Why I left Wealthfront

[Badger1754]

Last week, we made the difficult decision to pull all of our money out of Wealthfront and transfer it to Vanguard (after being Wealthfront customers since 2013). Part of it was nasrullah's post about the stock-level lock-in. Part of it was the sudden introduction of Risk Parity (and an 8 bps increase in fees). But most of it was math.

In short: I believe, under guidance/pressure from its VC investors, Wealthfront is pivoting from a low-fee automated roboadvisor with a distinctively Boglehead-friendly passive investment strategy to a higher-fee active management approach. After all, what is their new Risk Parity or Smart Beta thingy but "active management"? They used Direct Indexing and the opaqueness of your holdings (for example, not informing you of the cost basis) to create stickiness, so as to make it difficult for people to leave. Now, my hat is off to them, because if I were a VC interested in maximizing my returns, I'd do the exact same thing. They offer a slight cost advantage with a heckuva lot more stickiness. But it is no longer a product for adherents for the low-cost Boglehead approach.

For the model below, I used BlackRock as a proxy for Wealthfront's EBITDA margins (rounded up to 50% because I imagine Wealthfront has less legacy overhead), and for its EV/EBITDA multiple (rounded up to 20x for the tech premium and expected growth trajectory). I found the $204.5M in total VC money from Crunchbase. I assume a VC would expect a 30x return on investment.

Right now, Wealthfront (with its $10B AUM) is generating a 1.2x return on investment (the light blue highlight).

Now, in order to generate a 30x return on investment, Wealthfront has two levers: (1) it can increase its fees from 25 bps, or (2) it can increase its AUM from $10B. I believe its recent moves, such as Risk Parity and its announcement that it will no longer manage the first $10K for free, is a symptom of this fee pressure.The bottom table is a "sensitivity table" showing what it would take at different levels of AUM to justify its VC investment. Where I played with variables is highlighted in yellow.

At one end of the spectrum (right now -- at $10B AUM), Wealthfront would have to increase its expenses to 613.5 bps to create a 30x payback. Before you flip out, a 6% expense ratio is actually not that unheard of in the 2-and-20 world of hedge funds once you factor in performance expenses. At the other end of the spectrum, Wealthfront can keep its fees at 25 bps if it manages to increase its AUM to $245B.

So the question is, do you believe that Wealthfront can increase its AUM to $245B in the next few years, before the VCs lose patience? (Keep in mind they operate on a 5-7 year investment cycle.) If you don't, then Wealthfront's fees have no place to go but up, and they have created a brilliant product designed to lock customers in.

Here is the math:


Where I could be wrong:

• If the VCs expect less than a 30x return

• If the VCs operate on an IRR basis and not a cash-on-cash basis

• If Wealthfront can command a higher premium on the EBITDA multiplier

• If Wealthfront can generate a higher EBITDA margin due to automation, etc.

• If further VC investment is required

• If Wealthfront is generating 25 bps on a significantly lower portion of its $10B AUM, as certain assets are managed for free

• If Wealthfront can generate scalable revenue on something other than bps of AUM

Edited per Taylor Larimore's suggestion to explain some of the abbreviations

• VC = Venture capital. Firm that puts in money into early-stage companies, with the expectation of earning an outsize return on a few home runs -- but also accepting the risk that most of their portfolio will go to zero.

• EBITDA = Earnings before interest, taxes, depreciation, and amortization. A decent measure for profitability.

• EV = Enterprise value. The formal definition is equity + debt - net cash. It's the "all-in takeover price" to buy a company.

• EV/EBITDA. A multiplier that you can use to approximate the takeover value of a company. For example, if a company's EBITDA is $100M, and the EV/EBITDA is 10x, then the takeover price would be 10*100 = $1B.

• AUM = Assets under management. This drives Wealthfront's fees.

• bps = Basis points. 1/100 of 1%.

• 2-and-20. A typical hedge fund fee structure. They charge 2% of all assets under management, and then 20% of all gains over a given threshold. The threshold is typically something much lower than the S&P, and the 2% is in place whether ot not the hedge fund makes or loses money.

[livesoft]

I am not one to question your analysis, but I presume you are hinting that Wealthfront will sell its assets to another firm well before it gets to $245B and the VC's will be done with it after incurring a loss.

[Taylor Larimore]

Badger:

Interesting analysis. It would be helpful if you edited your post (use little window at top right) to explain your abbreviations.

Thank you and best wishes.
Taylor

[Badger1754]

I am not one to question your analysis, but I presume you are hinting that Wealthfront will sell its assets to another firm well before it gets to $245B and the VC's will be done with it after incurring a loss.

