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Jon Stein: 'Free Trading Is Actually Going to Cost You'

The Betterment founder and CEO on evolving beyond robo-advice, client behavior during the recent market swoon, and deterring harmful trading activity.

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Our guest this week is Jonathan Stein, the founder and chief executive of Betterment. Stein founded Betterment in 2008 as an automated, goals-based investing service, and it's currently the largest of the independent robo-advisors. Betterment offers two main services--Betterment Digital, which is a pure robo-advisor, and Betterment Premium, which offers clients ongoing financial planning guidance from a Certified Financial Planner. Stein began his career consulting with banks and brokerage firms on risk and products. He's a graduate of Harvard University and Columbia Business School and holds the Chartered Financial Analyst designation.

Background
Jonathan Stein bio 

Betterment.com

"Betterment: Jon Stein," How I Built This with Guy Raz, Oct. 26, 2018. 

"Jonathan Stein Built Betterment to Help Investors Make Better Decisions," by Bruce Rogers, Forbes.com, Jan. 18, 2018.

The Coronavirus and Investor Behavior
"Thoughts on the Volatile Market," by Jon Stein, Betterment.com, March 19, 2020.

"COVID-19's Impact on Investor Sentiment," Betterment.com, May 6, 2020.

"How Betterment's Customers Are Behaving Amid the Volatility," by Caleb Silver, Investopedia.com, April 10, 2020. 

"Betterment Halted Trade Amid Brexit Panic--Here's Why," by Anora Mahmudova, MarketWatch, July 1, 2016. 

"Coronavirus Turmoil, Free Trades Draw Newbies Into Stock Market," by Alexander Osipovich and Caitlin McCabe, The Wall Street Journal, April 29, 2020. 

"Americans Are Hoarding Cash: Savings Rate Hits Its Highest Level Since 1981," by Paul R. La Monica, CNN.com, April 30, 2020. 

Betterment's Offerings and Investment Process
Betterment Digital vs. Premium 

Betterment's Cash Analysis Methodology 

"Are Robo-Advisors Better Than Target-Date Funds?," by Arielle O'Shea, NerdWallet. 

Betterment for Business

"How Tax Impact Preview Works to Help Avoid Surprises," by Boris Khentov, Betterment.com, Oct. 29, 2014. 

"ETF Selection for Portfolio Construction: A Methodology," by Adam Grealish, Betterment.com, Aug. 27, 2014. 

"Value Investing: Research on the Risk and Return," by Adam Grealish, Betterment.com, Oct. 25, 2016.

Future of Advice
"The Fiduciary Rule Should Be Fully Implemented," by Jon Stein, Betterment.com, June 8, 2017.

"Will New SEC Regulations Change Anything for Retail Investors?" by Theresa W. Carey, Investopedia.com, June 8, 2019.  

"The Future of Advice: Jon Stein, Betterment," March 6, 2017. 

Betterment Paints It Black in Robo-Retail," by Oisin Breen, RIABiz.com, Aug. 5, 2019. 

Transcript

Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar, Inc.

Jeff Ptak: And I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Benz: Our guest on the podcast today is Jonathan Stein, the founder and chief executive of Betterment. Jon founded Betterment in 2008 as an automated goal-based investing service, and it's currently the largest of the independent robo-advisors. Betterment offers two main services--Betterment Digital, which is a pure robo-advisor, and Betterment Premium, which offers clients ongoing financial-planning guidance from a Certified Financial Planner. Jon began his career consulting with banks and brokerage firms on risk and products. He's a graduate of Harvard University and Columbia Business School and is a Chartered Financial Analyst.

Jon, welcome to The Long View.

Jonathan Stein: Hi, nice to be here. Thanks for having me.

Benz: We've been asking all of our guests about how they're working and where they're working through this period. Can you talk about how the pandemic has changed your day-to-day work life?

Stein: Today, I'm in Manhattan on the Lower East Side in my apartment of 13 years now, I guess. We've lived in this place since before I had kids. I've had many different roommates here. And we're packing a few things. We've been spending some time up north of the city. We have two small daughters and it's been nice for them to be able to get outside and not have to put on masks and everything right away. The playgrounds and everything around us here on the Lower East Side are closed. So, it's tough to be back here. I feel a whole bunch of emotions being around. I was just writing to the team yesterday, my weekly note to the team, about what it's like to be back here. And I said, I miss my life of two months ago like I miss my life of 10 years ago or my youth. It all feels distant in a way. So much has changed. It feels just like wildly different and inaccessible, like I just could never get back there. And I just keep trying to comfort myself that, most change is good in the end in hindsight, but that doesn't make it easy as you're going through it.

