Silicon Valley Tech at Wall Street Prices

Somewhere in the Bay Area, a developer teeters on the edge of insanity.

For the last 60 hours, he’s been A/B testing one word against another (“Get” or “Buy!” or “Install”?), one screenshot against the next. Delirious, he starts to A/B test reality — is that penguin really making paninis? — but all will be worth it in the end if he can manage to realize the impossible American dream: Convince you to pay one dollar, one time to install his life’s work on your iPhone.

Should he beat the odds, he’ll then take your 70 cents and plow them into another app on his phone. This app will not only charge him every day for the rest of his life, but it also increased his fee last year by over a dollar a month.

What the hell is going on here?

What Wealthfront Really Costs

That’s long been the promise on Wealthfront’s homepage: A $100,000 account for less than $20 a month.

Wealthfront loves to paint itself as the anti-Wall Street, but it exploits the same achilles heel as its Manhattan cousins: Many people don’t have an intuitive grasp of the magic of compound interest, and so they certainly haven’t internalized the tyranny of compound fees.

Then let us be clear: A 30-year old who invests $100,000 in his retirement with Wealthfront “for less than a night at the movies” will likely pay the company over $100,000 in fees by his 75th birthday.

If he sets aside additional money from his salary over that time period — say, $15,000 per year — the fees could come to half a million or more. Still less than a night at the movies, assuming you also had to produce the movie.

This is all a great deal for Wealthfront. If they hook enough young professionals early, the company gets to invest their money for the rest of their lives, skimming a larger and larger portion off the top as it compounds. Heck, I like this model enough that I consider investing in Wealthfront, Inc. at least twice a year.

But it’s not such a good deal for you. There are other options available that would enable you to stop working years earlier, and that fact gets buried in the self-righteous rhetoric that continues to flow from the company. As with Wall Street firms, this rhetoric must keep flowing to paper over the same infallible truth that has bedeviled meatspace financial advisors for decades.

The Dirty Little Secret

Here it is: If you open a retirement account, and you invest some of your paycheck each month into a Vanguard Target Retirement Fund, and you just…leave it…you just leave it right there until retirement…

…you don’t do anything when the folks on CNBC announce that the sky is falling; you don’t do anything when Cousin Eddy calls from a secure underground bunker in the badlands and says that the fed is printing money and it’s time to liquidate and ammo up; you don’t think it’s a sign that your parrot said “fuhgeddaboutit” but you thought she said “get a nugget” and surely that must mean a gold nugget? and you looked online and noticed that the price of shiny yellow metal was crashing and wait your parrot is also yellow and I’ll be damned if that isn’t a sign to buy…

… no, if you just leave it there to compound over decades…

…then you will probably make more money than if you hired the guy from Edward Jones, and even that Senior Executive Double-Stuf Vice Managing Director from Goldman Sachs. You will probably make more money than if you outsourced your investments to the kindly rabbi who performed your bris because my gosh how nice is he for offering to do my finances and I’m really starting to see him as a sort of father figure. And you will probably make more money than if you used Wealthfront.

The financial industry has spent decades and billions persuading people of the opposite — that investing is difficult, that it requires sophisticated certifications and products, that you better not go it alone, that it takes a lot of time. It’s not true.

Don’t take my word for it; take Warren Buffett’s.

Buffett recommends Vanguard because once you tune out the rhetoric from both coasts, one unassailable fact remains: As a non-profit that is owned by you and other shareholders, Vanguard is the only company in the financial industry that is not trying to make a huge profit off of you. Everyone else is talking their book. EVERYONE.

The Fine Print

That’s a pretty harsh reality for competitors, but it’s nothing a little creative marketing can’t mollify. Wealthfront’s CEO took pleasure in mocking Betterment’s spin today, but let’s take a look at what Wealthfront itself is putting out there.

We’re Cheaper than a Non-Profit!