That's a good way of putting it. I am suggesting the chances of Wealthfront remaining a viable, stand-alone roboadvisor is very slim as it assumes either massive increases in fees or in AUM, neither of which is likely. I'd have to wonder who would buy them. All the large brokerage houses are developing their own roboadvisors and I would find it very hard to believe Wealthfront's distinctive IP, for example, their automated risk parity algorithm, is worth however much the VCs would accept as an exit value.

[Agggm]

Last week, we made the difficult decision to pull all of our money out of Wealthfront and transfer it to Vanguard (after being Wealthfront customers since 2013). Part of it was nasrullah's post about the stock-level lock-in. Part of it was the sudden introduction of Risk Parity (and an 8 bps increase in fees). But most of it was math.

In short: I believe, under guidance/pressure from its VC investors, Wealthfront is pivoting from a low-fee automated roboadvisor with a distinctively Boglehead-friendly passive investment strategy to a higher-fee active management approach. After all, what is their new Risk Parity or Smart Beta thingy but "active management"? They used Direct Indexing and the opaqueness of your holdings (for example, not informing you of the cost basis) to create stickiness, so as to make it difficult for people to leave. Now, my hat is off to them, because if I were a VC interested in maximizing my returns, I'd do the exact same thing. They offer a slight cost advantage with a heckuva lot more stickiness. But it is no longer a product for adherents for the low-cost Boglehead approach.

For the model below, I used BlackRock as a proxy for Wealthfront's EBITDA margins (rounded up to 50% because I imagine Wealthfront has less legacy overhead), and for its EV/EBITDA multiple (rounded up to 20x for the tech premium and expected growth trajectory). I found the $204.5M in total VC money from Crunchbase. I assume a VC would expect a 30x return on investment.

Right now, Wealthfront (with its $10B AUM) is generating a 1.2x return on investment (the light blue highlight).

Now, in order to generate a 30x return on investment, Wealthfront has two levers: (1) it has increase its fees from 25 bps, or (2) it can increase its AUM from $10B. The bottom table is a "sensitivity table" showing what it would take at different levels of AUM to justify its VC investment. Where I played with variables is highlighted in yellow.

At one end of the spectrum (right now -- at $10B AUM), Wealthfront would have to increase its expenses to 613.5 bps to create a 30x payback. Before you flip out, a 6% expense ratio is actually not that unheard of in the "2-and-20 world" of hedge funds once you factor in performance expenses. At the other end of the spectrum, Wealthfront can keep its fees at 25 bps if it manages to increase its AUM to $245B.

So the question is, do you believe that Wealthfront can increase its AUM to $245B in the next few years, before the VCs lose patience? (Keep in mind they operate on a 5-7 year investment cycle.) If you don't, then Wealthfront's fees have no place to go but up, and they have created a brilliant product designed to lock customers in.

Here is the math:


Where I could be wrong:

• If the VCs expect less than a 30x return

• If the VCs operate on an IRR basis and not a cash-on-cash basis

• If Wealthfront can command a higher premium on the EBITDA multiplier

• If Wealthfront can generate a higher EBITDA margin due to automation, etc.

• If further VC investment is required

I never invested in any robos. Wouldn't recommend them to anyone. Stick with vanguard.

[jacoavlu]

Did you choose to leave Wealthfront because you feel what you're getting now for your fees is not worth the cost, or because of what you think might happen in the future?

Isn't the Risk Parity product (and it's associated increase in fees) an optional product, like the Direct Indexing product?

[retiredjg]

I'm interested in what you have to say, but was unable to figure out what a VC is. So none of it made any sense to me.

[Badger1754]

Did you choose to leave Wealthfront because you feel what you're getting now for your fees is not worth the cost, or because of what you think might happen in the future?

Both, but more on the latter. The structural lock-ins are designed to make it difficult to leave, and I wanted to have optionality if something dreadful happened.

Isn't the Risk Parity product (and it's associated increase in fees) an optional product, like the Direct Indexing product?

It is, but I both disliked the "nudge", requiring an active opt-out for the product, and what it spells for the philosophical direction of Wealthfront. I was attracted by its index approach and Burton Malkiel. But if it is pivoting toward active management, it's no longer in alignment with my priorities.

[Barry Barnitz]

Help for Taylor:

Here is an expansion of acronyms:

VC: Venture Capital
EV: Enterprise Value (see Investopedia)
EBITDA: Earnings before interest, taxes, depreciation, and amortization
IRR: Internal Rate of Return
AUM: Assets Under Management

[MJW]

I haven't heard as much about Wealthfront or Betterment as of late compared to maybe a couple of years ago. Haven't seen nearly as many forum posts about either company in recent months. Seems like maybe the novelty is wearing off?