Ptak: What's changed about the way you run Betterment? I don't imagine that you've shifted your strategy any but I would imagine when it comes to the day-to-day management and adapting to this unique and extenuating set of circumstances we face, there are probably some adjustments that you've had to make. What are those?

Stein: We've been lucky from a company perspective that we're already digital financial advisor, and we've made the transition pretty seamlessly. The team, before all the stay-at-home orders came into effect, before the schools closed--we were already working from home. We got to jump on things and that was good because we had a lot of team members who got sick. We had a lot of their family members who got sick. Some passed away. So, we've had some hard personal losses for the team. And it's been a hard couple of months.

But business-wise, we haven't missed a beat. Our trading systems performed admirably during all of the volatility of March. We were never down, right? All of our customers were always able to trade. Our service has always been responsive. We've always been live, and customers have really appreciated that--that we've been here for them in this time. And in some ways, we were built for this time. Our algorithms kind of kick to life when there's volatility like this, and we're rebalancing our customers' taxes efficiently, intelligently; buying on things that have dropped and helping our customers make the most of their money in this volatility.

Benz: So, do you feel like this crisis has revealed anything new or different about investor behavior and psychology?

Stein: We're watching and learning every day some surprising things. One, in all the volatility, which really peaked in March, we saw only a 2% increase in the number of withdrawals. And I'll tell you, I've been building Betterment for 10 years. We're just coming up on our 10-year anniversary in May. And I've heard on every podcast, on every panel, in every investor conversation--what happens in the downturn, what happens to Betterment in that time? And I feel like we might be now living in that moment. This is that downturn that we've been preparing for, for all these years. We were born in the last downturn. We came out of the 2008 crisis. And so, in many ways, we're built for this. And it's been great to see our customers staying the course, keeping invested. Of all of our customer base, again, in March, we saw 26% more customers making ad hoc one-time deposits than making any sort of withdrawal, and that's in addition to all the auto deposits, and most of our customers have some kind of auto-deposit setup as well. And for our millennial customers, for the younger customers, it was 37% more deposits than withdrawals. Younger people were more apt to see this as a buying opportunity and be moving into the market. And so, those are a couple of the interesting things. Although, we've done some surveying of our customers and there's been a lot of interesting findings.

Benz: Like what?

Stein: Well, for one, we found that most of our customers who got a stimulus check, had been depositing that money into longer-term savings. They'd been not spending it as maybe you might expect, but they'd been putting it into their IRAs or retirement goals, or even just saving for some future thing that's a couple of years out. The vast majority of our customers are doing that. Now, a little bit, that's who Betterment customers are. But to see only a tiny fraction, less than 15%, put them towards near-term goals is pretty surprising, I think.

Ptak: I know it's hard to generalize, but can you give us a thumbnail sketch of who your customers are? The behaviors that you describe are, I would say on the whole, they are laudable, right, the fact that they seem to be undaunted by some of the challenges and furthermore, they've continued on with their plans. It sounds like that doesn't typify most investors that we're familiar with who tend to exhibit other sorts of self-harmful behaviors. And so, can you describe who your customers are?

Stein: I talk about our customers as being smart professionals who want to make the most of their money. The average customer today at Betterment is 37 years old. She has an income over $100,000 and about $120,000 average and oftentimes has a family and is thinking about how to make the most of her family's money. It is hard to generalize, right? Because we've got a lot of customers who are 22 and just graduated college and just starting out in their saving and investing journey. And we've got customers who are in their 90s and are taking automatic withdrawals from their investments. We've got a retirement-income feature that they are using such that they never run out of money in their retirement accounts. And so, we've got a broad swath of customers. But in general, they're smart, they're professional, they tend to be somewhat tech savvy and they're believers that a tech-oriented solution is going to more reliably, more responsibly manage their money.

I'd like to say that we take all the things a great financial advisor would do if you had one, and we make them smarter, faster, cheaper, better. And we offer great financial advisors here at Betterment too. We partner with great financial advisors. It's not a knock on advisors. It's just that for most people, they're inaccessible, and we make human ones more accessible to our customers, and we make our services digitally available to those who don't have a human advisor.

Benz: You mentioned she and I'm wondering, do you observe any gender differences in your clientele?