Of all the tall tales in Wealthfront’s marketing, I imagine this is the one that spawned the most email threads marked “A/C priv.” It’s part of the company’s new effort to convince you that its service is cheaper than a product that is already run at cost:

The cost of our Direct Indexing service is actually lower than the Vanguard ETF it replaces. Vanguard currently charges an annual 0.05% management fee for VTI. For $500,000 accounts, our equivalent fee for Direct Indexing is only 0.02%. And for accounts above $1 million, our fee is even lower at 0.014%.
That’s because we do not charge a management fee for the roughly 80% of our Direct Indexing position that’s comprised of individual stocks. The cost of that service (including all commissions) is included in our annual 0.25% advisory fee.

Here’s even more good news: When it became illegal to sell foie gras in California, many generous restauranteurs decided to just give it away*!

(* But the cracker it was served on cost $20.)

Seriously, if someone at Wealthfront can justify the Hollywood accounting here with a straight face, I will breed them a panini penguin.

Because they do charge a management fee on your entire Direct Index balance. It says it right there: 0.25%. It appears that Wealthfront would prefer to call it an “advisory fee” here even though it relents with “management fee” on its homepage. Personally I like to call it a Safe Rides Fee. Whatever you call it, if you want to own the entirety of the public U.S. market, Wealthfront alone is going to take $2,500 out of your $1 million Direct Index to Vanguard VTI’s $500 on year 1. Sixty years later, this “next evolution of index investing” ends up considerably more expensive than the last one.

On and on it goes:

By allowing a Wealthfront investor to hold the individual securities that comprise an index in her own account on a commission-free basis, Direct Indexing effectively eliminates any Index fund or ETF management fees on the associated position, which reduces overall portfolio cost.


Owning an index fund or ETF comes with a fee. Although the fee may be small, it still acts as barrier to fully replicating the performance of a passive index investment.

and worst of all:

We believe our Direct Indexing service meaningfully addresses the two remaining shortcomings with modern index investing — the cost of the Index Fund and ETF management fees and the missed tax-savings from the inability to pass on tax losses. For this reason, we view Direct Indexing as the next evolution of index investing.

The divide between an “index fund fee,” which you pay to Vanguard to manage a collection of securities that track an index, and Wealthfront’s fee, which you pay to Wealthfront to manage a collection of securities that track an index, is a distinction without a difference. And it’s the oldest Wall Street trick in the book — the financial advisor who treats his esteemed clients to FREE! luxury box seats at the big game (*** when you pay him $10,000 a year).

Bottom line: Existing index funds trounce Wealthfront when it comes to the annual expense of owning the U.S. equity market. Please don’t pee on our leg and tell us it’s raining.

We’re Commission-Free!

It’s a wonder that with so many brilliant folks in Wall Street and in Silicon Valley, there is so much confusion over the definition of “free.”

Schwab, for instance, thinks its new Wealthfront competitor is “free” even though you pay for the service by keeping a mandatory portion of your portfolio in a Schwab Haha-Interest-That’s-A-Good-One Checking account.

Wealthfront also likes to take Schwab to task for commission-free ETFs that aren’t, while touting its own “commission-free” service instead.

A quick recap:

Free (/frē/): The miniature spoonful of frozen yogurt you asked for at the checkout counter so you could “test” that crazy new flavor, Vanilla.

Not Free (/nät frē/): The bacon-wrapped date samples that are “given” to you once you show your $55-a-year membership card at the entrance to Costco.

Wealthfront trades are certifiably the latter. If they’re going to play this game, I wish they would at least do it the Silicon Valley way — with creepily overtargeted ads.

Our Tax-Loss Harvesting Makes Up for Our Fee!

To the extent the SEC allows, Wealthfront argues that the benefits of its automated tax loss harvesting service can outweigh its fees. In short, they argue that there’s free money on the table.

