand for a lot of different products. Give us your own take on what that term means, and talk about what kind of advice robo-advisors are providing to customers.

Stein: Yes, the products in robo-advisors can be very different.

Betterment offers customers a solution that does all of the things you should do with your money and automates them, so that you do them without having to think about them, and provides that at an incredibly low cost. We think about it as taking all the things that maybe you would get if you did everything you should do with your money, and packaging that up — using technology to drive the cost down. So, that’s obviously good. That’s something everyone should be doing, and I think that’s what’s driving the growth of the industry.

Mitchell: Let me turn it around, just to clarify: What kinds of advice do robo-advisors not provide when it comes to money?

Stein: There is a range of different services out there. I think one of the difficult things about defining a term like “robo-advisor” is that since the launch of Betterment, there are now dozens of “me-too” firms. The big firms — Schwab, Vanguard, Fidelity, all of them — are getting into the business, trying to imitate what Betterment has pioneered.

Knowledge@Wharton: Is this viewed as disrupting the investment industry?

Stein: This is, I think, where the most exciting changes are happening in financial services — and beyond just investing. If you look at what’s happening from a regulatory perspective, with the proposed Department of Labor rule about fiduciary advice, with what the CFPB (Consumer Financial Protection Bureau) is considering around access to customer data, there’s a lot of interest in how we align financial services better with the customer’s best interests. How do we provide services that customers want — which is advice, fundamentally. Eighty-three percent of retirement plan participants say they want more advice than what they’re getting, yet only 0.1% of the mass market has a fiduciary financial advisor. So there’s this huge gap in financial services. Everyone wants advice, because the world is getting more complex, and almost no one gets that advice.

This thing we call a robo-advisor — it’s really about providing guidance and support to people who need it, and otherwise wouldn’t get it. That is the future of financial services: Everything you do with your money should be optimized for you, not just investing. It should be maximized so that you make the most of your money across all the things that you’re doing.

Knowledge@Wharton: When you think of your customer base right now, what percentage of them need that guidance, that helping hand along the way, compared to the ones who have a pretty good handle on what they want to do with their investments?

Stein: There’s this challenge in investing: People think, “Oh, the best thing you can do is just figure it out yourself.” It’s as though we live in a world where everyone thinks the best thing to do is to go home and perform surgery on yourself. It’s not. You can do a lot better.

We do things for our customers at Betterment that no one else does, and that you can’t do for yourself. We can trade fractional shares for you; do tax law service for you every day; rebalance dynamically; shield your dividends across your accounts. Even if you spent all day, every day on these things, you couldn’t do it at the level that we do it, because of the technology that we’ve built, because we manage our own broker-dealer, because we’re able to optimize in ways that the incumbent giants can’t. They just haven’t been built to optimize for customers’ best interests. They haven’t been built to maximize your money.

“This idea of technology-driven, smarter investing is really transforming the way that people think about what they do with their money.” –Jon Stein

People don’t understand this, so there’s a lot of work that we’re doing to open people’s eyes. The strategies of 40 years ago — the idea that you buy and hold a single mutual fund — don’t actually maximize your money. And I realize that’s a hard thing to hear for a lot of people who’ve been doing that for a long time. It used to be the best thing you could do, but now you can do so much better, and we’re opening people’s eyes to that fact.

Mitchell: Let me ask a little bit of a background question. As I understand it, during your on-boarding process for new customers, somewhere early on, you ask the customer goal-based questions. But a lot of my research has shown that Americans are tremendously financially illiterate; they don’t understand compound interest, risk diversification, inflation, you name it. In light of that widespread financial illiteracy, might that part of the on-boarding process run the risk of asking uninformed people to set goals that perhaps are not correct goals?

Stein: I would agree with your research, which says that in general, there’s not a lot of financial literacy. I don’t think just more financial education will solve that. The problem is that people will learn something, and then years later, when they’re faced with a financial decision, they’ll forget whatever they have learned.

… Our belief is that the advice, guidance and education has to happen in the moment that you’re making financial decisions. That means that the products have to provide that education, guidance, and advice. That’s why this idea of having aligned fiduciary advice as your core financial relationship is so important because you have to get that advice when you’re interacting with your provider, and so that advisor has to have your best interest in mind. That’s why I think what we’re doing is so important.

When it comes to recommending goals, we’ll recommend [investments] based on your age, profile and what goals might be appropriate for you. And we explain very clearly what those different goals mean, so that people can make informed and intelligent decisions.

Mitchell: From my reading, it does seem like most of the robo-advisors out there concentrate primarily on young people and maybe middle-aged people — helping them get their money in, helping people diversify their investments, and so on. What roles can robo-advisors play for people nearing or living in retirement, when they’re dealing with very complicated decisions like when to claim Social Security, how to handle health savings accounts, minimum distribution requirements, and annuities, etc.?

