His educational background is in software and design, but he’s had a passion for investing for years. He’s worked at major companies like Apple, eBay and Linked In, and is now working to add the many benefits of technology to investing at Wealthfront.
We cover a wide range of issues. For example, Adam talks about the often confusing topic of transferring taxable accounts with substantial unrealized capital gains. Wealthfront is developing strategies to gradually migrate assets into a new portfolio. The idea is to minimize the income tax bite in the process through features like tax loss harvesting.
I really liked what he had to say about tax loss harvesting. Adam emphasizes that tax loss harvesting is one of the central benefits for using a platform like Wealthfront. It is not available through traditional fund investing. In fact, historically, it has only been available to the very wealthy. Wealthfront offers TLH to investors small and large. Wealthfront’s strategy of using tax loss harvesting enables you to take advantage of the benefits it provides, while still maintaining the desired level of diversification in your portfolio.
Wealthfront even launched a fund last year – the Wealthfront 500 – that matches the composition of the S&P 500, but includes optimizing for tax loss in the management of the fund.
Adam also discusses the limitations of target date funds – an increasingly popular choice amount investors. He maintains that target date funds based primarily on age are an oversimplification because they fail to take into account other important aspects of an investor’s profile, such as preferences and risk tolerance. Wealthfront is set up specifically to incorporate these factors into the investment mix. And though it is not a target date fund, Wealthfront provides much the same result but based on a broader range of considerations. This is because Wealthfront is not limited by the restrictions that apply to mutual funds.
There’s a telling quote from Adam in the podcast that explains Wealthfront‘s overall strategy:
“All our success at Wealthfront has come from looking at things that the ultra-wealthy get in terms of financial services.”
That kind of insight from the CEO of an investment service of any kind makes this podcast well worth a close listen.
The following resources are mentioned in today’s podcast:
- Wealthfront Tax Loss Harvesting
- Wealthfront Investment Methodology White Paper
- Adam’s blog: Psychohistory
- Wealthfront Review
Transcript of my interview with Adam Nash
Rob: Adam, welcome to the show.
Adam Nash: Thank you. Glad to be here.
Rob: I am thrilled that you’re on the show. I’ve been on your website which is a fantastically designed website and I’ve wanted to talk to you for a while because I think what you guys are offering is really great. Most of the podcasts I do are for the listeners, but this one is for me. Well, for them too. As a starting point, Adam, why don’t you tell folks who you are and what you do?Adam Nash: Sure, I’d be happy to. My name is Adam Nash and I’m the CEO of Wealth Front. Wealthfront is the largest and fastest growing automated investment service out there. We now manage over $1.6 billion and we’re less than three years old. We launched in December of 2011. For me, this is a dream job. I’ve been interested and passionate about investing and personal finance for decades, since college. I actually have my own personal blog on the topic for about 10 years now. But, I came out of school focused on software and design, and really, the challenge of how technology can help people do the things that they do, better. I’ve worked at companies like Apple and eBay. Most recently I was the Vice President of the product, Linked In. So I really like going after big markets where there are clear problems facing a lot of Americans where I think technology can add a lot of value. There’s no question in my mind that automating the best practices around investing is one of those huge areas that has resisted disruption in the past, but is ripe for a change. I joined Wealthfront a little less than two years ago. We had less than $100 million under management when I joined and the growth in the past two years has just been phenomenal. Almost more than 1,500 percent. So we’re excited— I’m excited. I get the opportunity to build a fantastic team, doing brilliant work in investment research in software and design and hopefully add a lot of value for millions of individual investors who, frankly, need it.
Rob: Yeah. That’s great. You mentioned you had a personal blog. Do you still keep that updated?
Adam Nash: You know, I don’t get to do it as much as I used to. It’s still there. It’s called, Psycho History.
Rob: Psycho History, okay.
Adam Nash: It’s the along the lines of the science Isaac Asimov defined in his foundation theories. It was based on the idea that actually there is a science to the irrationality of people due to the computer reaction. But one of the big challenges when you use software is when you realize that machines are actually incredibly logical. The hard part is that humans are emotional when they use technology, so building great solutions is rarely simple and lined up with ones and zeroes. I find this fascinating all the while with the Heathrow Finance which is another passionate area of mine where, once again, money is very rational. The dollars and cents really do add up but humans are very emotional about money and make decisions in unpredictable ways. So the idea of the blog is to kind of talk about all these topics. It’s a personal blog, and actually, I do most of my blogging today on the Wealthfront blog so it’s not quite as exciting as it used to be.