This kind of claim crops up often in the investing world, so here’s a flowchart I use whenever I’m presented with a golden opportunity:

First, let’s get a few pesky facts out of the way:

  • If your nest egg exists entirely in a retirement account, as it does for many Americans, then tax loss harvesting won’t help you at all.
  • If you aren’t realizing capital gains on a regular basis, then the potential maximum value of tax loss harvesting is capped by the government as your net worth grows, while the amount you pay to Wealthfront each year is uncapped. And that’s a shame, because…
  • If you practice the kind of investing that Wealthfront itself evangelizes — buy-and-hold, passive, rational, long-term indexing that is rebalanced with new money or in retirement accounts — then you should not be realizing capital gains regularly anyway.

Having said this, let me be clear: Wealthfront and I strongly agree that tax loss harvesting can improve aftertax returns. But as with so many Wall Street firms, and contrary to its own holier-than-thou marketing, Wealthfront wildly overstates the benefits. There is simply no evidence, nor any theoretical reason, to believe that a portfolio managed with Wealthfront will outperform a simple Vanguard portfolio bought and held for retirement, once you account for Wealthfront’s fees.

The key gimmick that undermines Wealthfront’s marketing paper is that it tallies (and later even compounds) the entirety of every potential harvestable tax loss as if it’s all money in your pocket:

Tax Alpha is used to directly measure the tax benefit generated by proactively selling stocks with capital losses within a certain short period of time (say a single tax year)…We view Tax Alpha as an easy to compute and understandable metric to compute the performance of Direct Indexing.

Wealthfront claims that it “could” generate an “incremental annual after-tax return of 2.46% over just owning the S&P 500.” This is an astonishing number. If software could reliably generate 2.5% of investing alpha at one-tenth the cost, I would move my entire portfolio to Wealthfront tomorrow. Heck, Harvard would probably move its endowment.

But again and again, Wealthfront tries without blinking to draw a straight line between tax alpha and cold hard cash. For example, they offer a chart titled “After-tax Price Return of VTI vs. Direct Indexing” that appears to show that if you had merely flipped on Direct Indexing in 2000, you would have earned ~2% compared to losing 9% with Vanguard’s ancient index fund technology! They appear to reach these numbers simply by adding the maximum possible tax alpha to VTI’s return.

All these cases neglect to mention that you will probably only see the maximal gain if you are maximally messing up already, by needlessly churning your account to generate capital gains. As Vanguard’s founder advises: Don’t just do something; stand there.

So where else might you find these gains that Wealthfront will magically offset? Well, if you look at the fine, fine print on that paper (yes, even finer than Betterment’s): “The net tax benefit over the period includes the liquidation of positions transferred in and sold to invest the client account in the Wealthfront portfolio.”

In other words, Wealthfront will now partially offset the gains that you were only ever forced to realize by switching to the service in the first place. Hooray!

There are plenty of other holes in Wealthfront’s claims, which are well covered here (and still not substantively addressed by the company to date).

In short: When evaluating the benefits of tax loss harvesting, presumptively calculating and compounding anything beyond the government’s capped annual income deduction is like saying that you just made $400 million because you decided not to buy a 747 — okay, sure, but good luck trading that in for beer.

Why is Wealthfront so expensive?

Calm down, capitalists: Wealthfront should absolutely charge as much as people are willing to fork over. In fact, I hope they convince some folks to pay a million dollars a year, so that more informed clients like you can get it for free. (That’s how Wall Street works. It’s why you’re receiving 2% cash back on your credit card while your neighbor pays 12% on his. But it’s also why your advisor has a yacht and you don’t.)

I’m not asking why Wealthfront helps itself to such margins, which is obvious and perfectly normal, but rather why the market bears it. After all, it’s hard to think of many other service industries that work like this. You would probably find it unreasonable if your piano teacher charged you more and more each week just because you have more money than you did when you first started rounding the Circle of Fifths.

Or, to use an example closer to home: TurboTax doesn’t get to take a cut of every dollar you make until they put you in the ground, even though, like Wealthfront, they have a direct hand in growing your money. Navigating the Pease deduction cap, the Minimum Tax Foreign Tax Credit on Exclusion Items (“MTFTCE” for “short”), and the year-to-year tango in the rest of the U.S. tax code, is arguably far more intricate than passive index investing. But Intuit has to make do with fifty bucks a year — and even that is a miracle in this day and age. TurboTax doesn’t even get a bonus for maximizing your refund, but they owe you if they don’t!