Stein: We see a majority of our customers are male, which is in keeping with that of most investing sites. You don't see it show up until people are married. And then for whatever reason, the custom in America is that oftentimes the investing accounts are in a husband's name. And we see that in our case too. Our customer skew more female than those of most investing sites compared to say, the Schwabs or TDs or others who release information about this kind of thing. And in part, that's because our customers are younger, they are therefore less likely to be already married. And so, that's part of the skew. We don't make things the way that they are. It's just I think our customer base reflects the population and preferences.

Ptak: Maybe if we could widen out for a second. We've read stories about trading activity on other large brokerage platforms. Trading activities gone through the roof by many measures in recent months. And I guess on its face, it seems troubling. But my question for you is, do you think it can be healthy for investors to experiment with trading when they're young to sort of get it out of their system and maybe learn the hard lessons that will serve them well over the long haul?

Stein: I don't think that's crazy at all. I do think it's crazy to go and try and beat the market by trading stocks. I think that it's a bad idea. It is all but impossible, right? The chances that you do it are vanishingly small and have everything to do with luck and nothing to do with scale, in my opinion, and 99% of people will fail at doing that over time. And yet, you're right, people still do it. I did it. I mean, I studied economics at Harvard as an undergrad and I earned my CFA over time and was working in the industry and sort of had every reason… I'd read all the books about behavioral economics. I consider myself like a lucky, privileged, well-educated person. And yet I stupidly went out and was like trading my own portfolio. Frankly, because that's what was available.

I think that the advisors were essentially inaccessible to me, because I didn't have enough money for their minimums. And so, the obvious option was to self-direct into just manage my own funds. And working in the industry and opening accounts at maybe seven different broker/dealers, I saw that all of them were basically trying to get me to do the thing that was good for them, not the thing that was good for me. They all wanted me to trade more. And so, they put red and green on the home page, and they encourage you to trade--they give away information about which stocks you should buy, free content to encourage you to trade because that's how they drive revenue. And what that does is it reduces your money. Like, the more you trade, the less well you do. I don't really think that the average individual should be out buying stocks. Like I said at the beginning of my answer, I think it's a bad idea. But I did it. And I think today, a lot of people do it. So, I don't think it's crazy to think that, you know, get it out of your system while you're young and you have less to lose; just don't do it with most of your money. Put most of your money into Betterment; put it into something that's actually going to make the most of it. And if you have to kind of experiment or gamble with a tiny portion, just do that with 5% on the side.

Benz: One thing we've seen during this crisis in stark relief is just that people have trouble with amassing enough cash to help them defray emergency expenses. Can you talk about how Betterment approaches that issue with clients to help them rightsize their emergency fund, maybe before they even get started with their long-term investments?

Stein: I love that question. And we do see so many people kind of jumping over the safety net into retirement investing. We give advice at Betterment that's goal-based. So, you come, you tell us about your goals, and we'll make recommendations based on your age, your family situation, what you tell us your goals are, and we recommend a safety net for everyone. We recommend somewhere between three and nine months with an average around six months of your income saved for a significant downturn. And we can save that in a non-zero-risk portfolio. I think the current recommendation is about 15% stocks and about 85% bonds. And the recommendation there is based on trying to keep ahead of inflation, give you a little bit of additional return over what you get from like a purely risk-free portfolio, but still giving you plenty of cushion should you lose your job at a time when the market is down and so on. So, it's part of our advice to help make the most of our customers' monies. Everyone should have that safety net funded.

Now, there are cases where you'd fund retirement first, right? So, we take those into account. Maybe you have a match at work in your 401(k), well you want to max that out first, because that's free money. Maybe you have some high-interest debt and you want to pay that down before you start putting money into a safety net. But for most people, for the vast majority, saving that's around six months of their income in relatively low-risk investments is a smart way to get started.

Ptak: And did you say that this is a formalized part of your process of profiling a client and then recommending something to them as it were?

Stein: Correct. It is. And it's a differentiator for us. We also offer a 401(k) for employers. We call it Betterment for Business. And it's an amazing 401(k). It's the most accessible 401(k) in America. You can sign up purely online if you want to. You never have to talk to anyone. You can go through the whole process. You can call us, of course, if you want. We support our plan sponsors, the employers with full fiduciary services. We work for them. But part of the product that your employees get is not only the 401(k), but also this holistic advice around having a safety net so that you can weather ups and downs. And ultimately, that makes for employees, it makes for people who are better off or better able to weather things, feel more secure. And we think that's what employers want, ultimately, is to have their employees be happy and secure and know that they're on track.

Benz: Do you think helping people save for emergencies should be formalized, like, in a policy way where there are maybe add-ons to 401(k) plans that allow someone to set aside like a rainy-day fund?

