The Future of Financial Advice

The comfort of pensions once provided by blue-chip companies may be replaced by the promise of smarter technology.

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In January 2006, IBM froze its defined benefit pension plan for new employees. Exactly a year later, Apple announced the first iPhone. Both events are important milestones.

IBM was once synonymous with stable, lifetime employment. A life-long career was rewarded with the kind of retirement security that is virtually unattainable today.

The iPhone was a milestone in a revolution: hyper-connected, consumer-centric technology that is accessible, powerful, and infinitely customizable to our personal needs.

I believe that personalized technology, like the kind we are pioneering at Betterment, will resurrect the feeling of ‘defined benefit’ in a defined contribution world. The comfort once provided by blue-chip companies has now been replaced by the promise of smarter technology.

I believe that personalized technology, like the kind we are pioneering at Betterment, will resurrect the feeling of ‘defined benefit’ in a defined contribution world.

How We Got Here

A New York Times article earlier this year captured the common angst of modern retirement planning. It’s the story of a well-compensated professional who has lived a frugal life, has diligently contributed to his 401(k), and, still, thoughts of retirement fill him with dread. His pile of account statements offers him no comfort.

It wasn’t always like this.

Defined benefit plans, also known as pensions, were once the predominant form of retirement security. They were simple and predictable. Employers were responsible for managing the investments, and employees, once retired, could expect set monthly payments for as long as they lived. In 1979, 67% of the private sector workers who had a retirement plan available to them participated in a defined benefit plan.

Today, that world is nearly gone. By 2012, just 30% of workers participated in a defined benefit plan and many surviving plans are frozen and do not accept new employees. Instead, 70% of workers participate in defined contribution plans—primarily 401(k)s. With these plans, employees have nearly full control, and there is no guarantee that their savings will last.

Private Sector Participants by Plan Type


A string of legislative changes has contributed to this tectonic shift, underscored by cultural and market forces as well. Gone are the days of lifelong tenure with one employer, as Americans increasingly change jobs and geographic locations, and pursue career opportunities with greater freedom than ever. IBM’s announcement was as much a concession to employee preference for portable benefits, as an acknowledgement that administering such a plan was no longer practical.

Masters of Our Own Retirement Destiny

And so, most of us are now responsible for not only contributing to a plan, but also for choosing how to invest the funds. In many ways, the freedom and flexibility we gained from these changes are worth it. Yet few can deny what was lost, because it is so apparent on an emotional level. There is no amount of projections, expected returns, or glide paths can make us feel secure like a guaranteed pension did.

Sure, even pensions were never fully guaranteed. Pension plans have failed for almost as long as they’ve existed, typically due to mismanagement: inadequate funding and/or poor investment decisions. Still, they’ve always been a surer thing than self-directed management. Professionals make mistakes too but, on average, you’ll surely get a better outcome than when everyone is driving themselves.

Indeed, as the trickle of assets into 401(k)s in the 1980s became a flood in the 1990s, it became increasingly clear that giving the average American full responsibility for managing their own investments set off a slow-motion catastrophe. For every investor who is able to (1) have the discipline to max out each contribution, (2) avoid the siren call of stock picking and choose low-fee index funds, and (3) stay the course in the rockiest markets, there are likely dozens who fail at one or more of these behaviors.

Recent findings from Financial Engines, an investment advisor to 401(k) plans, dramatically demonstrate the advantage of receiving some sort of guidance (defined as either the use of a managed account, a target-date fund, or online advice). From 2006 to 2012, on average, 401(k) investors who used some kind of help outperformed those who did not by 3.32% annually, net of fees.

Median 401(k) Returns, 2006-2012


Meanwhile, a new academic field gained prominence, helping explain this phenomenon. Behavioral economics unleashed a relentless stream of evidence that when it comes to money, our decision-making apparatus is thoroughly riddled with biases. Traditional economic models tended to cast individuals as cool, calculating beings—but new research from behavioral sciences increasingly showed us to be deeply irrational.

The deck is stacked against us humans as effective long-term financial planners. But most of us are now managing our own, personal pension fund.

It’s a troubling combination.

The Next Chapter

In the 1990s, technology began a frenetic transformation of every aspect our economy. For two decades, however, it was hard to argue that technological advances in finance were actually producing a net benefit to the average American.

Online discount brokers made it vastly easier and cheaper to trade stocks, but most people have no business trading stocks—it was like handing them a sharper knife with which to cut off their own fingers. Vast amounts of engineering effort were poured into proprietary technology used by hedge funds, and later, high-frequency traders. As other sectors of the economy saw tremendous advances in productivity and convenience, financial technology benefited only the few.