Rob: Well, I’m looking at it now and I will link to it on the show so the folks can check that out if they are interested. So, tell us about Wealthfront. How does it help people become more effective investors?
Adam Nash: Actually, it’s very simple. Wealthfront is a relatively new service. It was launched in December, 2011. Before Wealthfront launched I think there was a lot of skepticism about the idea that people would use an online service to manage their money. No one had coined a determined automated investment service. No one even thought that was a category. When we made a billion dollars in less than two and a half year (which we hit in May of this year) a lot of that skepticism vanished, quite frankly, and flipped over to more open-minded questions like, “Why is this working? Why is there so much wealth? Who are the people trusting their money to this service and why are they doing it?” I think it’s pretty simple service. It really is an automated investment service that is designed to be incredibly simple. It goes through an updated analysis of your risk tolerance which is based on both objective and subjective criteria that gives you a risk score which maps to a level of volatility that you can tolerate in your portfolio. We’ve done all the hard work of finding the best ETFs, having different asset classes at ranks by low cost. It’s also tracks error and other sophisticated techniques liquidity and then we give you a portfolio of up to 11 different assets classes optimized for both tax portfolios and tax deferred portfolios like retirement accounts, IRAs, etc. Now, if you want to use that portfolio advice, it’s free. You don’t even need to give us an email address. So if you want to go to your brokerage account and like to do these things yourself, you can go and buy that portfolio. What people pay Wealthfront for, is actually automation. If you want Wealthfront to do it for you, it’s incredibly easy. You link your bank account, or you can transfer over a brokerage account. We will take care of not only investing your money in the ideal portfolio for you, we also automate all the best practices that individual investors should be doing but too often aren’t. We do trigger-based rebalancing. We do intelligent dividend reinvestment and we do tax-loss harvesting. On our larger accounts we have features like Wealthfront 500 which actually gives you the ability to optimize for tax losses within an index. We offer a range of services and are well known in the category of innovators. Most of the features that have defined the automated investment service are things that we launched first. We are all just so excited. I think that there’s an incredible array of things that we can do to automate investment for people so they don’t make the mistakes that too many of us succumbed to when we are managing our own money.
Rob: Okay. You have given us a lot to work on here. Let me break it down in a piece-by-piece fashion here so we can digest everything you’ve just said. Let’s begin with this. What account types do you offer?
Adam Nash: Oh, good question. As I mentioned, we have both taxable accounts and retirement accounts. For taxable accounts they can be personal accounts, joint accounts. We also support trust accounts and even corporate accounts like LOCs. For retirement accounts, we support normal IRAs—traditional. We also support wealth IRAs. For small businesses, we support SEP IRAs as well.
Rob: Okay. Let me address one of my first personal hiccups for using the service like what Wealthfront offers, and that’s the 401K. If I were to move my IRAs and my taxable accounts over to Wealthfront, as I understand it, I can’t move my 401K. I might get the convenience of Wealthfront for those accounts that I move over but I’m still kind of stuck doing all of the rebalancing, dealing with dividends and all that sort of thing for my 401K. First of all, am I right about that? Wealthfront can’t help someone with a 401K.
Adam Nash: Actually, there are two cases of the 401K. For your current employer, you’re correct. If you’re currently employed at a company that offers a 401K and you take advantage of it, you can’t roll that over to a third party service. You probably know most people switch jobs fairly frequently. And that’s becoming more common instead of less common. And when you leave a company, there’s too many individuals, quite frankly, who leave their money in a substandard 401K… One with poor investment choices, poor service and high fees. And, actually, many people more often do roll over those 401Ks once they leave their jobs for a new job, to a service like Wealthfront.
Rob: Right. And obviously they can roll it over to Wealthfront. That makes sense. The question I have is about my 401K at my current employer. Down the road, do you see the industry somehow being able to work with that kind of 401K? Is that, at least as far as we can see in the future, not something that’s possible?