Stein: I think that is a good idea. I think we have an opportunity right now to build a nation of savers. It's been amazing to see the savings rate pop up. I don't think that Betterment's experience here is unique. We've seen the national savings rate increase so much. People are spending a lot less right now in this moment. Now, I don't imagine that's politically popular. And as you know, the thing to do to get the economy going is to get people spending and get them borrowing again and increasing credit. I just think that we're too dependent on spending as a society and I think people are better off when they don't have to go into debt in order to fund their lifestyle. They're better off when they have a little bit of a security and the safety net. These are the kinds of things that Betterment recommends to our customers. And yeah, it'd be great if there were more policy that followed suit.

I think oftentimes industry has to lead and policy follows, right? So, I think, we are building this future, this vision of what money should be to actually really work for people to understand how people live today and to help them reach their goals. Over time, policy will catch up with that. Policy will start to formalize around the model that we're building. I believe that. But it is a long, long-term process.

Ptak: I wanted to shift to behavioral finance and advice, and these are things that permeate your offering at Betterment. You've alluded to it earlier in our conversation. I think that you said your interest in creating Betterment was prompted in part by some of your own mistakes as an investor. You talked about your frequent trading, which it sounds like you got over, but you were constantly monitoring multiple accounts. And so, how is Betterment set up to help investors avoid those types of bad behaviors? And maybe if you could give us an example maybe through the frame of somebody--let's imagine that on March 23rd they're seeing their accounts balance having fallen quite significantly and they're kind of freaking out. And so, are there things that you have consciously done to try and settle down that type of investor to prevent them from committing the kind of blunder that can maybe cut their plan to ribbons?

Stein: Right. So, I've got three things in mind. I mean, the first is when you log into this site, what do you see, is that investor who's seeing the market down. Remember, most people … Maybe you and I read the financial news, but that doesn't mean that most people are out reading the financial news every day. And so, when they log into their site, they might be wondering what's going on. And if you present them with a red or a green--and I've seen some of these trading apps, and the entire screen turns red or green, depending upon what's going on that minute. And of course, you're going to prompt behavior and that's what the trading apps want customers to do: trade, trade, trade. We have experimented with this and we've found that if we just show customers their balance, they're much less likely to react to whatever is going on in the day-to-day S&P flows in or out. And ultimately, that drives better performance. Even on our own site we noticed that when customers change their allocation, when they play with the personalization, when they change things around more, they underperform those who just leave it alone, because people are generally terrible at timing the market, but people are terrible at trading. And so, we really try to discourage it and just presentation is one part of it.

A second important thing that we do is Betterment is goal-based. Everything about your plan is based around your goals. We talked about the safety-net goal and that's a part of it. Your retirement goal is another. You might have a college-savings goal. You might have a house-down payment goal. And being goal-based, having a target in mind with a time horizon attached to it, a target balance, means that we can tell you in summary whether you're on track or not to that goal. And we can encourage you about things to do to get back on track.

Now, if the markets are down 20% and you log into your account, I'll tell you, if you've got a 20-year goal, doesn't mean you necessarily need to do anything. That kind of volatility is already built into a 20-year time horizon. And it's OK. It's part of the plan. And so, we'll continue to recommend auto deposit for you; we will continue to recommend regular contributions and staying the course. But seeing things frame that way and having money set aside that way, I think helps people stay the course.

I talked to my own parents in the downturn, and they were they were worried back in March about what should they do. They could be in retirement. They're both still working, but they're at an age where they easily could be retired now. And they were saying, well, we just, we'd like to have a little bit more cash and I said, look, we've talked about this--you have enough cash set aside. It's already in short-term investments. You have enough for two or three years there. You don't need to touch your longer-term retirement investments.

Now, ultimately, they are Betterment customers. I'm their advisor. And I couldn't sway them. They wanted to take a little bit out; they wanted to de-risk a little bit, and they put a little bit more into cash. And that's OK. I mean, at least it was a very small amount of their overall holdings. But I understand that. You know, humans are human, right? It affects me, it affects my family too. But our whole frame is around goals. And that helped them to know that most of their money is on track and didn't need to be touched.

And finally, when customers do go to make a change like that, as they did on that day, we will show the tax impact of that. We will show in the moment--if you have any sort of taxes that you're going to pay based on gains--how much. And we find that when people are just kind of casually looking at making a trade, maybe reacting to something that they've seen, that 75% of people who have a taxable transaction decided not to go through with it because of seeing that tax impact. So, we're saving them not only the taxes but also saving them from making what is likely a bad decision about market-timing. And that's just an incredible result. It's something I'm really proud of. I've been talking about that feature for maybe seven years since we launched it. And still we're the only people in the market who have it.