These developments, however, were essential in driving down transaction costs, setting the stage for the 21st century financial services which are now emerging. Now, three trends are converging to create a new generation of financial services that are benefitting the individual investor at last: mature internet technology, intuitive interaction design, and a keen awareness of our behavioral biases.

My company, Betterment, launched in 2010, was the first to apply these concepts to personal investing at scale and our product created the category of automated investing, or so-called ‘robo advisors.’

We ask for your financial goals and then make recommendations to help you achieve them. We then construct diversified investment portfolios online, automating strategies that used to be manual, expensive, and available only to the wealthy. Sophisticated rebalancing, tax loss harvesting, dynamic retirement income—these are now available at scale to over a hundred thousand customers.

No account is too small when software is doing the work. Unlike with the discount brokers, the new business model is aligned with the customers’ interests: it is low fee, calculated as a percentage of assets under management. Companies that earn their revenue this way are incentivized to encourage customer saving, not constant trading. And our algorithms are constantly monitoring and checking the portfolios we recommend, providing automated services and advice when things get off-kilter—this is more than a simple buy-and-hold strategy.

But these are still early days for platforms such as ours. Automated tax efficiency, a delightful interface, mobile convenience, truly paperless accounts—we are just scratching the surface. The big picture has always been to give customers peace of mind—to get people on track to meet their financial goals, and to keep them on track. In other words, to stack the deck for success.

“Any Sufficiently Advanced Technology Is Indistinguishable from Magic” - Arthur C. Clarke

How will this look? More integration, more automation, more personalization. No one iteration will be earth-shattering, but in the aggregate, it will feel like magic.

All of your accounts will not just be aggregated, but seamlessly integrated, from your bank, to your Roth IRA, to your 529 plan, to your HSA. We’ll know about your assets, but also about your liabilities: mortgage, student loans, credit cards. Algorithms will ensure that you are making the optimal decision at every point (and where appropriate, they’ll make the decision for you). Every rate will be crunched, and every dollar will be routed where it’s expected to maximize your wealth and help you reach your goals.

Forward-thinking, tech-savvy policy makers recognize that government can play a crucial role as an enabler of progress. They are already working on a framework that will allow us to build seamless, ‘magical’ experiences. Your accrued Social Security benefits will be downloadable directly from the government. Algorithms will integrate this data into projections, and will give you automated advice on how to maximize your eventual benefits. Likewise, you’ll authorize for your tax returns to be securely downloaded directly from the IRS, and your personal tax rates will be used to optimize every transaction.

Once in retirement, each income payment will be funded from the most tax-efficient source (taxable, tax-deferred or Roth), factoring in required minimum distributions, along with your evolving lifestyle needs. Our Retirement Income service already advises you on how much you can safely take as income, and automates that cash flow, but this is only the beginning.

And what about behavior? To date, the nascent field of machine learning as applied to finance has largely been limited to detecting patterns in large datasets (e.g. fraud). In the not-so-distant future, algorithms will learn about you directly from your actions, goals, and circumstances. They’ll automatically customize your advice, dashboards, design and alerts to put the levers that matter most to you and your situation front and center. They’ll answer questions before you even ask them. The interface will be about your future, not the past.

Some version of the things described above is currently done manually (i.e., less efficiently) by financial advisors for wealthy clients. Many industry observers are fixated on whether digital financial advice will 'replace' human advisors. This misses the point. Technology always has been, and always will be, a tool. The same tools that empower an individual to build and maintain her own financial plan, will give a skilled professional the leverage to simultaneously service 100 complex clients instead of 10. Advisors flocking to our advisor platform recognize this immediately. Good advisors will flourish, and more clients will benefit.

The New Infrastructure

Transportation offers an irresistible analogy for how this revolution will play out. The automobile ushered in an era of unprecedented freedom for us to live and work in entirely new configurations, suited to our personal preferences. However, it came at a cost—safety, environmental impact, and free time were all implicated in the trade-off. With the ability to move around exactly where and when we wanted, came the responsibility of operating and maintaining an expensive and complex machine, with very high stakes.

These days, you don’t have to be a techno-futurist to see that companies like Google, Tesla, Uber, and Lyft will eventually give us the best of both worlds. Self-driving, self-charging electric cars on demand will combine the hands-off ease, safety and efficiency of mass transit with the freedom, convenience and infinite customization of driving your own car. A fully automated network of personalized transport will be the new normal, and science fiction will become just another layer of infrastructure we take for granted.

The great financial services companies of the 21st century are on the cusp of becoming household names. Expect a similar revolution—you will have your peace of mind, designed just for you, and everything will just work.