[randomguy]

It is all about growth rate assumptions. They went from under 3 billion at the end of 2016 to 9 billion at the end of 2017. Continue that out for another 5 years and you are talking a couple trillion of AUM and they will be making 100x on their investment. Throw in things like the cost of running the business will not scale with growth (i.e. you need roughly the same code for 1000 people as 100k), the profitability will also increase. Can they get trillions of assets? Sure. Edward jones, Morgan Stanley, JP Morgan among others have all reached that level. Can Wealthfront, betterment,... get there? Who knows.

The other thing is that you are assuming the return is fixed. It isn't. The VC would love to make 30x+ on the investment. I doubt anyone at the company thinks they can raise rates to 1%+ and survive. If it turns out that wealthfront is like a single (5x) and not a grandslam (100x), the VC take their money and move on.

Is this path of offering advanced indexing/risk parity, a good one or a bad one? I haven't researched their exact methods but it is far from crazy to tilt towards some factors or look into risk parity strategies (see the long threads on things like qspix). It might very well not be a path you want to go down though. It is like investing in a AOI fund from a company like vanguard. You are at their mercy to add funds (i.e. international bonds) or changing the AA. That is sort of part of the reason you pay for them. For people with strong opinions about these matters, you are unlikely to be happy long term.

[Ethelred]

I think this is interesting, and well done, as well as being a discussion worth having, but a few possible objections for you:
- I'm guessing part of the reason venture capitalists expect that large a multiple, is that start-ups like this are high risk, and perhaps with a skewed distribution of returns - many companies will return nothing, some will do a bit better than break even, and a few will make up the majority of the return. Maybe Wealthfront will only be in their middle category?
- AUM fees don't represent the only way a company might profit from customers, especially for a buyer of Wealthfront, rather than Wealthfront themselves
- Maybe BlackRock is an unreasonable proxy for its financial metrics? This is probably as big an unknown as future AUM.
- Consider that many of their clients are young, with low asset levels, and that savings rates generally accelerate with age. Maybe they can approach $250bn? That said, that acceleration would mostly take longer than the 5 to 7 years you propose.

In fact, this article I just stumbled on sugggests that they are expanding their financial offerings, to increase profits, and makes some other observations.
http://www.businessinsider.com/wealthfr ... ite-2018-1

[jacoavlu]

The structural lock-ins are designed to make it difficult to leave, and I wanted to have optionality if something dreadful happened.

What do you mean by "something dreadful?"

[Badger1754]

The structural lock-ins are designed to make it difficult to leave, and I wanted to have optionality if something dreadful happened.

What do you mean by "something dreadful?"

Complete conjecture here, but an apocalyptic scenario is if they decide to go the Comcast "Triple Play" route, eg. you can get phone, Internet, and television for $60 a month, or just internet for $50 a month, to either drive you into higher-fee products or end up paying an overpriced amount for their basic product. If you are locked into their Direct Indexing product, your ability to unwind that is difficult esp if you have large capital gains, and they could raise prices with impunity (or decline to lower them as the rest of the industry drives downward).

Now that being said, I don't believe they will. But I know a Vanguard is committed to using excess earnings capacity to reduce fees, whereas a Wealthfront is required to maximize its value for its VC investors.

[Badger1754]

These are some very thoughtful objections. Let me try to add my two basis points in.

- I'm guessing part of the reason venture capitalists expect that large a multiple, is that start-ups like this are high risk, and perhaps with a skewed distribution of returns - many companies will return nothing, some will do a bit better than break even, and a few will make up the majority of the return. Maybe Wealthfront will only be in their middle category?

From when I worked in early-stage VC a long time ago, a typical breakdown would be 5 out 10 companies go to 0. 2 out of 10 will recover their initial investment (but years later, so the time value is lost). Another 2 out of 10 will make 3x-5x their investment, and the remaining home run will make 30x-50x their investment. However, when evaluating a company for investment, no VC ever thinks "gee, let's put money into this 1x or this 3x"; they evaluate all their investment opportunities with the expectation that it will be a grand slam, but accept that most of them will not. So in this world, the VCs are clearly expecting WF to be worth much more than its raw earnings capacity is now.

- AUM fees don't represent the only way a company might profit from customers, especially for a buyer of Wealthfront, rather than Wealthfront themselves

What else could it be? As a lender and other balance sheet activity?

- Maybe BlackRock is an unreasonable proxy for its financial metrics? This is probably as big an unknown as future AUM.

That's fair. I picked BlackRock because 1) it has a sizable index business, and 2) the other giant fund managers (Merrill, Fidelity, Morgan Stanley) etc are either subsidiaries without separate financials or privately held.