Adam Nash: The 401K is a bit of a painful subject. For me, having seen firsthand how earnest 401K committees are trying to do the best thing for employees, but are limited in terms of the options that are available. It’s quite frustrating if you are passionate about personal finance and investment options for individuals. I think the reality is, that 401Ks do see some form of improvement. Some 401K s offer some form of automatic rebalancing, for example. But it’s very hard to advocate. Most 401Ks have very poor fund choices. They don’t cover all asset classes. They tend to have exceptionally high fees. And more importantly, those fees are rarely disclosed properly. They’re built into fund costs and other costs that plague the individual. So with a few notable exceptions, there are some exceptional 401Ks out there. Most people switch jobs quite a few times in their careers. Actually, right now for young people, most of our clientele are under 35. Most young people switch jobs every two to four years. Our best advice is to take full advantage of matching. Take full advantage, if you can, of the tax deductions. When you leave your job, take advantage of the fact that you can now roll your 401K over to a good service with lower cost funds and better selection in options.
Rob: Why doesn’t Wealthfront get into the 401K business? Or is that just not quite so easy?
Adam Nash: We’re not even three years old yet, so— Sometimes your eyes can be bigger than your stomach. Frankly, it’s a very common request that we get. I don’t think that we’re alone, being dissatisfied with the 401K options. The truth of the matter is that the 401K business is very difficult to get into. It’s a large enterprise sale. There have been start-ups that have tried to get into that business. Most notably, Financial Engines, which is a company worth billions of dollars— It took them a long time to make a dent in that business. We would love to find a way to help people with their 401K accounts. But right now, what we discovered, is that for young people while they are saving for retirement (in the ideal case) with their 401Ks, there are also a lot of other saving goals they are saving for. And the appeal of an automated investment service is incredibly valuable to them. Because they change jobs so frequently, the fact that for a couple of years they some have assets in a 401K is really a short-term issue. Eventually they’ll leave that job for another one. Then they can roll that 401K in with all their other money at a service like Wealthfront.
Rob: For taxable accounts, I don’t see how I could move my taxable accounts right now without triggering significant tax liability? Am I missing something? Is there any way for me to take taxable accounts to have unrealized gains and move them to Wealthfront without incurring the tax liability?
Adam Nash: I love this question because it’s a very real issue. As a reminder, most of our clients are under 35 and from many of them, this is their first investment accounts. We tend run into this problem with either savers who’ve got an incredibly early start with investing or folks who are a little bit older who have an older investment account. Not just having an investment account, but one that’s old enough to have accrued significant gains.
Rob: Yes, that’s me. I’m the old guy.
Adam Nash: It’s a great question and I think it’s smart of you to bring it up. Actually, I’ve seen too many people ignore taxes as a very real investment concern. You’ll see people who are well meaning who are so worried about 10 or 20 basis points on expenses that they’ll incur thousands of dollars in immediate tax liabilities, not really doing the math on what’s more important. So I love that you raised the issue. So the short answer is that we do take taxes into account. We are one of few services out there that supported brokerage transfer from the beginning. If you move assets to us through our brokerage transfer— thanks to some regulatory changes, we actually are aware of the cost basis that you originally paid for these investments. There are cases that we will not migrate assets immediately to the ideal portfolio. There is mathematics that you can do weighing the benefits of a diversified portfolio with features like tax loss harvesting versus the taxes that you would pay in the short-term if you liquidate. It doesn’t come up as often with younger customers, but if you do a brokerage transfer at Wealthfront, you will be given options about how long you want to take to translate your current portfolio into what we consider the ideal portfolio.
Rob: Interesting. So I can transfer portfolio in kind and you will hold them. And, again, depending on the specific circumstances, I might slowly convert those into the Wealthfront ideal portfolio over a number of years?
Adam Nash: That’s right. We see people do this a couple of different ways. One way is by transferring assets. Sometimes they have multiple accounts. It might be one account, one year and another account in a different year. It’s not uncommon for people to actually have many investment assets (especially older investors) in different places. Or in-house, we can actually give you some control. There are situations where, if you’ve been holding the S&P 500 for 20 years, you may be sitting on enough embedded gains that even though would be better to be in a more diversified fund like DTI, it may never make sense to sell that. We pride ourselves on being tax efficient and tax aware. I think we are the first automated service to even offer tax related features in the first place. So I love that you bring up this issue especially for older investors. Being smart at tax like Burton Malkiel who is our chief investment officer who wrote the book, A Random Walk Down Wall Street, has a great way of putting this where he says there are three things that you can control. You can’t control the financial market because it goes up and down so you don’t have control over that. But you can control our fees, diversification and taxes. And there‘s quite a few investors who ignore that third bucket. It’s really a very important. Some of these tax-efficient— Even being smart when you’re withdrawing money, about choosing the lot that has the lowest gain, can have a phenomenal effect on the overall performance of your portfolio.