Stein: I love this question. Again, it depends upon the service that you select. At Betterment, we’ve always had a focus on those approaching and in retirement. In fact, we have, I think, the only retirement income product that’s available from a robo-advisor. We will tell customers how much they can withdraw each month, and then automatically adjust that amount over time, such that they won’t run out of money.

“Everyone wants advice, because the world is getting more complex, and almost no one gets that advice.” –Jon Stein

Retirees love that. It’s like getting a paycheck. It’s better than an annuity, because it’s lower cost and it’s taking directly from your investments rather than selling you another product. For all those other questions — Social Security optimization, all these kinds of things — they’re absolutely important. When we build your financial plan, we take into account what your Social Security benefits are, your pension if you have one, and therefore, how much income should you draw. Or if you’re still in your accumulation phase, how much you should be saving.

We’ve got advisors who will talk to you as much as you want — CFPs (certified financial planners) who you can get on the phone to answer these kinds of questions for you. I think access to all of that advice is something people don’t necessarily recognize they’re getting when they think of a robo-advisor. They think it’s just pure technology.

There’s a lot we do to invest in our customers and to build those relationships. The result of that is that 30% of our assets come from customers who are 50-plus, which I think surprises a lot of people who would think our demographic is younger than that. …

Mitchell: When people do understand the fees that are associated with robo-advisors, pretty soon it will become clear that there are fees associated with the underlying investments, like ETFs [exchange-traded funds], and then also the robo-advisor fees. Will financially literate investors continue to value the robo-model enough to remain with the firms in the long run?

Stein: I think there’s a misconception embedded in there — maybe a couple. One would be that financially literate consumers could do better elsewhere. In fact, robo-advisors are the best thing to do with your money.

… Our goal is to make these services accessible to anyone. That’s why we have no minimum balance. That’s why we crow about our services so much, but still our No. 1 source of customers is referrals. It’s people who are in-the-know, people who get it, and they refer their friends to it. That’s by far the No. 1 way that we get customers.

Mitchell: I’ve heard some discussions in the industry about the very high costs of customer acquisition. Obviously, word of mouth is helpful and probably not as expensive, but generally speaking, how do you compare the robo-advisors’ access to customers versus the more traditional bricks-and-mortar banks and mutual funds and brokers and so on?

Stein: On average, if you take all of the money that we spend on marketing and all of the customers that we acquire, it probably costs us about one-tenth of what it costs the traditional firm to acquire a customer. And that’s just because we have a better product, so we don’t have to spend so much to get people to use it. That, of course, drives the costs down for us, and we pass that value back to customers. It’s a virtuous cycle for us. Our costs to execute are also lower, so not only are our marketing costs lower — all of our operating costs are lower. These cost advantages are really core to our competitive advantage over time. Continuing to invest in driving those costs down and continuing to drive value back to customers is the core of our value proposition.

Knowledge@Wharton: Do you see robo-advisors as a significant growth industry in the next several years? Obviously, a lot of people still prefer the comfort of that hand-to-hand contact with an advisor.

Stein: Yes, and we hear that, too. And that’s why at Betterment we offer human advisors. You can select the level of advice that’s right for you. If you want the purely digital solution — which over 90% of our customers want– you can come to us.

“The strategies of 40 years ago — the idea that you buy and hold a single mutual fund — don’t actually maximize your money.” –Jon Stein

… If you want to have somebody that you talk to once a year, you can come in and get that. If you want a CFP that you can talk to any time you want them, we’ve got that. If you want to actually have an in-person advisor who’s meeting with you in the town where you live, we can recommend a fee-only financial planner or CFP where you live, who will invest your money on the Betterment platform.

Mitchell: As I understand it, Betterment is heavily committed to ETF markets, and certainly there’s been an explosion of worldwide interests in ETFs. But ETFs have also had some liquidity problems, notably during the financial crisis, and there may be some cooling off of the popularity of ETFs. Is the bloom off the rose? Is that something that could be a challenge in the robo-space?

Stein: I’ll take that in two different parts. First, on ETFs — the flows continue to go to ETFs. They continue to grow. I think the growth rate may be slower, but they’re still taking a share from mutual funds because they’re simply a better product. They’re more tax-efficient. They’re generally lower cost. You can trade them throughout the day, and that greater liquidity is attractive to investors. I expect ETFs will continue to grow.

Second, we, as investment advisors, are not tied to ETFs. Now, we do recommend mostly ETFs for our customers because of all those reasons: that they’re better, they’re more tax-efficient, they’re more liquid, you can personalize them, you can do fractional shares, they’re lower cost, etc. We recommend them for most clients. But we also manage individual stocks. We also manage mutual funds, and increasingly, we’re seeing customers transfer those kinds of things in and helping them build portfolios around them.

So there’s not a one-to-one linkage. My own view is in the long term, in many asset classes, we’ll move to a post-fund world. I think the idea of the fund really came out of the 1930s and 1940s, right? … At the time, it was a great technology. It was a way of helping to diversify individual investors. But you can actually be more tax-efficient the more you personalize the investments for an individual. So I think we’ll move to a post-fund world over time.

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