“Millennials” are remarkably conservative investors, if they invest at all, in part because of their lack of faith in financial advisers. But a new breed of software-based advisers like Wealthfront and Betterment is banking on them still trusting the market.
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"What people want is not to fuck it up," says Jon Stein, the 34-year-old founder and chief executive officer of Betterment, a software-based financial advice company.
Stein is referring to the massive skepticism people have — particularly the 20-something cohort collectively referred to as "millennials" — about investing in the stock market, which is driven by the sting of witnessing their first financial crisis five years ago and the lack of faith in traditional financial advisers it engendered. Young people, who according to standard investment advice should be taking more risk by investing in stocks and having greater long-run returns, are instead holding more money in cash. This means that a large number of them have been sitting out a sustained run up in asset values. The S&P 500, for instance, returned 32% in 2013 and 91% since 2010.
"The crisis merely confirmed the doubts that young people already had of Wall Street and financial services firms," Merrill Lynch's director of behavioral finance Michael Liersch wrote in a report. Added Chris Lucy, the managing director of Accenture's wealth and asset management services group: "[Young people] are less likely to take at face value the credential that a wealth manager might have brought to a prior generation."
Betterment, Wealthfront and a number of other automated, or software-based financial advising startups, have formed their business models around this generational disconnect. (Betterment has raised $45 million, while Wealthfront has raised $65.5 million.) Their bet is that young people aren't disenchanted with the idea of investing, just with the traditional stock market gatekeepers.
Bay Area-based Wealthfront, run by former LinkedIn executive Adam Nash, is the largest of this new breed of companies, with $1.1 billion under management. Betterment, founded by Stein and Eli Broverman, has amassed $625 million in client money since 2010. The average age of clients is 36 at Betterment and 35 at Wealthfront and they skew heavily (though, they would insist, not exclusively) from the technology world. Their basic pitch is simple — trust that academics have it right about how to best invest and trust in software to best execute that strategy.
"Software doesn't sleep, software doesn't take a vacation, software doesn't tell one customer one thing and tell another customer something else. Software doesn't have a vested interest in promoting a certain stock," said Stein.
The firms, which have several startup competitors along with brokerage behemoths like Fidelity and Charles Schwab, have slightly different investment plans and features but are based on the idea that the overwhelming majority of people with enough assets to think about investing are best-served by low-cost investments that track indexes and are automatically rebalanced over time.
Young people are much more financially conservative than other investors
Indeed, there's been a wave of newfound interest in investing in index funds and broad-market ETFs, mutuals funds and stock-like funds that try to track a broad index like the S&P 500. Nearly 20% of all stock mutual fund assets are currently controlled by index funds, compared to 9.5% in 2000. Actively managed domestic stock mutual funds have seen net outflows of $575 billion in the last five years, according to the Investment Company Institute, while in 2013 $114 billion flowed into index funds. There was similar growth in index ETFs — some $99 billion of shares in broad-based stock ETFs were issued in 2013 compared to $58 billion in 2012.
What these automated financial advisers offer is a way of realizing the widely held academic view that individuals are very unlikely to outperform simple investing benchmarks over a long period of time and that a low-cost portfolio of stocks and bonds (and in the case of Wealthfront some other assets) can provide satisfactory risk adjusted returns.
Wealthfront's chief investment officer, the economist Burton Malkiel, is the author the best-selling A Random Walk Down Wall Street, which critiques methods of analyzing individual stocks and argues that the best risk-adjusted strategy is to have a diverse portfolio of investments that changes as you get older. Betterment's stock ETFs are slightly tilted towards small-cap and "value" (i.e. cheap relative to its fundamentals) stocks, based on academic work done by Eugene Fama, who also first formulated the efficient markets hypothesis.
"If you expect the world economy will grow, then asset values will grow," Stein says, "the two should correlate over time, and historically asset values have grown faster than the world economy."
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