And part of the reason is, we're the only ones who really are aligned with our customers. I really think most companies just want their customers to trade because that's a big way that they get paid. And so, they're not really helping people make the most of their money. Most customers aren't savvy to that. Most customers aren't paying attention to the kinds of signals they're seeing about behavioral economics through their financial advisors' sight. Betterment cares a lot about this. We believe in the long game. We believe our reputation is really important. So, we do everything we can to do right by our customers.

Benz: You've talked about the importance of removing frictions to help young investors-- younger investors get started--but that can cut both ways. So, let's talk about when frictions are useful and how have you built that into what you do.

Stein: Well, for us, it's just generally great to get people investing early. Young people--we're going to set them on the right course and the earlier the better. I don't see a way that that cuts the other way. If you're going to go and pick stocks, having a little more friction there is actually good because free trading is actually going to cost you because you're probably going to buy things and lose money. Most individual investors who go out and just pick stocks are going to lose money in that. And I've seen that as a customer; I've seen that as a consultant working for some of these brokers back in the day, who would literally take the other side of their clients' trades and that was a source of profits for them. Using retail-order flow, if you just do the opposite of what retail customers do, it's a great profit-driving engine, because people are that bad at trading. So, I guess, I think that some friction around that kind of trading could be good, but not friction around the way that Betterment advises portfolios.

Ptak: You have a lot of experience trying to digitize financial advice. Based on that what do you think advisors tend to most underrate and overrate that they offer to clients?

Stein: Wow. I think that advisors are just tremendously valuable in general, and I don't think that advisors overrate their value. I think that they generally underestimate it. I think customers underestimate it. I'm very bullish on financial advice. I think that we are in a prolonged period of the ascendance of advice. We've been seeing it for the last decade. I saw it before I started Betterment a decade ago. I saw that advice was growing. Registered investment advisors were growing assets. It was part of my thesis for wanting to build an advice-focused business. And I think we're still in early days of this. Gone are the days of just like, go figure out your financial life on your own. I hope for most people that's going away, because it's just, it's terrible, why? It's like, if I told you, you have to figure out how to build a house entirely on your own, you might have fun with it. But if you've got a job, you're not going to be able to do a very good job of actually learning all of it and doing it right. Or if I told you that you're entirely responsible for your own healthcare, there's no doctors, you get to pick any drug, you get to do any procedure, but you have to do it on your own. You'd say, can I get a little help?

Well, frankly, the financial world has become more and more complicated over the last century, right and particularly so over the last 10 or 15 years. We just live in a more complicated world. And our advice system hasn't kept up and the acceptance or adoption of advice hasn't kept up. It is accelerating. More and more people are adopting platforms like ours. I think that our vision of a smart money manager that goes beyond just your investments but helps you make better every day smart financial decisions has been broadly accepted by the industry. We're seeing more and more competition. We're seeing people come in and kind of get it. But we're still in the very early days of the growth of advice.

Where financial advisors might sometimes--I think that this is common knowledge now probably among your listener base--where they might overestimate their value is on things like portfolio creation. Of course, a financial advisor isn't going to create a better portfolio than a broad-based smart, broadly diversified index, unless the customer has a unique situation. And if you're building around that customer's unique situation, maybe that customer has a lot of exposure to a certain industry because she works there or has a large embedded gain and she can't unload it because she has a bunch of stock that she inherited or something like this. Maybe that wouldn't be in that case, but you get the idea. Certainly, in those cases, you can help to adapt a portfolio around them, but I think most advisors overestimate the value of portfolio creation and might underestimate the value of things like just saving more.

The most important thing we can do--I remind our team often--is to help our customers save more. If I can get a customer to save 5% more per year, over the long term, that's going to swamp by an order of magnitude, the impact of here's an additional 50 basis points of tax alpha, or here's an additional 50 basis points of supposed portfolio alpha, and it's guaranteed, right? If you're saving more, boy, you're sure to see more savings in retirement by doing that. So, that's the most important thing is those things that you can control, and that really is savings rate at the very top of the list.

Benz: Switching over to Betterment’s services. Let's start by talking about your original offering, Betterment Digital, a pure robo-advisor charging 25 basis points a year. What are the benefits for new advisors of choosing Betterment Digital over, say, a target-date fund for their IRA?

