A cluster of tech-savvy digital RIAs have already revolutionized the advisory industry with their automated, low-cost, web-first approach to investment management.

Now they need to prove that they can survive the long game. In just a few years, an emerging group of digital RIAs — often characterized as “robo advisors” — have amassed over $16 billion in assets, according to New York–based research and consulting firm Corporate Insight. The leading players include Wealthfront, with about $1.6 billion in AUM; Betterment, with around $1 billion; and Personal Capital, at around $800 million.

But revenues are lagging, profits mostly nonexistent and market share is still minuscule — and now one of the big custodians has announced a new entry that may upend the market.

So the question has become: Can the online upstarts survive long enough to become viable, sustainable, profitable businesses in a reshaped market for financial services?


Gambling that a broad shift is underway in the financial services sector, investors and venture capital firms have poured more than $1 billion into tech-driven financial services startups over the past three years.

“They’re betting there will be a fundamental change in the way people invest, that the marketplace will see a paradigm shift to automation and simplicity,” says Andy Putterman, founder of platform provider Fortigent; Putterman now runs his own consulting business and is an investor in Betterment. “The game is not breakeven or incremental profits. The win is being there when — and if — the market shifts.”

That bet is exactly why Menlo Ventures, a major Silicon Valley venture capital firm, has invested in two funding rounds that raised $42 million for Betterment, says managing director John Jarve.

Digital-led investing is “one of the biggest innovations in financial services in a long time,” Jarve says — on par, he argues, with the low-cost revolution that swept firms like Charles Schwab, Fidelity and Vanguard to dominant market positions.

And well-positioned digital RIAs such as Betterment or Wealthfront could reap a similar bonanza, Jarve maintains.

“I’ve been in the business 30 years, and it’s really clear that this [market shift] could have a huge outcome,” he says, adding that Menlo believes Betterment can reach a $1 billion valuation in five to seven years. “My major role is going to be talking the founders out of accepting all the acquisition offers they will be receiving between now and the IPO.”


Meanwhile, the startups facing a host of daunting challenges with a still relatively untested business model. Maintaining steady, scalable, long-term growth in assets, revenue and clients will be key, industry executives and experts agree.

The goal for digital firms, says Rebecca Lynn, a general partner at Canvas Venture Fund, which is backing FutureAdvisor, is to generate enough volume to hit a “tipping point” where they can scale rapidly and every new customer becomes incrementally profitable.

These firms are pursuing a variety of growth strategies to get to that point.

The biggest digital-only advisor, Wealthfront, is planning to ride the millennials’ wave the way Schwab focused on baby boomers, reeling them in early — Wealthfront just lowered its minimum client age to 18 — and keeping them happy with features such as free financial advice for accounts with $10,000 or less, a 25 basis point fee for other accounts, and automatic rebalancing and asset allocation.

Betterment, meanwhile, is pursuing a two-pronged strategy, marketing both to retail clients and to financial advisors, who will get a white-label version they can roll out to their own customers. Fidelity recently announced a deal to market Betterment to its custodial clients.

Other competitors, like Future Advisor and Personal Capital, have their own specialties as well.

Central to all the strategies is rapid growth to achieve thresholds necessary to spark market interest in a public offering or a sale. Jarve, for example, believes Betterment ideally needs to reach $100 million in revenues before it can consider an IPO, and Betterment chief executive Jon Stein cites an AUM benchmark of at least $10 billion — more than 10 times its current asset level.

“We’re not measuring ourselves by profitability,” says Bo Lu, a former Microsoft product manager who founded FutureAdvisor four years ago. “It would be a tremendous waste of everybody’s time if we eked out $2 million in profit. Our goal is to serve more customers, serve them better and become the next financial service organization for the middle class.”

To date, growth rates have indeed been impressive. In just three months, from April to July, assets held by the 11 leading digital RIAs increased 36.5%, according to Corporate Insight.

But is that kind of growth sustainable? And what critical issues must digital firms solve to keep expanding?


Most digital firms are relying on the addition of smaller accounts, usually less than $100,000, than traditional RIAs normally take on.

Those accounts represent a huge untapped market — Americans have an estimated $33.5 trillion in investable assets, and advisory firms manage approximately less than one-fifth of that amount.

“We’re not taking existing share,” Lu says. “We’re creating more pie, not taking a slice of the pie. In fact, about 80% of our clients have never had a financial advisor before.”

