Large, Fragmented, and Stratified: Venture Opportunities in WealthTech
This post is the first in a series on WealthTech written with Charge by me, Renee Li, a full-time MBA student at Columbia Business School. Prior to B-school, I was an Investment Associate at BlackRock.
The wealth-management industry, a market with $487 billion in value in 2019, is large and fragmented. UBS, the global leader, has a 3% market share. There were more than 270,000 personal financial advisors working in the US in 2018 according to the Bureau of Labor Statistics.
Despite the abundance of wealth advisors, the vast majority of the market is underserved. The industry stratifies customers in a manner similar to airlines. The result is that mass-market consumers, the ones that need advice the most, get little to no service. “Affluent” clients, with between $300,000 and $1 million in assets, get premium-economy treatment i.e. may talk to advisers by phone and choose from ready-made funds. “High-net-worth” clients, with up to $15 million, fly business class, picking stocks and getting in-person advice from advisers. Flying private are the “ultra-high-net-worth” individuals, who have access to alternative assets, currency hedges, dinners and golf outings. While high-net-worth individuals typically pay no more than 1% of assets in fees each year, the mass affluent often pay over 2% for inferior service[1]. Cattle class gets no service at all.
The Business of Wealth Management and its Discontents
The majority of wealth advising firms operate under the “brokerage” model, where licensed financial advisors are paid on a commission basis and are responsible for all aspects of serving their clients, including selling, onboarding, advising, as well as portfolio management. The brokerage model contrasts with the “banking” model, where financial advisors are paid on a salary basis and are part of a large wealth management company with segregated Relationship Managers, Investment Specialists, and Support Teams who serve clients collectively.
While the brokerage model has its obvious benefits (e.g. clearer incentives and revenue ownership), it presents many challenges for wealth advisors. It burdens wealth advisors with many non-core tasks that take up a lot of their time. From my conversations with wealth advisors, many complain about the amount of time and hurdles that they have to jump through to serve their clients. For example, when a certain client becomes identified as a “high risk” individual, advisors spend hours on obtaining the relevant checks in order to serve these clients. According to a survey conducted by Forwardlane, wealth advisors spend less than 50% of their time on servicing clients (see chart below).
Processes in the Wealth Management Business
The advisors take a “commission”, or “asset-based” fee, although the industry is transitioning to “fee” based. Fee-based revenue now contributes 69% of overall gross production, up from 49% in 2015. The industry is challenged by declining margins. Annual fees for new accounts (for households with $1 million to $1.5 million invested) averaged 1.01% in 2019 down from 1.07% in 2015[2]. Dwindling margin is another reason why the wealth management industry must adapt to increase their operational efficiency and client engagement.
Another trend is the proliferation of Registered Investment Advisors (RIAs). These are independent, fee-only firms regulated by the Investment Advisers Act of 1940 that are required to be fiduciary. This contrasts with the traditional “wirehouse” full-service brokerage firms such as Morgan Stanley, Bank of America’s Merrill Lynch, UBS, and Wells Fargo, who are incentivized to sell their own products and services. As consumers become savvier and realize the conflict of interest of these non-fiduciary investment advisors, they migrate to RIAs, resulting in the number of RIA clients soaring 85% over the past eight years to 43 million[3].
Given the demographic profile (high net worth, ~65 years old) of the clientele as well as the advisors themselves (~50 years old), wealth management is a highly relationship-driven business. Most clients are acquired through referrals of families served. Other channels include conferences, networking events and centers of influence (accountants and attorneys). Advising is typically conducted through in-person conversations, dinners, or golf outings.
However, the high-touch, relationship-driven, business model is fundamentally unfit for today’s digitally native millennials. Millennials are defined by DIY culture, prefer to compare features before making decisions, and have little patience for inefficient service. While some LeadGen startups have emerged to serve millennials, much more can be done in this space. Moreover, millennials view their banks as transactional and not relational. On the other hand, financial advisors have traditionally preferred serving clients more holistically (rather than serve clients who may be spreading their assets across different advice providers). From 2015 to 2019, average accounts per household served have climbed up to 3.1 in 2019 from 2.7 in 2015[4], showing a deepening of client relationships. Therefore, we believe that there are opportunities for lighter-touch wealth advising business models to serve the millennial segment.
The Underserved “Lost Generation”
Saddled with debt and unable to accumulate wealth, millennials have become the new “lost generation”. Despite being the largest US workforce, they only hold 4.6% of US wealth. As a generation, millennials earn 20% less than boomers did at their age and have $600,000 less wealth than boomers when they were millennials’ age[5].
It is therefore not a surprise that millennials are not a customer segment valued by wealth advisors, whose earnings are linked to their Assets under Management (AUM). The average age of a wealth management client is 64 years old[6]. According to the Financial Conduct Authority, only 6% of 18–34-year-olds paid for financial advice in 2017.
Given the lack of tech-savvy clientele, the services offered are provided in an old-fashioned and high-touch manner. Despite much talk of digitizing the industry, the adoption of technology has been slow at most wealth management companies.