Stein: I like to think of Betterment as the next iteration of a target-date fund. Just imagine that target-date fund is now personalized to you instead of just being you and 5 million people who are going to retire within five or 10 years of you. And if your situation changes, it adapts to you, and it's tax optimized for you. And all of that I think of as a value. A few specifics. So, one is that for the average customer who's saving for retirement over a 30-year horizon, by investing with Betterment, they're going to have 38.8% more cash in their account after taxes when they retire than if they were to invest on their own in say a zero-fee target-date fund with no trading costs. We have a white paper where we--you can find it on our site--where we talk about this analysis that we've run. And a lot of our advantages come from tax advantages that you may think you wouldn't see as much of in an IRA account. And yes, having a taxable account and a 401(k) and an IRA, having all these different types of accounts actually benefits you, because we can do some clever tax things across them. We can put your high-return investments in your Roth; we can put dividends into tax-shielded investment accounts; we can tax-loss harvest in your taxable accounts. But even if you don't have a taxable account, we can still do asset allocation; we can still do smart rebalancing and things that help you to make more of your money over the long term.

Ptak: Maybe shifting gears a bit, it seems like for someone to be able to take maximum advantage of what Betterment has to offer, they ideally have to give you some information about their situation and their other accounts and they'd sync those accounts with Betterment systems. So, the question is, how do you thread that needle, getting people started so that you can propose good holistic solutions for them without bogging them down in sort of the data-input process?

Stein: Well, the best thing for someone to do is just to transfer all their money to Betterment, and we make that really easy. So, you can use automated transfer systems. We link to all the major brokerages out there and we can automatically transfer that for you. We have a rollover concierge who can walk you through the process that makes it really, really easy. And it can be done all electronically in most cases. You can just do it yourself through the website, following the prompts if you don't want to call us up and talk to one of our advisors about how to do it. We help customers make plans. So, many of our customers are creating their plan on their own. Others are calling us, and we have a premium service. Still others are working with financial advisors on our Betterment for Advisors platform and that advisor is making the platform and doing the transfer of assets.

But ultimately, the answer is to just, yeah, move your money to us. Betterment works best when you consolidate on Betterment, because we're making you more on every dollar. And so, you ought to have all your money with us. If you're doing it somewhere else, frankly, you're not doing as well. And I think that, yes, you can aggregate when we show you, maybe you have some reason, you just can't move a certain asset type. We don't support every asset type yet. If you've got a single stock that you want to hold on to somewhere else. Sometimes we can transfer that in, but there may be some assets that we can't hold yet. And so, we'll aggregate that, and we'll show you a full picture. And of course, it takes some people time to get comfortable with a platform like Betterment, right? Maybe they want to try it out before they consolidate everything and go all in. That's a very common path. And so, for them, yeah, we have aggregation. We will show you your full financial picture at Betterment, things that you have with us and things held elsewhere. And that view is used to help us make recommendations about your accounts and your allocations and your contributions and all the advice that Betterment gives to our customers.

Benz: Your portfolios include exposure to plain-vanilla total-market ETFs, but they also incorporate fairly meaningful size and value tilts. I was running through some portfolios yesterday and one that I looked at included 60% of its U.S. equity position in a total market index and then another 40% in various value ETFs, large, mid and small. So, assuming that those tilts toward value have hurt performance relative to a total-market portfolio, have you had internal discussions about backing off of the tilts? And maybe you can walk us through sort of your process for reviewing and updating your firmwide portfolio strategies?

Stein: Yeah, I'll start with where … Actually, we've got a team meeting today from our investing team, just talking about some of the things that we're working on, some of the latest and greatest that the investment and advice teams are putting together. They just really inspire me, the folks on the investing team because they're so customer focused and so thoughtful and analytical, and we have a robust process. They are looking… we have screens running all the time around what are the lowest-cost funds in each asset class, what are the least tracking error and low cost to trade. So, we look at multiple forms of cost and risk in evaluating the funds that we select. And so, in each asset class, we have these automated screens that recommend these are the best funds in this asset class and quarterly or so we'll meet to make changes. I guess it is every quarter we do but we don't always make changes. And we evaluate these factors. We have this documented process that we're following based on these costs to choose the right primary ticker in each asset class, secondary and tertiary. And that way we have the one that we recommend for most of our customers plus some alternates that we can use for tax-loss harvesting and other strategies that we employ for our customers. And that's always running.