When it comes time to market to those who work at Google and at Facebook and at Twitter, Wealthfront all but demands that we evaluate it as a technology company than a stuffy banking firm. Yet when we judge Wealthfront on its own terms, it looks virtually unprecedented.

It’s not just that Wealthfront charges users for its software, which is rare. It’s not just that Wealthfront charges users a recurring subscription fee, which is even rarer. It’s also that, on average, Wealthfront increases its subscription fee every day.

And Wealthfront enjoys other invaluable perks over most consumer tech companies: It does all this automatically, without having to notify users or seek proactive permission (jealous, Amazon?). It does so without having to give Apple or Visa a large cut. The train rolls on even when the customer changes credit cards, or addresses. It doesn’t have to send you a bill, or add a line item to your Amex statement, or otherwise ask you if it’s cool to charge you $9 for a service that cost you $8 this time last year.

Wealthfront also boasts high switching costs. Sure, there’s no account transfer fee — you can take your balls and go home at any time. But with Direct Indexing, you’ll be walking away with thousands of individual stocks. Do you plan to manage all those by hand? Or liquidate and take the tax hit? Once you go robo, you never go back.

The market tolerates this pricing because Wealthfront has pulled the oldest trick on Wall Street: Cherry-picking the benchmark. They’ve anchored us all to something irrelevant, then blown it away before our eyes. How could anyone complain about a 0.25% fee when the Wall Street average is 1%?

But for all its bleating about Valley-style tech disruption, Wealthfront is still just milking the pricing precedent that the Street established decades ago:

The more money you earn, the more money we earn.

It’s Time to Kill the Proportional Fee

By the time we all knew Uber was better than taking cabs, it was already showing us why it’s better than owning cars. But Wealthfront is still just telling us that they suck less than Bank of America. If you insist on wrapping yourself in the cuddly blanket of Silicon Valley, then you must also take the swing.

Here’s what that means to me: The standout technology companies here take repetitive, mundane, ridiculous chores that no human should ever have to do — rebalancing retirement funds across 9,000 companies, or calculating the generation-skipping gift tax — and write code once to do them for us a million times over.

This technology helps wring out real, quantifiable savings; the code doesn’t care if that net worth integer is 1,000 or 1,000,000. These cost benefits are so obvious and undeniable that the sales team doesn’t even need tricks to close the deal; they just need to write down the truth.

Those savings are then passed on to the consumer, even as the founder walks off — yes, just like Wall Street — with a huge barrel of money. So much is created in the nuclear transition from unscalable human effort to unrelenting CPU that both the house and the gambler can win big.

This might surprise you, then: I’m certain that Wealthfront, or something like it, is the future. There is tremendous alpha to be realized through automation — if you’ve ever paid a bill one day earlier than you had to, or left a penny uninvested one day longer than required, then you know this must be true. It is inevitable that computers will optimize our cashflow, our investments, and our taxes to a degree that will make the status quo look downright laughable to our grandkids. The right solution in this space will mean people can retire earlier and spend more of their time doing what they love. I desperately want to see it exist so I can recommend it to my mother, and my brother — and use it myself.

But for now, Wealthfront is just another pretender to the throne, tilting at Schwab windmills and Fidelity bogeymen even as it tacitly joins them in guarding Wall Street’s greatest secret: It doesn’t have to be this way. You don’t have to work harder and harder into your gray years, paying more and more of your paycheck to an advisor who is doing the same amount of work as the day you two shook hands.

So, to borrow a page from Wealthfront’s chief:

We can do better than this. We have to be better than this. Stop charging proportional fees for advice.

The world doesn’t need another Wall Street.

(If you like tech snark, you can also check out my post on Uber.)