Twitter & The Greatest Wealth Transfer
Despite their relative lack of wealth, many millennials are working professionals who are accumulating wealth and going through important financial decisions, such as estate planning and getting mortgages. Due to their lack of access to traditional sources of financial advice, Twitter has become the main avenue for financial advice.
Moreover, millennials are set to inherit a tremendous amount of wealth from their baby boomer parents. The “Great Wealth Transfer” will see an estimated $68 trillion passed down from boomers over the next 30 years[7]. By 2030, millennials will be five times richer than they are today[8]. As digital natives, millennials are set to adopt different ways to manage their wealth. Research by Kings Court Trust shows a quarter of inheritance beneficiaries are already walking away from their parents’ or grandparents’ IFAs, typically taking $380,000 with them, with reasons given from physical distance to confidence that younger people can manage money for themselves[9]. According to a Deloitte research, Up-and-Comers are shown to demand a combination of high-touch and digital interactions [10].
By 2030, Millennials Will Hold 5x as Much Wealth
Forecasted total financial assets ($ T) held by millennials
Digital Propensity by Generations and Wealth Tiers
Are Robo-advisors Really the Answer?
We have already seen the rise of robo-advisors in response to millennials’ desire to manage their financial needs. Millennial investors are now able to invest with $500 or less using robo-advisor services such as Betterment, Wealthfront and Sofi. Traditional wealth managers such as Goldman Sachs have also announced their plans offer robo-adviser services.
However, unlike shopping for most products online, making financial decisions is unique in its complexity. Some young investors still want a greater level of support with financial decisions, but they are simply priced out. Maximilian Rofagha, the founder of Finimize, calls this the “information asymmetry” that has sustained the financial advice industry for decades, i.e. that financial matters are so complex you must pay a middleman to explain them to you.
Sheena Gillett at Pimfa says its research forum found that young people are still big fans of “human interaction and relationship-building” [11]. Even some robo-advisers are realizing that automated services do not replace in-person interaction. In some cases, robo-advisor companies such as Nutmeg start to offer services like 15-minute phone calls.
Due to the complex nature of wealth management and financial planning, making financial decisions is different than buying a product online. The lack of options for millennials investors has resulted in Twitter being the #1 place for young investors to look for advice — not a good place to start. Companies such as Public.com has capitalized on this need to launch its platform where users can display their investments and stocks that they are interested in on a public page, follow other people, and explain their investment choices in a public feed.
Thank you for tuning in for our opening remarks on WealthTech. In coming posts, we will explore the different layers of companies that are transforming the wealth management industry.
This post was written by Renee Li and edited by Brett Martin at Charge.vc. If you are working in or thinking about the WealthTech space, we’d love to connect! Get in touch with the team @ Charge.vc!
[1] “Wealth managers are promising business-class service for the masses.” The Economist, 2019 Dec 18, https://www.economist.com/finance-and-economics/2019/12/18/wealth-managers-are-promising-business-class-service-for-the-masses
[2] “The state of North American retail wealth management.” PriceMatrix, 2019 June, http://www.cetfa.ca/files/1591624202_State-of-North-American-Retail-Wealth-Management.pdf
[3] Tobias Salinger, “Record RIAs, bullish outlooks put financial advisors in the spotlight,” FinancialPlanning, 2019 Sep 17, https://www.financial-planning.com/news/2019-evolution-revolution-report-tracks-ria-growth#:~:text=The%20number%20of%20RIA%20clients,past%20year%20to%207.3%20million.
[4] “The state of North American retail wealth management.” PriceMatrix, 2019 June, http://www.cetfa.ca/files/1591624202_State-of-North-American-Retail-Wealth-Management.pdf
[5] Hillary Hoffower, “Millennials dominate the US workforce, but they’re still 10 times poorer than boomers.” Business Insider, 2020 Oct 12, https://www.businessinsider.com/millennials-versus-boomers-wealth-gap-2020-10#:~:text=A%20report%20by%20think%20tank,when%20they%20were%20millennials'%20age.
[6] Amanda Schiavo, “Advisors should change fee structures to attract next-gen client.” FinancialPlanning, 2019 Jan 7, https://www.financial-planning.com/news/financial-advisors-should-change-their-price-module-to-attract-new-clients
[7] MacKenzie Sigalos, “$68 trillion is about to change hands in the US.” CNBC, 2018 Nov 20, https://www.cnbc.com/2018/11/20/great-wealth-transfer-is-passing-from-baby-boomers-to-gen-x-millennials.html
[8] “Wealth Tech Trends to Watch in 2020.” CBInsights, 2020, https://www.cbinsights.com/research/report/wealth-tech-trends-2020/
[9] Iona Bain, “Where millennials turn for financial advice.” Financial Times, 2019 Mar 15, https://www.ft.com/content/1390be10-4404-11e9-b83b-0c525dad548f
[10] “Retooling wealth management for the digital age.” Deloitte, https://www2.deloitte.com/us/en/pages/consulting/articles/retooling-wealth-management-for-the-digital-age.html
[11] Iona Bain, “Where millennials turn for financial advice.” Financial Times, 2019 Mar 15, https://www.ft.com/content/1390be10-4404-11e9-b83b-0c525dad548f
