The battle to become the primary financial relationship for consumers continues to intensify, with the lines blurring between traditional banks, digital banks, robo-advisors and tech firms offering financial services.
With the COVID-19 crisis driving consumers to digital banking options, satisfying the desire for new ways to save, invest and conduct transactional banking became a necessity. Consumers are finding alternatives to bank or credit union that has dozens or hundreds of branches. From low-cost options designed to replace check cashing facilities, to more sophisticated options focused on investment accumulation, the marketplace has become very crowded.
One such solution that entered the market following the financial crisis was Wealthfront, an automated investment services firm that uses best-in-class and academically proven techniques to support a diversified portfolio of re-balanced low-cost index funds. With low minimums and low fees, Wealthfront has continued to add more capabilities to provide younger, upwardly mobile and digital consumers the type of investment support usually reserved for only the very wealthy.
Wealthfront has recently expanded their offerings to include traditional banking services like an FDIC-insured high-yield cash account and even an automated savings strategy, called Autopilot. The latter is a free service that automatically transfers excess funds from a consumer’s checking account to an investment account.
I was very fortunate to be granted an exclusive interview with Andy Rachleff, Co-Founder and Executive Chairman of Wealthfront as part of the Banking Transformed podcast. Along with Dan Carroll, Co-Founder and Chief Strategy Officer, Rachleff has built Wealthfront into one of the premier financial services organizations in the country, expanding from the foundation of a digital wealth management firm to providing high interest digital checking and savings accounts as an option.
The following is an excerpt from the discussion we recorded for the podcast on the growth and transformation of Wealthfront and the future prospects of building an expanded digital financial solutions organization.
Rachleff: It actually happened by accident. I was a career venture capitalist. I’d been in the business for almost 25 years. The last 10 years I was a co-founder and partner of a firm called Benchmark Capital. When I retired, I wanted to give back. So, I decided to teach at my grad school alma mater, Stanford Graduate School of Business, where I’ve been teaching for 15 years. I also became a trustee at my undergrad alma mater, at University of Pennsylvania.
One of my responsibilities as a Penn trustee was to sit on their endowment investment board. One of things that I observed on this board was that much of what they did was manual. And I thought, if you just automated what they do, you could democratize access to the most sophisticated investing in the world.
In other words, you could do something about 80% as good as the best in the world, but deliver it to the masses. Over time, the vision for Wealthfront was built out and grew, and through that, we transitioned into banking, and are now doing very well there.
You emphasize the outdated need for branches in today’s digital world. Can you explain?
Rachleff: Everything that most traditional banks do reinforces their strength … which are branches. We did an analysis that showed that the average branch costs the average customer about $200 per year. The question then becomes, “Do you get $200 worth of value from going to those branches?”
The audience that we target – young professionals or “Millennials who save” – don’t want to go to a branch. But a bank has to generate revenues to support that branch. They do it through hidden fees that are really quite frustrating.
Instead of having branches and charging fees, we’re built software that doesn’t require any branches and doesn’t require a consumer to talk to anyone. In this way, we can share the economics so we can make money with you, not from you. We can favor people, not institutions.
Can you describe your ‘product market fit’ philosophy?
Rachleff: I’m a big believer, from observing tech companies over 38 years now, that companies succeed and fail based on what I call product market fit. If the dogs want to eat the dog food, you can screw up everything in your company and you will succeed. Conversely, you might be great at management and execution, but if people don’t want to buy your product, you’re going to fail.
It’s all about how well the product fits the market. How badly the market wants your product. And so, as a result, we’re riveted on testing whether or not people love what we do. So, we got started with a diversified and re-balanced portfolio of low-cost index funds. By accident, we hit upon something called tax loss harvesting as an enhancement to that.
Our goal is to provide “self-driving money.” We want to make it possible for a consumer to direct-deposit their paycheck with us. We’ll automatically pay your bills, and then, route the remaining money to the most appropriate account, depending on your situations and goals.
If you have a lot of high interest debt, we’ll pay off your debt even before we invest it for you. So, that’s a feature that we call Autopilot that we just introduced, that automatically routes money around and does it intelligently, and very, very quickly.
Is Autopilot an AI solution?
Rachleff: There’s no AI required to do that. Many people overstate what artificial intelligence does. So, what we do is you direct deposit your paycheck with us. We automatically pay the bill through auto-pay. And then, we figure out which account it should be routed to. That’s a function of optimization versus artificial intelligence. That’s very, very old technology and very straightforward to implement in software.
How does Wealthfront differentiate itself from other digital wealth management solutions?
Rachleff: One of the frustrating things to me about the fintech world is that reviews are done based on websites, not based on products. In the technology world, people used to actually buy products to review them. But in our world, they review you based on what your website says, and everybody says they do the same things. They don’t.