In fact, this article I just stumbled on suggests that they are expanding their financial offerings, to increase profits, and makes some other observations.
http://www.businessinsider.com/wealthfr ... ite-2018-1

That's very interesting, and I wonder what other products they would offer. I don't think their automated financial planning tool (savings rate, etc.) is worth paying any money for. Their are lending money at interest right now, but that is contingent on (1) their own balance sheet and liquidity, and (2) regulatory arbitrage in the land of shadow banking. Maybe they will go the Personal Capital route next and offer a live advisor.

[Raabe34]

I know it is conjecture but I have a hard time believing that they are even profitable at the current level. All the software and high end personnel I think can eat up 25 mil pretty quick.

I've guessed for years who will buy them and the guesses are changing as I think they're value is currently eroding.

[Badger1754]

It is all about growth rate assumptions. They went from under 3 billion at the end of 2016 to 9 billion at the end of 2017. Continue that out for another 5 years and you are talking a couple trillion of AUM and they will be making 100x on their investment. Throw in things like the cost of running the business will not scale with growth (i.e. you need roughly the same code for 1000 people as 100k), the profitability will also increase. Can they get trillions of assets? Sure. Edward jones, Morgan Stanley, JP Morgan among others have all reached that level. Can Wealthfront, betterment,... get there? Who knows.

The other thing is that you are assuming the return is fixed. It isn't. The VC would love to make 30x+ on the investment. I doubt anyone at the company thinks they can raise rates to 1%+ and survive. If it turns out that wealthfront is like a single (5x) and not a grandslam (100x), the VC take their money and move on.

Is this path of offering advanced indexing/risk parity, a good one or a bad one? I haven't researched their exact methods but it is far from crazy to tilt towards some factors or look into risk parity strategies (see the long threads on things like qspix). It might very well not be a path you want to go down though. It is like investing in a AOI fund from a company like vanguard. You are at their mercy to add funds (i.e. international bonds) or changing the AA. That is sort of part of the reason you pay for them. For people with strong opinions about these matters, you are unlikely to be happy long term.

At the end of the day, I'm not saying Wealthfront will fail. In fact, I think the VCs and management have put forward a brilliant business model with the decks stacked in favor of it succeeding. What I am saying is that ordinary passive investors, especially those of the penny-pinching Boglehead persuasion, should no longer see this product as aligned with their interests.

[retiredjg]

....Boglehead persuasion, should no longer see this product as aligned with their interests.

From a potential customer's point of view, I would agree (after spending some time on their website after reading your first post today).

I also spent time at Betterment. In the past, they were kind of apples and apples in my mind. In fact, I could hardly remember which was Betterment and which was Wealthfront.

My evaluation today was that Wealthfront seems to be becoming mighty slick while Betterment seems to be sticking closer to simple low cost investing principles.

[car733]

This might be a bit offtopic:

I join bogleheads to understand if I should move my investments out of Wealthfront and Betterment. I still do not understand why people say Vanguard is cheaper. Doesn't vanguard charge a % as well?

[Badger1754]

Above all, I'm disappointed in Burton Malkiel. That guy was my hero from when I first read his book as a teenager. I studied his papers and research in college and grad school. My decision to invest with Wealthfront was partially influenced by Malkiel's involvement.

The conclusions of his research (see here) was that actively managed funds routinely underperformed passive index funds on a total shareholder return basis once adjusted for (1) management fees, (2) taxes, (3) transaction costs, and (4) survivorship bias.

He now seems to suggest that if #1-3 were lowered enough, you can achieve persistent long-term outperformance (that is, professional managers, if they were free and it cost nothing to trade, could outperform the indices). While that sounds fishy to me, I am of an open mind that Wealthfront's strategies over the long-term can in theory make sense.

However, I no longer believe in Wealthfront's commitment to keep fees low and continue to drive them lower; they structurally can't and still carry out their fiduciary duties. Therefore, Malkiel's premise in the case of Wealthfront no longer holds.

[Badger1754]

This might be a bit offtopic:

I join bogleheads to understand if I should move my investments out of Wealthfront and Betterment. I still do not understand why people say Vanguard is cheaper. Doesn't vanguard charge a % as well?

Wealthfront charges 25 bps + whatever the underlying fund charges (anywhere from 4-19 bps in my portfolio).

Vanguard just charges the underlying fund fees (4-11 bps for the ones I look at).

The point of this thread was to point out that Wealthfront has "upward pressure" on their fees. As a mutually owned company that doesn't have external shareholders, Vanguard has consistently exerted "downward pressure" on their fees.

[nisiprius]

This might be a bit offtopic:

I join bogleheads to understand if I should move my investments out of Wealthfront and Betterment. I still do not understand why people say Vanguard is cheaper. Doesn't vanguard charge a % as well?

