Mar 31, 2021
During the month of March, the Narwhal client service team read "The Money Hackers" by Daniel Simon, a book chronicling the rise of financial technology in the 21st century. As advisors, we are well acquainted with the ongoing power struggle between traditional finance and technology disruptors from Silicon Valley, and Simon's book gives some fascinating perspective to the history and current state of this struggle. His chronological approach tracks some of the most unique origin stories behind financial technologies that now exist as part of daily life and conversation. The stories behind Venmo, Credit Karma, Acorns, and Bitcoin were our favorites, as these are now household names, but none of us knew how they were initially founded. Venmo, an app that I use almost daily for personal reimbursements, is an especially fascinating tale of entrepreneurial resilience and persistence. In 2012, three years after Venmo was founded, the app had only 3,000 users and had officially notified its employees that they were shutting down the business due to lack of funds. At the last second, a software company called Braintree bought Venmo, revamped the monetization structure of the platform, and then was completely bought out by Paypal. Now, Venmo has over 50 million users and is projected to make $900 million in 2021. For anyone interested in the entrepreneurial process, this book is a goldmine. Not only does it provide fantastic case studies of success (and failure), but most of these founders did not progress through the ranks of traditional financial institutions. While it is clear that banks and brokers have long held the keys to industry access, they appear to be losing their grip as a result of these tech-based disruptors.
As advisors, we were particularly fascinated by Chapter 4, "Rise of the Machines: Robo-Advisors and Inclusive Investing." Although we have yet to lose a client to a robo-advisor competitor, we have certainly encountered the sentiment that "algorithms can invest faster and more accurately than humans, and it's cheaper too." Simon's chapter on robo-advising explores the advent of this technology and is centered around the key thesis that robo-advisors exist to provide more accessible versions of the service that human advisors are already offering. As Simon claims, not only are robo-advisors faster and easier to use, but they are promoted as being significantly cheaper, and resulting in better performance.
To better understand the viability of the robo-advisor, it is important to examine the discussion that has surrounded the adoption of this technology. First, there are legitimate arguments made by Simon as he dissects the traditional human advisor, and these opinions are worth discussing. Second, there are structural weaknesses in the robo-advising model that are not necessarily disclosed in the marketing or the surface-level user experience. Finally, we hope to make the argument that firms like Narwhal fight hard to bridge the gap between traditional (human) advising, and the efficiencies created through investing-specific financial software. Not all firms do this well, and none do it perfectly, but we feel that our direction points to a marriage of the approaches rather than a dogmatic loyalty to either one.
It's not surprising that robo-advising platforms have experienced massive success in the last decade. Most modern, young investors are accustomed to performing most life functions through their phones, so why should investing be any different? Ease of use is a top priority for any software, and robo-advisors certainly make "ease" their crowning achievement. Traditional wealth management relationships often have minimum investing standards that work against the acquisition of young, tech-savvy investors. Minimums range from $100 thousand to $1 million among independent advisors, and big players such as Goldman Sachs or J.P. Morgan require $10 million to start the conversation. Even for successful young folk, the lower end of industry minimums is a massive barrier. For any young professional, building a standalone portfolio worth $100 thousand will likely require wise investment selection from the beginning. Beyond minimums, entering into advisor relationships can have strings attached. Choosing the wrong firm could result in poor investment performance, expensive products being pushed on you, or even just annoying insurance sales pitches. Narwhal has crafted many of our core systems around these considerations, as we've completely removed our minimum asset requirements and strive to keep performance, simplicity, and efficiency at the heart of our end-client experience. Even with this in mind, we recognize that there will always be individuals who prefer a contact-less approach to investment management, and our model cannot be viewed as a one size fits all approach.
Despite the conveniences that accompany the robo-advising experience, some fundamental weaknesses should be addressed. The primary flaw is a lack of depth in the development of client profiles. Regardless of how deep the inquiries go, the end-result for every robo-advisor questionnaire is the client being placed into a bucket. Investment decisions are then made on behalf of the client according to the rules for that bucket. While the algorithms are undoubtedly sophisticated and accurate, they lack the element of human guidance that is so critical in advisory relationships. This is not to say that every human advisor can outperform a robo-advisor algorithm, but it is to say that human oversight is a critical element in the formation of an in-depth client profile. The caveat to this argument is that relational trust is imperative for the advisor-to-client connection to thrive. It shouldn't come as a surprise that there is a multitude of certifications that combine financial planning and counseling, as most financial conversations involve heavy elements of emotional, spiritual, and interpersonal decision-making. Investors who are willing to engage at this level with their advisor will find that their evolving client profile will have an undefinable, yet tangible level of depth that an algorithm-based questionnaire simply cannot achieve. A secondary flaw in robo-advising systems is the lack of agility with tax-management. This same assessment could be made of individual investors who purchase funds or indexes with a long-term buy and hold approach. Regardless of what robo-advisors purchase for each client, there will likely be a low amount of turnover in each portfolio. While there are short-term advantages to the buy-and-hold approach, especially when trading fees are involved, there can be long-term tax implications as embedded gains begin to build. One of our arguments in favor of active trading is that it provides flexibility in managing tax liabilities. While fund heavy portfolios rarely change course, accumulating gains and losses over time, active portfolios are constantly taking advantage of gains and losses to minimize yearly taxes and maximize agility for cash needs. This active approach is elevated further with the elimination of trading fees at many of the leading financial custodians.
At Narwhal, we take pride in identifying as an independent investment advisor. We are undoubtedly a traditional wealth management shop, focusing on individual stocks and bonds, performing our research in-house, and emphasizing client education. We place a strong emphasis on building and maintaining relationships that inform every investment decision we make. However, we recognize and embrace the need for technological development. As our client base has grown, so has our internal requirement for software that can help us with performance, reporting, and client communication. It's been fascinating to watch the old-school and the new-school combine forces within the context of our firm. In the last year especially, we have been aggressively pursuing opportunities to streamline operations through existing tools as well as new technology. We hope that smoother internal processes result in more bandwidth for team members to focus on the traditional relationship building that is undoubtedly the most rewarding part of our work.
"The Money Hackers," tells a story of technology filling in gaps that have existed in the world of finance for many decades, all for a cleaner, cheaper user experience. We welcome this trend and hope to see technology continue to disrupt dated and disorganized institutions, but we also hold onto the core competencies of our firm that simply cannot be replaced by technology or algorithms. Market beating performance, pro-active service, and ongoing education are the pillars of Narwhal, and we believe that all three are driven by fundamentally human efforts. There is no doubt that technology plays a significant role in assisting all three endeavors, and we welcome continued integration with the cutting edge of fintech.
Luke joined Narwhal’s client services team in the spring of 2019 after working as a wrangler on a West Colorado guest ranch. He holds a B.S. in psychology from Davidson College and competed for four years on the Davidson men’s swim team. His role at Narwhal focuses on 401(k) planning and client services. In his own time, Luke enjoys all things related to fitness and the great outdoors.
At Narwhal Capital Management, you’re more than just a portfolio, and it’s not all about the numbers. Let’s start with a meeting about your needs and future goals.