Welcome to Scaled and Failed! My name’s Amil Naik and I’m an aspiring VC and founder at The University of Texas at Austin. I write about startups that scaled and startups that failed to draw insights about the patterns of startup failure and how to avoid them. Everything is clearer in hindsight, so it’s worth looking back.
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TLDR
Today’s Topic: Robo-Advisors
Scaled: Betterment; Pursued automated passive strategy, partnered with financial advisors, and expanded its offerings to a human-robo hybrid model to better serve clients.
Failed: Hedgeable; Invested in unorthodox offerings for a robo-advisor in a bid to attract higher net-worth Millennial clients but ultimately failed to achieve the scale necessary to stay competitive.
Lessons Learned: Enemies can be friends until you’re ready to take them on, so do what’s best for a startup on a shorter horizon and look to follow a longer-term vision when it’s viable. However great a product may look, the fundamental economics to scaling it and the costs of gaining customers are more important.
Today’s Topic: Robo-Advisors
Investing can be a tedious, difficult undertaking to succeed in regardless of what instruments you’re putting your money into. Investment advisors have existed almost as long as banks and accessible investment precisely for that reason and typically take a percentage of the value of assets as a management fee. There has been a single fact that my university finance degree program has drilled into me repeatedly; the majority of these advisors will not beat the market and you’re better off putting your money into a market-tracking index fund. Of course, it’s still difficult to manage your investments effectively to reduce risk and take advantage of complex strategies like tax-loss harvesting. These reasons going beyond simple returns have been the primary reason to stick with letting people manage your investments, but technology is providing a solution that is cheaper and more efficient: robo-advisors.
Betterment is among the first and now one of the many fintech startups automating investing and has expanded its offerings deeper into the financial space. Following giants Vanguard and Schwab, its stand-alone robo-advisory service is the largest by managed assets. Hedgeable, a similar robo-advisory platform targeted towards millennials, was founded in 2009 and launched in 2010. Its key differentiator from competitors was its emphasis on active management and investment in less traditional assets. This wasn’t enough for them; the startup shuttered its platform in 2018. The robo-advisory space is stiff with competition, and so far no startup has come close to touching institutional giants like Vanguard. Only time will tell if any startup will truly win in the robo-advisory space, but so far companies like Wealthfront and Betterment seem to be doing well enough.
Scale: Betterment
Officially founded in 2008, Betterment spent two years building its platform and navigating the regulatory landscape with some angel funding prior to launching. The investment philosophy behind the company was simple, as explained by founder and former CEO Jon Stein:
Our passive, goal-based, and automatic investing philosophy was clear; it’s the way I’d learned to invest from college, my financial services career, my classes in business school, and my Chartered Financial Analyst (CFA) certification.
Seems like everyone learns the same lessons in business school; automatic, passive investment would be the core of Betterment (hopefully Warren Buffett is proud). Early in 2010, Betterment debuted at the first TechCrunch Disrupt event in New York and made it to the finals. Though Betterment didn’t win the competition, it clinched the title of “Best New York Disruptor” and the startup got its first customers as its doors opened for business. By the end of 2010, it had raised its $3M Series A from BVP and secured its future.