Whenever you own a mutual fund or ETF, there are fund expenses built into the fund itself, the expense ratio. When you hold that mutual fund or ETF directly, yourself, at a brokerage, there are often no additional fees at all just to hold the fund. If you hold Vanguard ETFs at Vanguard, there are zero fees to buy, hold, or sell them. (There may be "account fees" if your account is too small and you insist on mailed statements, stuff like that).

When you hold mutual funds or ETFs "at an advisor," the advisor usually? always? adds an additional fee on top of that, often based on the size of your account. It's often on the order of 1%/year; that is, the advisor shaves off 1% of your total portfolio value every year. The roboadvisors charge less; Wealthfront, I think, charges only 0.25%, but that's still added on to the funds' expense ratios.

Although things are changing so this might be up to date, a few years ago a typical portfolio at Wealthfront was a fairly Bogleheadish-with-tilts portfolio of six to eight ETFs--mostly Vanguard ETFs, in fact. For example: Vanguard VTI, VIG, VEA, VTWO, and VNQ, iShares LQD and EMB. At Wealthfront you would pay the expense ratios of these funds plus 0.25%. At most brokerages, you would pay only the expense ratios of these funds.

[Toons]

I agree.
Keep It Simple.
Vanguard.
Cut out the" minutiae"

[retiredjg]

I still do not understand why people say Vanguard is cheaper. Doesn't vanguard charge a % as well?

Vanguard does charge a fee (in addition to the fund fees) if you have them manage your money. If you simply buy your funds/ETFs at Vanguard and manage them yourself, there are no fees other than the fund fees. The robos don't allow that.

[Badger1754]

An article was just posted digging into the innards of Risk Parity.

The takeaway is that it could add 25-125 bps of hidden costs (not covered by the increased 8 bps of management fees) as part of their total return swap structures.

Micah Hauptman, financial services counsel at Consumer Federation of America, a consumer research, education and advocacy organization, said Wealthfront's stated cost to investors doesn't include the cost of a total return swap. By taking assumptions from Wealthfront's white paper, costs could be as high as 1.25%, which Mr. Hauptman said could increase as interest rates rise.

Meb Faber, chief investment officer of Cambria Investment Management, said in a note on Twitter that the fund is "probably a fine product" with fees that are in line with separate accounts and cheaper than most mutual funds.

However, the Wealthfront fund uses total return swaps that are not included in the fee, and could add about .25% in extra costs, he estimated.

[randomguy]

At the end of the day, I'm not saying Wealthfront will fail. In fact, I think the VCs and management have put forward a brilliant business model with the decks stacked in favor of it succeeding. What I am saying is that ordinary passive investors, especially those of the penny-pinching Boglehead persuasion, should no longer see this product as aligned with their interests.

Penny pinchers never should have seen this product as aligned with their interests:)

The thing with a company like wealthfront,betterment, vanguard AIO funds, or any of the others is that
a) you have to believe in the advisors and their plan both now and the future and accept that it can change. If you get upset that wealthfront has added a tilt to value,size and whatever other factors, you aren't going to enjoy leaving your money there. See the people that get upset when vanguard messes around with international allocations in their AIO funds.

AOI/Roboadvisors are great for the people that want to learn almost nothing about investing and have a somewhat decent plan. Compare any of those portfolios to what 90% of the people hold in 401(k)s, and AIO/roboadvisors look brilliant. For people willing to read bogleheads and spend a couple hours/month on their portfolio, the value add drops significantly.

[BeginnerInNYC]

I recently put a few bucks into M1 finance. They've been mentioned previously on this board for lowering their management fees to 0%, and seem to geared towards buy-and-hold investors who use a fixed asset allocation. The automatic investment of newly deposited cash into funds that are under your specified percentage is a nice feature, and should make maintaining your AA during accumulation phase pretty automatic.

But these same pressures may end up applying to them as well. I'll wait and see. I still have the vast majority of my holdings at Vanguard.

[Gig em]

Just joined trying to figure out what to do with taxable investing, once retirement is maxed.

What about Wealthfront tax loss harvesting? I am in the 25% bracket and no state income tax.

[JoMoney]

Just joined trying to figure out what to do with taxable investing, once retirement is maxed.

What about Wealthfront tax loss harvesting? I am in the 25% bracket and no state income tax.

You may get a better response if you post your question in its own thread.
Note that as of 2018, thanks to the Tax Cuts and Jobs Act of 2017, there is no 25% bracket.
https://taxfoundation.org/2018-tax-brackets/

For capital gains to be at 0%, you need to be in the 10% or 12% bracket.

[unclescrooge]

I recently put a few bucks into M1 finance. They've been mentioned previously on this board for lowering their management fees to 0%, and seem to geared towards buy-and-hold investors who use a fixed asset allocation. The automatic investment of newly deposited cash into funds that are under your specified percentage is a nice feature, and should make maintaining your AA during accumulation phase pretty automatic.