Rob: Right. You mentioned fees. My understanding with Wealthfront is that accounts over $10,000— The first $10,000 I guess there’s no Wealthfront fee. Above that it’s 25 basis points plus the cost of the ETFs?
Adam Nash: That’s right.
Rob: So why Wealthfront? Why not just buy a Vanguard target date fund?
Adam Nash: I think the Vanguard target date fund is a phenomenal product. Target date funds have had a mixed history. There’s a variety of allocations where some of them are layered fees on top of fees that are counterproductive. I think the Vanguard target date fund is a great example of a target date fund that’s done well. Targeted funds are a great product but the one thing that limits the target date fund is actually the fund structure itself. In the end, it’s a single, one-size-fits-all financial product. To give you an example, if you have a 30-year old who makes $50,000 a year and has saved $100,000, they’re in a very different financial situation than a 30-year old who makes $100,000 a year but has only saved $20,000. Their risk tolerance just isn’t the same. Their financial situation isn’t the same. When the target date fund uses age as the single indicator of how much risk you can take or should take, that’s over simplification. You can think of Wealthfront (at least in its simplest form) as taking a lot of benefits of a target date fund and instead of implementing that as a mutual fund, we actually implement that as a personalized service for your brokerage accounts. While you get the same automated advantages of asset allocation rebalancing dividend investment, you get more flexibility to have more asset liquidity, the flexibility of personalized risk tolerance. And most importantly, when it comes to taxes… this may sound like a little bit of a historical detail or trivia point, but it turns out that the 1940 Investment Company Act, even though that happened almost 80 years ago, still has a profound impact on what mutual funds can and can’t do. Mutual funds have to distribute gains and dividends every year to a certain extent but they’re not allowed to ever distribute losses. It turns out that there are certain things that you can do in an individual account (something like Wealthfront) that you can’t do in a mutual fund. Tax loss harvesting is a perfect example of that. The Wealthfront 500 is a perfect example of that. Those are the advantages that have been enjoyed by ultra wealthy, for quite some time. Wealthfront automated that services in software so that everyone can have access to it.
Rob: Let’s talk about tax loss harvesting. I want to talk about Wealthfront 500 because that’s just an amazing thing to me. Putting that aside first, just talk about tax loss harvesting in general. How does Wealthfront make that work?
Adam Nash: I’m glad you brought that up. There are two very different things. Tax loss harvesting is a service that we rolled out about two years ago but has now been broadly copied in the industry. It’s become a standard feature for an automated service. The original idea of tax loss harvesting was the ETFs offered the opportunity to do something automatically that wealthy financial manages had done by hand for decades for wealthy individuals. For tax loss harvesting at the ETF level, instead of picking one ETF for any given asset class (like the emerging markets) we actually pick two. And that gives you the ability that if emerging markets go down, you have the opportunity to sell, this year, the first ETF and take the loss so you get immediate benefit on the taxes this year but still buy the second ETF so you still have a diversified portfolio. When the emerging market goes back up, you’re not undiversified. You still can participate in that upside. It turns out this is a very hard thing to do by hand, but very easy for computers to do. So in the real world previously, you had to have a huge family office, potentially with tens of millions of dollars, if not hundreds of thousands of dollars to pay a team of people to do this for you. In software, this could be inexpensive enough that we could offer it to many of our investors as an automated feature.
Rob: Do you have two ETFs for each asset class?
Adam Nash: That’s right.
Rob: And again, is that just to avoid the wash sale rule effectively?
Adam Nash: That’s correct. But actually they’re at two different industries, two different securities.
Rob: What triggers the sale? Is there a certain percentage loss in the asset class that would trigger Wealthfront to sell that ETF and buy the second one?
