the apple of finance

This startup captured $200 million of people’s savings by turning financial advice into an algorithm

June 4, 2013
Obsession
Digital Money
June 4, 2013

Imagine if poring over your finances were as easy as using your favorite app, or smartphone—or any of today’s crisply designed technologies that make life easier, smarter and more efficient.

Such is the task of Betterment CEO Jon Stein, who believes the financial services industry is actually making life more complicated, and could use a dose of disruption.

Betterment, Stein’s three year old startup, manages more than $200 million in assets—mostly in the form of savings and retirement accounts—for thousands of customers. The company’s approach to managing money is fundamentally democratic: its customers include everyone from the very rich to those who can barely afford to sock anything away for retirement. Like most financial advisors, Betterment charges an annual fee on the assets it manages. Betterment’s no-minimum account starts at 0.35% a year; customers who can afford to put more in are charged lower rates. (According to Betterment, that is one-tenth of what traditional financial advisors charge.)

Bringing financial advice into the age of intuitive design

Betterment’s offerings aren’t fancy; they’re intentionally unsophisticated. When people move their retirement or savings accounts to Betterment, their only options are index and exchange-traded funds from Vanguard and iShares—the sort that track the stock market passively, turn over investments infrequently to avoid tax hits, and have very low fees. (Betterment’s recently-hired “chief growth advisor” was last employed at Vanguard.)

“We don’t focus on bells and whistles,” says Stein. “We’re not trying to help you get a better return than the [stock] market.”

In lieu of the usual promises of financial advisors—which generally come down to assurances that they can beat the market though sophisticated strategies, and thus justify their fee—Betterment offers straightforward online tools that allow savers to manage their investments themselves, if they want to. Alternatively, customers can leave most of the decision-making to Betterment simply by telling the software about their goals and risk tolerance. (The video at the top of this article is a good introduction to the philosophy behind Betterment, and how that informs the design and function of the product.)

How it works

Savers start by creating an account at Betterment, and they can connect their bank accounts to Betterment’s own systems. For retirement savings, Betterment allows people to roll over their personal or corporate retirement plan. Then they are encouraged to create “goals”—which range from big ambitions like saving for retirement to smaller tasks like saving for an upcoming vacation. Adjustable sliders corresponding to risk tolerance and time horizon allow people to play with both and see, in real time, how long it will take them to reach their goals. Imagine managing your investments through a program as simple and straightforward as the Nest thermostat, which was created by a former designer of the iPod, and has its own “intelligence” in order to make it easy to save energy.

Betterment is so user-friendly that if someone doesn’t have any specific financial goals, the site will suggest them, based on what other users with similar profile—be it income level or profession—are saving for.

Betterment vs. DIY brokerages

Almost all online brokerages, from E-Trade to Vanguard, now offer advice and even financial tools to make managing your finances simpler. But too often, those tools merely reflect the complexity of the financial services industry rather than boiling it down, which can be intimidating and fatiguing. Betterment tries to cut through the complexity to make financial decisions as easy as, say, working an iPhone. “For that younger customer who’s reaching that inflection point where they have enough savings that they need some guidance, but does not have a large enough stake that advisors are calling them every week, I think there is an opportunity for Betterment,” says Craig Martin, director of the wealth management practice at market research firm J.D. Power. Even people who worry about saving regularly and setting specific financial goals often don’t do it. And for many, employing someone else to do it is too expensive.

Taking on the finance industry

Betterment also thinks tech-savvy users might trust its website more than a human advisor. “A financial advisor could have a bad day, or might give you advice based on some sort of conflict of interest,” says Stein. “An algorithm can’t do that because the conflict of interest would be coded into the software. It’s illegal to do that and traceable.” In other words, regulators could trace the origin of any code that programmed the software to make trades involving a conflict of interest. (Whether regulators would bother to look is another story.) Like many financial advisors, Betterment does not earn commissions on the products it sells.

So what exactly goes into the algorithms? According to Stein, Betterment’s algorithms “implement the [financial] advice that almost everyone agrees on,” including having a diverse portfolio with a balance between stocks and bonds, and some exposure to international markets. Betterment’s software regularly rebalance the portfolio and manages automatic deposits from users. The site has a customer support line to answer questions about how the site works—but employees never dispense financial advice, says Stein.

Taking the cost of trust to zero

Betterment can afford to charge less for its services partly because it doesn’t have the overhead of traditional brick-and-mortar financial advisors. Its service also don’t require costlier live interactions.

Small mom and pop advisors are “extremely expensive to do, and may not be worth that much. You’re trusting somebody, but why? Especially when you can do the same thing with a massively scalable platform like ours,” says Stein.

Stein’s firm reflects the changes in the industry due to rising wealth disparity. More financial advisors are branding themselves as “wealth managers” to target high-net worth individuals. To keep costs down, lower-end advisors often just enter a customer’s information into a computer system that looks a lot like Betterment, if less user-friendly. “If your firm uses basic financial advising tools like Betterment already, and you’re just an overlay on top of that, then how much added value do you bring?” says J.D. Power’s Martin.

Eradicating financial advisors, one human at a time

If Betterment’s business takes off and spawns imitators, some financial advisors may find themselves in the same unfortunate position as the travel agents who lost their jobs to online booking websites. For its part, Betterment just expanded to 36 employees, about half of which are engineers.

Stein says he is frequently approached about licensing Betterment’s technology or partnering with a large bank, brokerage or financial services firm. But for now, he’s riding out the company’s fast growth. “We’re totally focused on building our brand,” says Stein. The bike rack and nap room in Betterment’s Soho office in New York send a clear signal: Betterment’s brand wants nothing to do with its white shoe shop competitors.

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