I found an interesting blog post from 2012 that viewed robo-advisors as no real threat to human financial advisors. By this point, many competitors had entered the fray to capitalize on the robo-hype. The post makes a few valid points: financial planners offer more life advice beyond investment and asset allocation advice, the real competition would be existing passive investment product providers like Vanguard and Charles Schwab, and that gathering clients and their capital would be more difficult than many anticipated. It also argues that the greatest potential of this type of technology would be to augment human financial advisors. There are some irreplaceable benefits for sure; in times of market volatility, a robo-advisor can’t reassure you and help you rationalize the best financial decision when emotions are running high. That’s why Betterment employs financial advisors for clients meeting an asset threshold and willing to pay a slightly higher fee (though still much lower than the traditional 1%), giving them the best of both worlds. I doubt anyone could have predicted how far technology would advance either. Personalized financial advice for other decisions like retirement planning or college is now a staple on many robo-advisor platforms, delivered far more effectively than an “informational website” as the blog suggests as the maximum potential. And while growth may not have lived up to early estimates, $460B AUM for the robo-advising industry with projections of $1.2TB in 2024 are not numbers to dismiss easily as a short-term trend. Criticisms of robo-advisors from those early days suffer from one serious flaw: they underestimate adoption by digital native generations as they accumulate more wealth. Gen Z and Millennials (including myself) have no problem entrusting their assets to robo-advisors and DIYing parts of our financial planning; learning and using technology doesn’t present a huge barrier. As these generations gain wealth, robo-advisor growth will continue to make strides. That said, waiting around for us probably isn’t a good business strategy.
Back to the journey! Betterment raised a $10M Series B led by Menlo Ventures in 2012 and continued to scale the company and improve its offering. Growth for startup robo-advisors was catching eyes in 2014, though 36.5% growth from $11.5B to $15.7B in a few months seems quite small compared to today. 2014 also saw the milestone of 50,000 customers, over $1B in AUM, and the launch of Betterment Institutional, the company’s platform for financial advisors to access its services for their own clients. It seems the vision of a human augment robo-advisor was coming to fruition, though many were still skeptical of the near-term potential. Capital would continue to flow in over the years, with current funding topping $275M. While its offering presented the most appeal to younger generations, Betterment wanted to rope in an older population of customers as it grew by 2016. After all, the company couldn’t sit around and wait years for young people to accumulate more wealth, and older clients on average had more money to manage. To that end, it focused its new content and product offerings around retirement planning and cooperation with financial advisors. Betterment Institutional became Betterment for Advisors with additional portfolio strategies offered through Goldman Sachs Asset Management and Vanguard on the Betterment platform, increasing appeal for financial advisors and wealthier clients indirectly. The shift in targeting and expanded product offerings paid off; Betterment became the first independent robo-advisor to pass $5B in AUM that year. Plenty of employers were offering 401(k)s and other retirement accounts through Betterment too, with Uber signing on with Betterment that year too.
2016 was a good year, and the startup wasn’t going to waste the momentum. In 2017, Betterment opened up personalized financial advice from a human to anyone with an account through a messaging platform in their app. No longer was the higher fee percentage a barrier (though it got you a lot more touchpoints and attention). As more startups and traditional players were entering the robo-advisory space with hybrid models involving their own financial advisors, Betterment needed to double down on the human element to compete. In a further push to increase the human element in its services, Betterment began allowing financial advisors to control asset allocation (along with many more portfolio strategies and partners) in client portfolios in 2018 to meet the demand for further flexibility. The same flexibility was opened to wealthier clients in a bid to accrue more assets from customers. As most fintechs seem to do, Betterment also launched banking functionality in 2019 in a bid to attract even more customers.
The end of 2020 saw a significant change for Betterment as founder and CEO Jon Stein decided to pass the torch to Sarah Levy, a former executive at Viacom CBS. Levy was brought on to take Betterment through the next stage of growth and compete for dominance with the plethora of copycat institutional robo-advisors; with $25B in AUM and half a million customers, Betterment had come a long away. However, the startup was still dwarfed by traditional financial institutions with their own robo-advisor and hybrid platforms. Levy’s tenure started off strong with record Q1 growth for Betterment and the new Co-Pilot product launch to help advisors engage with their clients. Only time will tell if Betterment will reach the levels of Vanguard and Schwab. It may not have lived up to the predictions of robo-advisors destroying traditional financial advising within the decade, it has certainly increased access to financial planning and passive investment to the masses and forced transparent, competitive offerings in the market. All in all, it has made things better for you and me.