Adam Nash: It’s a very perceptive question. So we just celebrated the second anniversary of our service with a third generation tax loss harvesting engine. Actually, this is one of the features that we uniquely offer. It turns out there’s actually mathematics based on how volatile a given asset class is that determines what the raw thresholds would be. Our new engine, that we upgraded this year, actually has a different set of thresholds for every single one of those asset classes. That percentage that you’re looking for turns out to be different for emerging markets than it is from UniBonds.
Rob: So it’s tied to their volatility— their standard deviation. So it would be different. Presumably a more volatile asset class would require a greater loss before triggering tax loss harvesting than an asset class that didn’t have the same volatility.
Adam Nash: One of the fascinating area about this service, it turns out that when you implement things in software, you have to think people have to adopt the math and the rule. Historically, the way people in tax loss harvesting, either you or your advisor— it would get to be November and you start to consider whether you should sell your losers to pay some of the winners, for the most part. You can always buy them back next year.
Rob: You just described my process.
Adam Nash: Yes. We did some of the research. There is some value to the assets. It’s not bad advice. It turns out less than half of the value (by our analysis) that you can get by actually looking at it in a daily basis in a more automated fashion. The problem with tax loss harvesting of individual stock— If you sell Apple, there really is no comparable stock. Like, Google is not Apple. Tesla is not Apple. No matter what people say, Pepsi is not Coke and Coke is not Pepsi. With broad index funds, however, even if they are different industry and different security, mathematically the correlation is high enough that you don’t lose a lot in terms of diversification. It is one of those things that’s very, very hard to do yourself. Doing that math every day. In 2013, most of the tax benefit— that tax loss harvesting offered our clients happened in three weeks in June. If we knew that ahead of time—that there would be a rough three weeks in June for a new emerging market and a few asset classes, you couldn’t have predicted it. This year, obviously September and October were brilliant months for tax loss harvesting. The market has largely recovered now. Wealthfront clients enjoyed automated service that was, A— smart enough to be watching the market every day and B— was unemotional enough to jump in and do all those right things you’re supposed to do like rebalancing and tax loss harvesting on the days where most individuals, quite frankly, had the least incentive to actually watch the market. Plain and simple. That’s the benefit of automation.
Rob: Tax loss harvesting only applies to taxable accounts, right?
Adam Nash: That’s correct.
Rob: Do you have a minimum invested in a taxable account to get this level of service?
Adam Nash: You do. Our current research shows that to get real benefit from the service, you need $100,000.
Rob: For clients that have that, can they log in to their accounts and see all of this happening? They can see they’ve just sold or bought something… That they have tax loses for this year of $2,000 or whatever?
Adam Nash: That’s exactly right. It may sound counterintuitive, but we may be the only investment service that actually puts the amount of loses that you’ve harvested this year, on your dashboard. We really want people to recognize that saving money on taxes, really is additional money that you have to invest for the future. If you save $400 on your taxes, that’s $400 more that you have to save.
Rob: Let me play the devil’s advocate here a bit. I think you guys have written papers to quantify for the advantages of tax loss harvesting. But, tax loss harvesting is not avoiding tax, you’re delaying them. Which, of course, has value, obviously. I mean, that’s what a 401K is or IRA is. It’s a delay of taxes. But I’m curious. When you quantify the advantages of tax loss harvesting are you factoring in that it’s a delay and that eventually you are going to lower your cost basis? You’re going to pay your taxes— you just get a reprieve. You’re still going to pay them later?
Adam Nash: You know, it’s a great question. We recently updated our white paper in October with a lot of new research. I think we were the first firm to not to only look at the historical time period but actually do a Monte Carlo simulation across hundreds of thousands of different potential futures to see what happens if you use tax loss harvesting for 10, 20 or even 30 years. And in that model, we also looked at what happens in the future if you keep compounding your portfolio, if you liquidate half of your portfolio or liquidate the complete portfolio. We try to get the whole picture. It turns out that liquidation strategies like when you retire and you’re living off your portfolio can vary a widely. Like when people move to another state and pay a different tax rates. Sometimes they donate their lowest cost basis shares to charity or leave them to inheritance where they live off the highest cost basis shares. The truth is, they’re a very individual process. We took our best attempts in our research of giving people a range of different options and showing how that affected it. As it turns out, there are two benefits that are very significant in terms of doing tax loss harvesting. The first is just tax deferral. You brought up a great example. Whether it’s retirement accounts or 401Ks, the ability to defer taxes means that money you saved this year can compound for 10, 20 or 30 years. And that has immense value over long time periods. The second source of value is short-term capital gains have a very high tax rate and long-term had a lower tax rate. And that’s different across the country depending on what state you’re in. But there’s always a difference. So the idea of taking short-term losses but holding investments for long-term gains also has value over a long period of time. Those are the two primary source of the value in tax loss harvesting.