We are also looking at the weights and the tilts across our funds. And we use a Black-Litterman optimization to come up with what the weights should be. And we're updating that regularly as well. We dynamically update customer portfolios. We don't just pull the trigger and trade everybody, but we look at things like what the taxable impact of this… I love the team--in the volatility that we saw in March, we saw an opportunity to transition some customers who had been on an older version of the portfolio, but because there were some losses in there, we could taxlessly transition them towards the newer portfolio, and the team just sees these things come up in the data; they come up in the screens; they’re run automatically; we notify customers to see if anyone doesn't want to make that change, which we believe is beneficial for them and then we go through and execute it. So, that's always running. And we've got our quarterly external investment committee where we'll meet to talk about some of the new ideas and the next generation of investment management, plus what should the overall philosophy around tilts or exposures be, the things like you mentioned.

Ptak: As a student of markets, do you still have faith in small and value as being tilts that pay off to investors, as we know those styles have slumped mightily for an extended period of time now. And so, I guess has that broken your faith in those types of tilts in a portfolio?

Stein: I think they probably don't help much, which is why our tilt is very minor in those things, but I also don't think they hurt. I think over the long term, they're probably just a little bit better than average, which is what the long-term data would show. And of course, that effect can go away for periods of time, but historically, it's returned. And part of that, you know, the case that I believe is that over the long term is that there are behavioral reasons why these things happen. People pursue growth stories, people know large-cap names. And so, there's some behavioral mispricing that goes on and our strategies seek to take advantage of that for customers over the long term.

Benz: Does Betterment Digital provide any guidance on nonportfolio allocations? So, maybe I'm someone who has issues with debt, or maybe I'm an older adult who would benefit from an annuity. Do they give me any guidance on doing things with my money that don't involve my portfolio?

Stein: Our site will tell you if you have a lot of debt, don't invest. Generally, the rule of thumb--although it comes through in different places in the site--but a rule of thumb is, if you're paying more than 5% interest on debt, you probably want to pay that down before you're investing. And our human advisors will of course do that. But we don't provide a ton of advice around debt within the service because we really focus on everyday cash management, on saving, and on long-term investing. Those have been our sweet spots. We don't ourselves issue any debt. I see that as a strength. I think a lot of services are looking to push customers into debt or encourage debt. And we don't. I think that's generally not good for most people to be taking on debt. There's situations where you have to if you're buying a house, it's very common; if you're going to college, it's very common. But those situations are relatively rare and pretty well served, I think, by existing lending options.

Ptak: Shifting over to Betterment Premium, which provides unlimited access to a CFP for people with accounts of more than $100,000, if I'm not mistaken. I'm just curious. It's a fee-based model. But we've talked to a number of planners and advisors who had become, I would say, increasingly outspoken advocates of the hourly model. And so, we were curious whether that's a model that you've considered incorporating into Betterment's offering or if not, what some of the obstacles to that might be?

Stein: Indeed, we have, and we have that offering. So, you can come to Betterment, you can just use our digital service and get access to all the things that we've been talking about on this call for the very low fee of 25 basis points and all the kinds of returns projections idea are all net of that fee. You're getting this performance benefit on top of that.

You can also come to us and you can pay for an advice package. So, you can pay an hourly rate. I think the packages range from $99 to maybe $399. And it's not per hour, but it's for a package of several hours of consultation with our advice team. And the packages are around themes like college savings or buying a house, and we'll do some analysis for you. We'll take your data into consideration, we will talk with you, and we'll make sure you have all the right factors in hand, and then we will arm you with an answer to better manage retirement, for example. And all of the advice is fiduciary based. We're not selling products. We don't sell annuities. Again, we're an advisor. And so, I am a big fan of the hourly advice movement, and it's something that's available to all of our customers to pay on as an add-on to the generally great investment management that we provide to all of our customers.

Benz: Are the CFPs you work with employees of Betterment or are they contractors?

Stein: We have both. We have a number of employees on our team that talk with our customers all the time. They're full-time employees. But we also have our Betterment for Advisors platform. So, any advisor--and we work with thousands of advisors--many are startup advisors, or some are very large-scale nationally known brand advisors. And they manage their clients' money on Betterment. We provide the recordkeeping, the billing, the account management, the tax management, so that the advisor can spend time making sure that they get the plan right, doing the kinds of consultation that I've mentioned that we might charge hourly for and we love working with those advisors too and their clients. It's a really exciting and fast-growing part of our business today.

Ptak: You mentioned it earlier--you've made forays into the 401(k) market. I'm curious what you've learned from that experience.