Fail: Hedgeable
Not long after Betterment’s founding, New-York based Hedgeable was founded in 2009 and came on the scene in 2010 as well. While it maintained the promise of low-cost automated investing, the startup opted for more aggressive active investing strategies comparable to hedge funds, hence the name. The company raised some seed capital in 2013 and 2014 as it pursued its differentiated strategy to robo-advisory targeting millennials, though things were slow going in the beginning. Investors on the platform had access to rather exotic offerings for a rob.-advisor: venture capital, bitcoin, and custom portfolios to name a few. Fees were higher than Betterment and other passive robo-advisors given the active strategy, ranging from 0.30% to 0.75%.
Hedgeable was much “flashier” in its new product offerings than Betterment, fitting the image that one may expect from both a hedge fund and fintech startup aimed at younger people. In a bid to create a community experience around its platform, Hedgeable launched an “Alpha Club” rewards system in 2015 to let customers get access to opulent rewards like club nights or a weekend with a Lamborghini based on their investments. It also won Best in Show at the Finovate competition that year. Growth had picked up at this point, with 900% YoY growth by then. Things looked very bright in 2016, with hopes to add P2P loan investments, international launches, and chatbots in the near future. Unfortunately, with an increasingly competitive landscape, Hedgeable couldn’t sustain its growth and reach the scale needed to be a viable option. By the time of its closing in 2018, it only had around $80 AUM and 1,700 clients. For all of the product differentiation and its great image, Hedgeable couldn’t keep up with its more traditional competitors.
Lessons Learned
Do I think robo-advisors still have the capacity to displace a large proportion of financial advisors? Yes. Are they there yet? No, and they won’t be for a while. Robo-advisors have a lot of benefits, but detailed financial planning for major life decisions and customized advice for very high net-worth clients are not among them. Robo-advisory is a more generalized retail product for now, though it does have the potential to be so much more. Companies in the space can’t wait around for that time though, and being friends with your enemies until it’s time to take them out isn’t a bad strategy over the long term. For all the media sensationalism around robo-advisors replacing people, it wasn’t going to happen in the span hoped for. Betterment extended its hand out to these advisors in a show of cooperation and was well-compensated for it; Betterment for Advisors is a valuable offering that has performed very well as a component of financial advisor’s services. Support from that audience has helped spur it forward in the face of the crushing weight of institutional players like Vanguard and Schwab that dwarf it. Maybe one day Betterment can poach clients entirely from advisors in the long run, but startups die in the long run. Founders have to weigh long-term potential against the short-term reality and make the best decision for now even if it doesn’t line up with the plan down the road. You can’t follow your 20-year plan post IPO if you’re not around for the next year.
Hedgeable’s offering, attractive visually though it was, didn’t have the same growth potential. It was a pure retail product for those with the money to throw around; most financial advisors and lower-income investors wouldn’t invest much in cryptocurrency and venture capital. Though Hedgeable did roll out its own platform for advisors, it never achieved growth like Betterment’s. After all, the first rule of serious investment for the average person is to stick to passive strategies and be patient. Given Hedgeable’s target of higher net-worth millennials, the market was already very niche; the economics to scale it didn’t work out like Betterment’s passive strategy and partnership with financial advisors did. The combination of that small market size and potential as well as the strategy that flouted the foundations of basic finance (to be fair, some hedge funds do manage to beat the market) put Hedgeable in a difficult spot from the start. Even if a product looks good, some fundamental assumptions in regards to scaling potential and costs of acquisition have to line up for a startup: there need to be enough customers and it can’t cost too much or be too difficult to get them. Don’t put yourself in a position with few, expensive, and hard-to-engage customers. If you find yourself with a business idea that faces all three of those, it’s better to find a new one.
More Reads and Info
Thanks for reading! Let me know what your preferred robo-advisor is (or was prior to going under). If you found this interesting, consider sharing it with friends and subscribing if you haven’t already!
Cheers,
Amil