But these same pressures may end up applying to them as well. I'll wait and see. I still have the vast majority of my holdings at Vanguard.

Hope do you stay in business if you're charging 0%?

[Daitokuji]

I recently transferred all the assets in my Roth IRA from Wealthfront to Vanguard. I didn't feel like I was getting any value for 25bps/year and wanted more control over my investments. I also wasn't sure about the mix of investments they picked nor the reasoning for it. They put you heavily into emerging markets and international. The robo funds seem good for people who have no interest whatsoever in learning anything about investing and want a "set it and forget it" solution. But with even a minuscule amount of effort, you can easily make up for the fees they charge.

[schrute]

Last week, we made the difficult decision to pull all of our money out of Wealthfront and transfer it to Vanguard (after being Wealthfront customers since 2013). Part of it was nasrullah's post about the stock-level lock-in. Part of it was the sudden introduction of Risk Parity (and an 8 bps increase in fees). But most of it was math.

In short: I believe, under guidance/pressure from its VC investors, Wealthfront is pivoting from a low-fee automated roboadvisor with a distinctively Boglehead-friendly passive investment strategy to a higher-fee active management approach. After all, what is their new Risk Parity or Smart Beta thingy but "active management"? They used Direct Indexing and the opaqueness of your holdings (for example, not informing you of the cost basis) to create stickiness, so as to make it difficult for people to leave. Now, my hat is off to them, because if I were a VC interested in maximizing my returns, I'd do the exact same thing. They offer a slight cost advantage with a heckuva lot more stickiness. But it is no longer a product for adherents for the low-cost Boglehead approach.

For the model below, I used BlackRock as a proxy for Wealthfront's EBITDA margins (rounded up to 50% because I imagine Wealthfront has less legacy overhead), and for its EV/EBITDA multiple (rounded up to 20x for the tech premium and expected growth trajectory). I found the $204.5M in total VC money from Crunchbase. I assume a VC would expect a 30x return on investment.

Right now, Wealthfront (with its $10B AUM) is generating a 1.2x return on investment (the light blue highlight).

Now, in order to generate a 30x return on investment, Wealthfront has two levers: (1) it can increase its fees from 25 bps, or (2) it can increase its AUM from $10B. I believe its recent moves, such as Risk Parity and its announcement that it will no longer manage the first $10K for free, is a symptom of this fee pressure.The bottom table is a "sensitivity table" showing what it would take at different levels of AUM to justify its VC investment. Where I played with variables is highlighted in yellow.

At one end of the spectrum (right now -- at $10B AUM), Wealthfront would have to increase its expenses to 613.5 bps to create a 30x payback. Before you flip out, a 6% expense ratio is actually not that unheard of in the 2-and-20 world of hedge funds once you factor in performance expenses. At the other end of the spectrum, Wealthfront can keep its fees at 25 bps if it manages to increase its AUM to $245B.

So the question is, do you believe that Wealthfront can increase its AUM to $245B in the next few years, before the VCs lose patience? (Keep in mind they operate on a 5-7 year investment cycle.) If you don't, then Wealthfront's fees have no place to go but up, and they have created a brilliant product designed to lock customers in.

Here is the math:


Where I could be wrong:

• If the VCs expect less than a 30x return

• If the VCs operate on an IRR basis and not a cash-on-cash basis

• If Wealthfront can command a higher premium on the EBITDA multiplier

• If Wealthfront can generate a higher EBITDA margin due to automation, etc.

• If further VC investment is required

• If Wealthfront is generating 25 bps on a significantly lower portion of its $10B AUM, as certain assets are managed for free

• If Wealthfront can generate scalable revenue on something other than bps of AUM

Edited per Taylor Larimore's suggestion to explain some of the abbreviations

• VC = Venture capital. Firm that puts in money into early-stage companies, with the expectation of earning an outsize return on a few home runs -- but also accepting the risk that most of their portfolio will go to zero.

• EBITDA = Earnings before interest, taxes, depreciation, and amortization. A decent measure for profitability.

• EV = Enterprise value. The formal definition is equity + debt - net cash. It's the "all-in takeover price" to buy a company.

• EV/EBITDA. A multiplier that you can use to approximate the takeover value of a company. For example, if a company's EBITDA is $100M, and the EV/EBITDA is 10x, then the takeover price would be 10*100 = $1B.

• AUM = Assets under management. This drives Wealthfront's fees.

• bps = Basis points. 1/100 of 1%.

• 2-and-20. A typical hedge fund fee structure. They charge 2% of all assets under management, and then 20% of all gains over a given threshold. The threshold is typically something much lower than the S&P, and the 2% is in place whether ot not the hedge fund makes or loses money.

I love this analysis, are you a VC or work in the VC industry?