Stein: Well, one that in general, you know, B2B is a different beast as you can see. I think if I learned anything it's that I have a large ambition to build an advisory business, a direct-to-consumer business, and a B2B business. And taking on all those things at once has definitely been a challenge. But we continue to invest, we continue to push it and grow. And recordkeeping for 401(k) is tougher than I thought it might be from the get-go. I knew it would be hard. And fortunately, we were building on six years of already having a recordkeeping for our consumer business before we got into it. So, we had the trading mastered, we had the portfolio creation and glide pathing and all of that kind of stuff was in hand. But as we built out 401(k), we've learned a lot about the space. I think I mentioned earlier, we have the most accessible 401(k) today. And I've learned that employers really want everything to be seamless and easy. So, when I talk about accessibility, there's so much … A lot of the small businesses that we're working with--yes, they want something that's low cost, it's got to be cheap. But time is money. And so, it has to be the absolute easiest thing in the world. And I think that that's where we shine. It's low-cost, it's easy, and it's a great experience for the participant. But having all of those is important to closing the deal with a B2B partner.

Benz: Earlier in the firm's history, you were competing against other independent robo-advisors like Wealthfront. Now, you're up against much larger firms like Schwab and Vanguard and the like. What competitive advantages do they have over your firm and what do you think you have over them?

Stein: I said when we launched back in 2010 that if we were successful, we would have lots of competition. We'd see every firm in the industry would have to get into this space. Now, at the time I said that, and maybe I only half believed it, because I wasn't sure we'd be successful. I thought, boy, I have this vision of what I want the future to look like, but, of course, I wasn't sure we'd ever get $10 million on the platform. And it took us a while to get to scale. But today, the movement that we started back then does feel inevitable and it feels like we've got lots of imitators. There's lots of people coming after us. But I think if you take a closer look, they're very different. They're very few, if any, that are as customer-centric as Betterment is. I think we have the brand and we're known as being really the consumer champion, right? We really advocate on behalf of our customers. We do everything we can to help make the most of their money and that is unique. We don't sell our own product. We don't manufacture our own funds and try and cram them into our customers' portfolios. We've never done that; we will not do that. I see every other competitor out there essentially doing that--double dipping as I like to call it--by selling you the advice and selling you the funds. I think that's a mistake. I think it's a shortsighted, profit-seeking and long-term growth-destroying kind of a mistake. Betterment is the consumer champion. And I think that's what differentiates us from the competition.

Benz: I guess a question is, do you think Betterment will be a stand-alone entity in three years and how important has independence--it sounds like it's been very important to the firm's identity and success--but let's talk about the direction and evolution of the firm.

Stein: I've always said that for us to realize our ambitions we ought to be a stand-alone public company. We ought to be stand-alone because I think that there's a lot of conflicts in the industry and it's impossible to avoid all the conflicts. So, try as I might, and despite all the things I say, we also have conflicts, right? Unfortunately, there's no such thing as a company that's not … For instance, we're looking to make money, right? We are looking to profit. And that immediately puts us at odds, in a sense, with our customers. Now, we do everything we can to minimize that. And I think that that drive and that ambition is, I think we benefit from being independent. There are some amazing public companies out there that share my passion and enthusiasm for doing what's right by the customer. And I would never put it out of question that we couldn't find ourselves a home within one of those companies. But my ambition has been to be public, has been from the beginning, and I think we're on a good course today to get there.

Benz: You've been an outspoken proponent of a fiduciary rule. Does Reg BI fall short in your view?

Stein: It's complicated. Yes, I've been on the record of saying … I think that ultimately what we did was not just fall short but reverse the fiduciary standard. Reg BI says no one is a fiduciary, and in fact, it says they never have been. Why did you ever think you could have a fiduciary? I think that's disappointing. I think the ideal of having somebody who has got your back, who has to make the right decision for you, the client--I think that should be extended to investment management. I think you think you can trust your lawyer; you think you can trust your doctor; most people think they can trust their financial advisor--I think the regulations ought to support that.

Instead, what we got is, Reg BI, which says no one is actually a fiduciary. You got to do what's suitable for customers. And I find that to be a disappointing outcome for customers. But I think things will continue to evolve. If I see a silver lining, it's that we have one standard. So, we can no longer argue about which is the right standard or which is better. We just have a single standard across the industry. And now, we can push to make that standard better. I have no illusions that that won't take a long time, because there's a lot of lobbying money and a lot of vested interests who fought against the fiduciary rule in the first place who are fighting now to see that they don't have to do more customer-friendly things.

Benz: Well, Jon, this has been a super interesting discussion. We really appreciate you taking the time to share your insights with us today. Thank you so much.

Stein: Thanks so much for having me. It's always a pleasure. Thanks, Christine. Thanks, Jeff.

Ptak: Thank you.

Benz: Thank you.

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts. You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)