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Costs And Risks: Why MoneyGeek Won't Become A Robo-Advisor

January 15th, 2015

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This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

In general, there are two ways that entrepreneurs can start a new business.

One way is to start out on their own, without seeking any large investors money, and relying instead on their own savings and/or contributions from their friends and families. Because a company starting out wont have much money, the entrepreneurs will likely spend little on creating their first product, relying mostly on their own skills and efforts. This way of starting a company is called "bootstrapping".

The second way of starting a company is by seeking large investors money. The entrepreneurs will write up a business plan and seek investors for their new venture. If they find some willing investors, they will sell a portion of their company to the investors in order to raise money. The entrepreneurs will use this money to hire many more people to create a bigger product. This method of starting a company is often referred to as "venture capital".

When I started MoneyGeek, I deliberately chose to bootstrap instead of raising venture capital. In doing so, I've closed the door on MoneyGeek becoming a "Robo-Advisor". In this article, I'll explain what a Robo-Advisor is, and why MoneyGeek won't become one in the near future.

Difference Between Robo-Advisors and MoneyGeek

The term "robo-advisor" describes the new breed of online, automated financial advisors that have sprung up in Canada over the past year, including ShareOwner, WealthBar, and Wealthsimple, to name a few.

Like human financial advisors, robo-advisors take their clients' money and invest on their behalf. But unlike most human advisors, most robo-advisors invest their clients money in a portfolio of index funds or Exchange Traded Funds (ETFs). As you may know from reading my free book, index funds and ETFs charge much less than mutual funds sold by human advisors. In my opinion, this is a good thing. The lower cost has enabled index funds and ETFs to outperform most mutual funds in the past.

However, there's a reason human advisors don't recommend index funds or ETFs. Unlike mutual funds, index funds and ETFs don't typically pay out sales commissions to the advisors. Robo-advisors, therefore, charge an explicit fee, which is usually a combination of a flat fee and a fee as a percentage of the size of the account. For a good summary of the fees, check out this spreadsheet. For example, if you have $100,000 with ShareOwner, ShareOwner itself will charge you $480 per year, and the index funds and/or ETFs will charge $310 per year on top of that.

MoneyGeek, on the other hand, is a toolbox for Do-It-Yourself (DIY) investors.

Similar to robo-advisors, a subscription to MoneyGeek provides you with access to model portfolios that consist of stocks and ETFs. However, MoneyGeek doesn't actually invest on its clients behalf. Instead, it leaves the choice and the implementation of each portfolio up to the client. We provide lots of help via tools and videos so the process is dead simple. Although this difference between MoneyGeek and robo-advisors may seem relatively small, it has huge consequences on the way we operate our respective businesses. Let me explain.

Costs And Risks

Being a robo-advisor comes with huge costs. Let me list some of the major ones.

Because robo-advisors deal with clients' money directly, a security breach can be catastrophic, especially if it leads to theft. The hackers don't necessarily have to withdraw clients' money to steal from them. They just have to have control over the client portfolios. For example, before an attack, perpetrators could buy shares in a little known penny stock. Then, when they've gained control of the client portfolios, they could direct the money to drive up the price of the penny stock. The perpetrators could then sell the stock at the inflated price, and leave the clients hanging with a vastly overpriced stock.

Although I haven't spoken to them personally, I imagine the entrepreneurs of robo-advisors are well aware of the threat. I wouldn't be surprised if they have a full time security expert on their payroll in order to defend themselves against potential security breaches. Unfortunately, such experts don't come cheap, and even experts fail from time to time (just ask Sony). I'm sure that if you asked any of the robo-advisors, they would swear up and down that their services are safe. But given that any other answer is unacceptable, I don't know how much weight you can give to their word.

In contrast, by letting clients control their own investments, we don't have to worry about any of this at MoneyGeek. The absolute worst that could happen to a MoneyGeek customer is that the customer's credit card information gets leaked. Note that this is very unlikely, given that we don't store credit card information on our servers, relying on a big third party payment processor instead.

In a similar vein, because robo-advisors control their clients' money, a potential bug in their program can be catastrophic. For example, let's say that a bug in the software causes a 'safe' portfolio to allocate 90% of its money into a volatile ETF. A human will intuitively know that something's wrong if he/she looks at it. However, machines lack that natural intuition, and may go ahead and invest 90% of their clients' money into the volatile ETF. Perhaps this particular scenario is unlikely, but there are many more ways that a bug can have a negative impact on clients.