[Badger1754]

I love this analysis, are you a VC or work in the VC industry?

Nah. I used to be a banker, but the principles are the same.

[CyclingDuo]

I recently put a few bucks into M1 finance. They've been mentioned previously on this board for lowering their management fees to 0%, and seem to geared towards buy-and-hold investors who use a fixed asset allocation. The automatic investment of newly deposited cash into funds that are under your specified percentage is a nice feature, and should make maintaining your AA during accumulation phase pretty automatic.

But these same pressures may end up applying to them as well. I'll wait and see. I still have the vast majority of my holdings at Vanguard.

Hope do you stay in business if you're charging 0%?

They are doing quite well!

https://www.wealthmanagement.com/techno ... nance-free

[nisiprius]

...At the end of the day, I'm not saying Wealthfront will fail...

Wealthfront has succeeded in staying in business under the same name, but in my view Wealthfront has failed about four times to find a long-term sustainable strategy. Wealthfront has changed so many times during its brief existence that I can't imagine it lasting long enough in its present form for any current customers to reach retirement.

I wonder how many people who had accounts at kaChing! in 2009 still have accounts at Wealthfront today.

First it was kaChing! which was going to let individual investors ride along, replicating the investments of "experts," because "Individuals are desperate for advice and transparency from people who help them manage their money, and mutual funds do not provide enough." Source

Then "We learned that individual investors don't know how to find and don't want to find their own money managers,” and it changed its name to Wealthfront and announced it would "shift away from encouraging investors to search on their own for money managers. Instead, the company will recommend financial advisers who match specific investment profiles." Source

They they positioned it (somehow) as a company built by techies for techies. That didn't last long enough for me to figure out what they actually meant by that.

Then they hired Burton Malkiel and for a while it was a roboadvisor that would administer fairly simple portfolios of six to eight low-cost ETFs, with slight differences depending on whether the account was tax-advantaged and taxable, a balance depending on age and risk-tolerance questionnaires, and reflecting some of Malkiel's recommendations and tastes. At this point, it was fairly Bogleheadish in strategy.

Then they got into "direct indexing" and a strong emphasis on automatic tax-loss harvesting and the supposed benefits thereof.

Then, as noted in an article in Wired,

The robo industry... [is]... beginning to move away from the passive-investing ideals that excited so many of its early adopters.... At Wealthfront... a recent $75 million investment round led by Tiger Global Management... seems to have precipitated a ... drastic change.

Instead of putting investors solely into a low-cost indexing strategy, Wealthfront has now decided to invest 20% of its investors’ funds into an internal “risk parity” fund... The fees associated with the old strategy averaged out at 0.09%; the new strategy, by contrast, carries a fixed fee of 0.50%, all of which goes directly to Wealthfront.... I’ve looked hard, and I can find no one outside Wealthfront who thinks this is a good idea.... Wealthfront is moving from passive to active and from cheap to expensive, but only when Wealthfront itself owns the fund in question.

So, in just nine years, it has adopted five different strategies: Pick a manager to clone; let us pick a manager-clone for you; passive investing into a small portfolio of low-ER ETFs guided by Burton Malkiel; "direct indexing" and tax-loss harvesting; and "our very own risk parity fund."

Bait and switch and switch and switch.

[retiredjg]

I had no idea....

[bagle]

I assume a VC would expect a 30x return on investment.

Right now, Wealthfront (with its $10B AUM) is generating a 1.2x return on investment (the light blue highlight).

Sure, the VC hoped ex ante that Wealthfront would be the homerun with the 30x payout. But the investment is a sunk cost.

I don't see how either (i) AuM could expand by 24.5x (from $10B now to your $245B calculation) in the short remaining VC timeframe or (ii) their cost-sensitive clientele would stay if Wealthfront charged 2+20 hedge fund fees despite a track record of merely matching the market. So, seems to me ex post the VC at best will have to accept the 20% chance of a 3-5x return.

BTW, nice analysis. Could you share the spreadsheet?

[columbia]

I dabbled a bit with Betterment and even trying to import to various lot data (and churn from TLH) into H&R Block was a significant hassle; no thanks.

[gd]

Without having a clue what I'm talking about, vaguely perplexed that someone who can analyze a company like that would be using a roboadvisor in the first place.

[Badger1754]

I don't see how either (i) AuM could expand by 24.5x (from $10B now to your $245B calculation) in the short remaining VC timeframe or (ii) their cost-sensitive clientele would stay if Wealthfront charged 2+20 hedge fund fees despite a track record of merely matching the market. So, seems to me ex post the VC at best will have to accept the 20% chance of a 3-5x return.

BTW, nice analysis. Could you share the spreadsheet?