So, for example, on the investment side, it’s really, really easy — it’s an absolute commodity — to do a diversified portfolio of low-cost index funds. But tax loss harvesting is only done by three or four firms, and by the way, they’re not all equal.
There’s a radical difference in the quality of what we do on the investment side and what everybody else does.
On the banking side, by the end of this quarter, no one will have more features than we do. So, things like direct deposit and getting paid two days early. Pay your bills and your friends automatically. We enable a consumer to use Venmo or their Cash App in addition to paying their bills. We offer a debit card that allows consumers to buy things and to make withdrawals from ATMs. We also have automatic check deposit, mobile check deposit, and we’ll have the ability to send checks by early October 2020.
Those are sort of table stakes, but hardly anyone else pays meaningful interest on your checking balance. You have to transfer the money into a savings account. Right now, we’re paying 35 basis points on checking balances. The ability to automate the routing of money and automate finances is something that no one else has invested in.
How does Wealthfront generate brand recognition?
Rachleff: We have built our business almost exclusively through word of mouth. If you think about the most successful tech companies, they’ve all built themselves that way. Not through marketing. You never saw Facebook ads in their first 10 years. You didn’t see Google ads. You didn’t see Netflix ads. Tech companies build their businesses through word of mouth.
We win through delighting customers through product. That’s what we’re focused on. Over half of our employees are engineers. I challenge you to find any other fintech company like that. Most fintech companies are big fin, little tech. They do a very thin layer of software on top of some other technology supplier and spend all their money on marketing. We’re the opposite. We spend very little money on marketing and spend all our money on our product teams to deliver delightful products.
How does Wealthfront manage the innovation process?
Rachleff: We’re really big devotees of Lean Startup methodology. The book, The Lean Startup, written by Eric Reese, has had a big influence on us. Eric is a constant guest of my product market fit class at Stanford. And it basically defines a methodology for coming up with product ideas, and then, testing them through experimentation.
Our view is that the ideas can come from anywhere in our company. Sometimes it’s from feedback to our product specialists. Sometimes it’s based on our market research. Sometimes it’s a wacky idea that one of our engineers has. It’s something that you can do with technology that wasn’t possible before. And then, we set up an experiment to see whether or not there’s any heat there. First, we test the concept. Then, we test the implementation. We put out a minimum viable product. And we expect well less than a third of the products or features that we create to actually hit a nerve. And then, if they don’t, we fail fast and cheap, and move on, and build other ones.
This idea that the majority of what you’re going to build is not going to succeed is very uncomfortable for most people.But if you’re going to work at Wealthfront, you have to embrace it, and fortunately, our people have, and we’ve been able to build many, many innovative features that people benefit greatly from.
How do you see COVID impacting the fintech and banking ecosystem?
Rachleff: There are always way too many companies that are funded, then there’s a shake out, and there are a few winners. So, that’s natural. That was true in disk drives. It was true in PCs. It was true in mainframes. It’s true in literally every area of technology. Fintech is no different.
I don’t see that as a negative. It’s the normal course of evolution. With regard to the banks, they all face an innovator’s dilemma, and that innovator’s dilemma is if they move to the new model, they’re going to make a lot less money. And that’s really unattractive. But if they ignore it, then, that leaves room for innovators like us to take share from them. So, they’re damned if they do and they’re damned if they don’t.
From a product standpoint, you’re going to see us add new checking account features every few weeks. That’s the beauty of being a software-based business – you can roll out new services very quickly, in contrast to a people-based business where you have to train people, and that’s very, very difficult.
You’re going to see us become the company that automates all finances. We give the consumer control, by the way. We’re not trying to take control of a consumer’s finances. We’re trying to take what they do and just make it more convenient and easy.
What is your target market?
Rachleff: We aim for Millennials who save. They have balances. Routing money to the most appropriate account, so they maximize their savings, is really important.
The challenge for the big banks is they’re trying to serve everyone. And when you try to appeal to everyone, you appeal to no one.
Do you ever foresee Wealthfront seeking a banking license?
Rachleff: The benefit of having a bank charter is you can make more money on your money. The downside is that the regulators will keep upping your capital requirements to slow your growth. People-based banks can’t handle growth, whereas software-based banks can. But the regulators don’t have any experience with that.
So, we think it’s probably better to make a lower margin but to have the flexibility to try new things. Bank regulators expect you to give them a business plan from which you do not deviate. That’s totally antithetical to the Lean Startup methodology. So, I doubt if a banking license makes sense for us right now.
What is the biggest opportunity for Wealthfront going forward?
Rachleff: Banking is one of two industries that has a negative net promoter score. A net promoter score is a proxy for the likelihood you will recommend the service to your friends. The only other industry that has a negative net promoter score is cable. People hate banks. So, I think that there is a lot of opportunity to make banking delightful for, in our case, young people.
What is the biggest challenge for Wealthfront going forward?
Rachleff: Hiring enough engineers.