Again, I imagine that most entrepreneurs of robo-advisors will be aware of this potential problem. To mitigate the risks of such a bug, these entrepreneurs will have undoubtedly hired highly skilled programmers, and instructed them to thoroughly test their software. Unfortunately, such programmers don't come cheap either, and even highly skilled programmers make mistakes. That's why Windows and iOS receive regular bug fixes.

While MoneyGeek has suffered from bugs occasionally, none of these have been catastrophic. Since users get to examine the output of the tools, they will likely know if somethings not quite right. I try my best to limit the number of my mistakes, but I also sleep well at night knowing that if I screw up, at least our users will probably catch it before it affects them.

Drawbacks Of Raising Money

To pay for the heavy costs I mentioned above, robo-advisors have had to raise a lot of money in order to start their operations. Unfortunately, raising money itself incurs its own costs.

Before I launched MoneyGeek, I investigated how much effort it would take to raise money. The handful of people I talked to gave me unanimous answers - raising money is almost a full time job on its own. It's common for entrepreneurs to spend six months giving presentations before they get their initial investment.

But the job doesn't end there.

Because of the high costs, unless they are extremely lucky and they make a ton of money overnight, robo-advisors will run out of their initial capital before they become sustainable. To keep the operations going, the entrepreneurs will have to embark on yet another fundraising trip, and keep raising more for many years.

Raising money from investors could also come with strings attached. Typically, entrepreneurs will give up some voting power every time they raise money by selling shares to investors. With most startups, the entrepreneurs end up losing enough voting power such that investors as a collective ultimately gain control over the company.

The loss of control has the potential to put entrepreneurs in a bind. For example, the entrepreneurs may have started their robo-advisor with a mission to provide cheap and honest financial advice. However, not every investor may share the same vision as the entrepreneurs. If the robo-advisor goes through a rough patch, these investors could agitate the entrepreneurs to switch from recommending ETFs to recommending higher cost mutual funds, in order to start earning sales commissions. entrepreneurs would then have to choose between betraying their vision or losing their jobs.

In contrast, by not raising any money or dealing with outside investors, I've avoided all such costs and pitfalls with MoneyGeek. As it stands, I have 100% of the voting power over MoneyGeek, and I will never do anything contrary to my mission of providing honest education and access to investing tools.

Dubious Benefits

Although operating as a robo-advisor is much more costly, I would consider turning MoneyGeek into one if the benefits outweighed the costs, and if I could figure out a way to retain control over the company. After two years of operating MoneyGeek, however, I'm not convinced there would be any benefits to operating as a robo-advisor.

From the client's perspective, the major difference between robo-advisors and MoneyGeek is the extent to which the client is involved. With MoneyGeek, clients have to educate themselves and trade their own stocks and ETFs. To use a robo-advisor, on the other hand, requires no client involvement beyond the initial setup.

While those who feel they lack the skills to invest their own money may find robo-advisors attractive, Ive found that most people don't need a lot of education to invest competently. I've condensed what I believe the average investor needs to know into a free book that is less than 30 pages. I've also explained how an investor can trade stocks and ETFs in a couple of short videos. I estimated that the entire work of setting up a brokerage and trading the initial batch of stocks and ETFs would take less than an hour, excluding waiting times for money to transfer. Once set up, I estimated that it would take the average user less than an hour every year to maintain his or her portfolio.

If I were wrong and if this had proved to be a painful process, I would have received a lot of emails asking me to create a fully automated service (i.e. a robo-advisor). But in my two years of operations and after having received emails almost every day, I've had only one person ask me if I could create such a service. Far more people have asked me if I could create a tax optimization tool, for instance (which I did create).

However, I recognize that people don't always ask for what they want; they tend to use the service they are provided with. A sign that a fully-automated service really is desired would be if robo-advisors experience far higher growth than MoneyGeek. Although it's too early to tell, I don't see signs of that kind of growth yet.

By taking the bootstrapping route to creating MoneyGeek, I've been able to keep the company very lean. For our customers, that has two benefits. First, it means I can keep prices lower for them. Second, it means MoneyGeek will last. If robo-advisors fail to raise additional rounds of money, they can potentially go out of business. On the other hand, keeping MoneyGeek alive costs very little, and mostly consists of paying myself.

If I turn MoneyGeek into another robo-advisor, customers will lose those benefits. I'm not saying I'll never do it, but I will do so only if the requests flood in and if the costs of becoming fully automated become manageable. For now though, I just don't see myself taking that plunge.

This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.