Sorry! Deleted the spreadsheet ages ago. But agree that the VC is not going to get the expected return. Which makes me wonder why Tiger went and place more money in them -- unless it's meant as a strategic investment, e.g. as part of a buildout of a distribution platform.

[Badger1754]

Without having a clue what I'm talking about, vaguely perplexed that someone who can analyze a company like that would be using a roboadvisor in the first place.

It's because of:
1) Lack of time
2) Excess of laziness

[av111]

I put a little money in wealthfront in the middle of last year to test the waters

My specific tlh portfolio is rated at 7.5 risk. Seems I lost 9% in the q4 with equivalent in tax losses harvested which should reduce my tax liability in this year or beyond.

I did not generate any tax losses in the other taxable account but still have similar loss in value . I made no effort in either account.

So, to me, it appears that wealthfront fee at 0.25% was not a problem. I am waiting for the tax forms but barring something weird in the tax forms , I am thinking of moving all my taxable account there during the year

Is this position naive?

[livesoft]

Is this position naive?

It might be. If you have the same ticker symbols in another taxable account, then you may have created cross-account wash sales that you don't know about.

[drk]

Yup, there was a recent SEC enforcement action against Wealthfront because, even if you gave them access to your other accounts in order to avoid wash sales, they never bothered to program their software to pay attention.

[Whakamole]

So, to me, it appears that wealthfront fee at 0.25% was not a problem. I am waiting for the tax forms but barring something weird in the tax forms , I am thinking of moving all my taxable account there during the year

Is this position naive?

Yes. They've changed their business plans enough times that there's no telling what it will be next year. That could be increased fees, a different investment plan (more in the hot strategy that makes them the most money), whatever.

If you ever think about leaving, you may find that your portfolio looks like this or this or this or this or end up with 490 individual stock positions like this poster, and either you'll have to deal with managing all these individual positions for a long time (assuming a rising stock market, there may not ever be an opportunity to TLH out) meaning increased complexity - tell me, can you tell me if any of the equity portions of those portfolios are total market cap weight? - or you stay with Wealthfront. What's that they say about the Hotel California?

Doing TLH yourself very easy.

[car733]

Yup, there was a recent SEC enforcement action against Wealthfront because, even if you gave them access to your other accounts in order to avoid wash sales, they never bothered to program their software to pay attention.

It's not that easy. Even if WF wanted to, there is no API from Vaguard to get your trades information.

[wootwoot]

I put a little money in wealthfront in the middle of last year to test the waters

My specific tlh portfolio is rated at 7.5 risk. Seems I lost 9% in the q4 with equivalent in tax losses harvested which should reduce my tax liability in this year or beyond.

I did not generate any tax losses in the other taxable account but still have similar loss in value . I made no effort in either account.

So, to me, it appears that wealthfront fee at 0.25% was not a problem. I am waiting for the tax forms but barring something weird in the tax forms , I am thinking of moving all my taxable account there during the year

Is this position naive?

Not at all. Wealthfront does a good job with automating TLH and should find enough opportunities to more than pay for the .25% fee. I use the free tier of Wealthfront myself and appreciate having a portfolio that automatically rebalances and takes advantage of TLH opportunities as it finds them.

[drk]

Yup, there was a recent SEC enforcement action against Wealthfront because, even if you gave them access to your other accounts in order to avoid wash sales, they never bothered to program their software to pay attention.

It's not that easy. Even if WF wanted to, there is no API from Vaguard to get your trades information.

It is very easy not to claim that the software will watch customers’ other accounts to avoid triggering wash sales when the software was never programmed to do so. That was the SEC’s concern (in addition to undisclosed marketing relationships with lifestyle bloggers).

[av111]

So, to me, it appears that wealthfront fee at 0.25% was not a problem. I am waiting for the tax forms but barring something weird in the tax forms , I am thinking of moving all my taxable account there during the year

Is this position naive?

Yes. They've changed their business plans enough times that there's no telling what it will be next year. That could be increased fees, a different investment plan (more in the hot strategy that makes them the most money), whatever.

If you ever think about leaving, you may find that your portfolio looks like this or this or this or this or end up with 490 individual stock positions like this poster, and either you'll have to deal with managing all these individual positions for a long time (assuming a rising stock market, there may not ever be an opportunity to TLH out) meaning increased complexity - tell me, can you tell me if any of the equity portions of those portfolios are total market cap weight? - or you stay with Wealthfront. What's that they say about the Hotel California?

Doing TLH yourself very easy.

Thanks but are the fears logical? I would think that they will always need to be competitive with the market to attract new money. If you decide to exit, liquidate

[av111]

Is this position naive?

It might be. If you have the same ticker symbols in another taxable account, then you may have created cross-account wash sales that you don't know about.

How is it proven that wash sale was triggered? Who does this analysis