The bad news is those clients with small accounts can be hard to find, unprofitable — at least in the short term — and may jump ship if and when their assets do grow to a substantial level.

“When a client starts making more money, and has more to invest, how are robo firms going to customize and diversify?” asks Greg Friedman, president and chief executive of Private Ocean Wealth Management in San Rafael, Calif.

“Who is going to help them with an 83(b) election or with an estate plan? And if [the online firms] do start using real advisors, how many will they have per client — 60 to 80, like most RIAs? Or 500?”


Digital firms will adapt to those issues when they arise, industry advocates say. “The industry will mature and change, and the digital firms will find solutions,” Putterman says. “Their approach is through technology, and they will make adjustments.”

As for customer acquisition, digital firms claim they don’t need traditional advertising plans; instead, they point to their social media prowess and the widespread publicity they are now receiving.

Meanwhile, they say, fully automated systems allow them to onboard and service new accounts inexpensively.

That’s partially true, says Grant Easterbrook, an analyst for Corporate Insight in New York. “Acquisition costs can be high, but the cost of serving each one for digital firms is much less,” he says. “With the right volume, that can lead to healthy margins.”


One of the most commonly cited challenges for digital firms centers on their ability to hold on to assets of smaller, younger investors who are unaccustomed to market volatility — and losses — during a steep market downturn.

“If markets start to turn in the wrong direction, “says Jarve, “you’ll want to see if, instead of taking money out, clients will be content to change their allocation instead.”

But the startups argue that even a steep stock market slide may not hurt online firms as badly as skeptics contend.

Indeed, Putterman says, an equities crash might actually help online players — at least those charging significantly lower fees than traditional RIA firms.

Wealthfront and Betterment charge roughly 25 to 35 basis points on assets, although Wealthfront offers the first $10,000 for free, and Schwab pledges that its new Schwab Intelligent Portfolios service, due to launch in the first quarter of 2015, will charge no fees to clients. Personal Capital, by contrast, is now charging 89 basis points.

“In really bad markets, accounts go down for everybody,” Putterman says — “and people leave to go somewhere else. If you’re unhappy with an advisor who’s charging you more, why wouldn’t you look for a lower-cost solution?”

Online players face another issue that most traditional RIAs don’t have to contend with.
Many digital RIAs boast that not having to pay human advisors lowers their costs and allows them to scale more rapidly. But they are less likely to mention that their platforms’ success relies on expensive software engineers.

“The burn rate for a firm like Wealthfront, which has to hire dozens of well-paid engineers along with other costs and is only making around $3.5 million in revenue, based on their AUM, has to be substantial,” says one veteran Silicon Valley wealth manager who is familiar with the firm and asked not to be identified.

A healthy portion of the ‘robo’ firms’ budgets is indeed spent on hiring talented software developers, who don’t come cheap in Silicon Valley. “It’s a hard problem,” admits Wealthfront CEO Adam Nash. Still, he argues, the payoff is worth the cost: “The more high-quality talent you bring in, the more you can attract.”


Survival for the leading digital firms also entails fending off an onslaught of competition, both big and small.
Schwab has its own offering, Fidelity is promoting its “strategic alliance” with Betterment, and Vanguard is promoting the low-cost (0.3% of assets) Personal Advisor Services offering for clients with more than $100,000 with the firm.

And new competitors keep entering a market that’s already crowded with around three dozen digital startups. In the past year alone, launches by well-funded firms like Acorns, WiseBanyan and Wealthminder have attracted attention and assets, Easterbrook notes.


Nonetheless, established digital companies and their backers claim not to be concerned.

“The great thing about asset management is that it’s not a winner-take-all business proposition, like [car service] Uber,” Jarve says. “Firms like Schwab and Vanguard never had 100% of every dollar,” Jarve adds.

“And people have multiple accounts — they don’t park all their money in one place. We’ve seen average account size at Betterment go up over time. The question [going forward] is what share of wallet can we get?”

Venture capitalist Lynn also expresses confidence. FutureAdvisor’s brand of digital service will “absolutely” cause disruption in the advisory business, she argues.

“They are securing relations with customers whose average net worth is growing incrementally in value over time,” she says. “Historically, [charging] 1% to 2% to manage money for people with under $1 million to invest has not proven to be a good model.” 

Charles Paikert is a senior editor of Financial Planning. Follow him on Twitter at @paikert.

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