I have fond memories of 1999. My year ended at the top of Nob Hill in San Francisco, celebrating with a group of my business school classmates. I have a vague memory from that night of singing along to that famous song by the artist formerly known as Prince.
The dot-com world was one big party in 1999, fueled by seemingly endless cash from investors, creative new business models, and often-outlandish claims from company founders. I remember talking to an analyst colleague after a conference call with a high profile dot-com company: when asked about the rationale behind the company’s stock split, the company executive responded “because that’s what growth companies do.” No, we didn’t buy that that stock.
Many companies and sell-side analysts came up with creative new approaches to valuing businesses, sometimes based on sound thinking about the future but more frequently based on dubious theories that ignored basic economic realities. We know how the party ended, with riches for some and expensive lessons for many others.
On a smaller scale, I think that we’re seeing some parallels to 1999 in the robo-advisor arena. Money is flowing into robo initiatives from venture capital providers and from incumbent financial services firms that don’t want to miss the party. The latest incumbents entering the fray include TD Ameritrade and Pershing, following the launch of Schwab’s retail offering earlier this year and the June launch of Schwab’s robo solution for advisors. A couple of the leading robo firms have more than $100 million of venture capital funding, and incumbent firms are spending their own money to keep pace.
With so much attention paid to this arena, we’re seeing some head-scratching claims. Cue the music for the latest:
- “We’re profitable on a per customer basis”
Betterment claims to be profitable on a per-customer basis, a statement hard to align with generally accepted accounting standards given assets under management that imply revenues of less than $10 million a year, and a cost structure that includes staff (reportedly nearing 100 employees), office space and advertising. Even with the most generous estimates of revenue, annual costs appear to be a multiple of the firm’s current revenue.
- “Betterment customers can expect 4.3% higher returns than the typical DIY investor”
This is an eyebrow-raising kind of claim, one seemingly based on simulations conducted under the most favorable of conditions. I’d like to see the actual results from the inception of their program receive the same prominence on the website as simulated results.
- “Schwab Intelligent Portfolios charges no advisory fees, no commissions and no account service fees”
Very few services are truly free, and when a financial services provider claims to offer a free service, I look for hidden costs or subsidies. Although Schwab isn’t charging an explicit fee for the service, they will profit through indirect mechanisms such as spreads on cash balances maintained at Schwab Bank, ETF platform fees, management fees for Schwab ETFs included in the program and payments for order routing.
This is the classic example of the codependent relationship between consumers and financial institutions, in which consumers embrace a service with low explicit costs while paying potentially high implicit costs.
- “It is worse than payday lending, and it needs to stop” Wealthfront CEO Adam Nash comparing the $3 per month fee that Betterment charges to investors that deposit less than $100 per month to the charges imposed by payday lenders. I suspect that Senator Elizabeth Warren and her former colleagues at the Consumer Financial Protection Bureau might disagree with this assessment.
Now that I’ve poked some good-natured fun at excessive exuberance among robo-advisors, I’d like to explain how advisors who ignore the robo threat do so at their peril.