Rob: Where are the assets held? Who is the custodian? Are you the custodian?
Adam Nash: We are not the custodian. We use a third party custodian called Apex. They’re not consumer custodian. You can’t go to their website and open an account. We actually take pride in the fact that we have a third party holding your assets. There is a lot of extra security and value in having a third party that’s not only holding your assets but also auditing and validating all of your investment statements.
Rob: But there are some in your space I think act as a custodian.
Adam Nash: I don’t know of any.
Rob: I won’t name any names.
Adam Nash: It turns out there’s a wide range of investment services that we can do for our clients. One of the differentiating factors at Wealthfront, if you look at close of the industry, is that your average account size is quite large. It’s much larger than most. We have accounts ranging from $5,000 which is our minimum all the way up to $10 million. Our average client has about $90,000 with us. We are a little bit more optimized for security and that third party validation then other start-ups. We take pride in that because we think that if you’re going to trust your money to a service having those extra layers for protection and auditing are very valuable.
Rob: Yes, absolutely. I just wanted to make sure that I knew who the custodian was. But I kind of interrupted our tax loss harvesting discussion so I’d love to hear about Wealthfront 500.
Adam Nash: I love that you brought up the topic because it’s a good story. All our success at Wealthfront has come from looking at things that the ultra-wealthy get in terms of financial services. Seeing that there are good ideas that we can put into software and bring to a much broader audience, Wealthfront 500 is a great example of that. It turns out that there’s a number of firms that have done this for the ultra-wealthy for decades. There’s a very famous firm called Parametrics that now manages over a hundred billion dollars that literally has been doing stock-level tax loss harvesting for decades. When we were discussing what would be the next innovation we could bring to this market after doing ETF level tax loss harvesting, Burt Malkiel suggested, that while there’s a lot of value to be had in doing tax loss harvesting at the asset level, there’s a lot of more volatility than individual stocks. And he talked about Perimetric, Imperial and other firms are doing this. The problem with that is, you can’t open an account with Perimetric or Imperial. You have to have a traditional wealth manager and usually with a very high minimum (five million or more) who will then be able to put a slice on your account into those firms. And, by the way, there are fees on top of fees for using their services. As you mentioned before, the Wealthfront 500 is actually a very simple idea. If you have enough money, instead of buying an S&P 500 index fund, we can actually buy all 500 in one stocks, market rated in the S&P 500, in your account. But instead of just optimizing for tracking error which is what a typical index fund does, we’re also free to optimize for tax losses because stocks open go up and down throughout the year.
Rob: Do you take the same approach where you have some sort of volatility measure and a certain loss percentage triggers action?
Adam Nash: No, it actually turns out be not as simple as the ETF.
Rob: I can imagine.
Adam Nash: There’s no way to pick a stock that’s the same as Apple. There’s no real match for General Electric. It turns out that every company is different. The way to solve it has actually been pretty well established by firms like Perimetric. The reality is that any given day, just like with 501 stocks, there are certain sets that are candidates for harvesting tax losses. Like I mentioned, they’re significantly down from the point where you bought them. What our software does is say that on this given day, if there’s a certain sets of stocks that can be harvested for losses— is there another set of stocks that we could purchase that would actually keep tracking error of the index relatively low, right? Because you want to match the index.
Adam Nash: Because in the end, it’s designed to be an index fund. And sometimes there isn’t another set. Like, if there’s 18 stocks today that you can harvest for losses and you can find another 20 year 25 to match that. But it turns out that on many days you can find that match. And so by taking advantage of all that individual volatility, you can end up with an index fund that has very low tracking error in terms of matching the index, but can generate a significant amount of tax loss in any given year. Our software looks at the market every day for opportunity. It doesn’t necessarily trade every day. In fact, in our rough estimates, it trades every third day or so depending on your personal account and deposits you’ve made.
Rob: Do you have performance data and tax loss harvesting data that you publish with your Wealthfront 500?
Adam Nash: We do. It’s a new service that we launched in December of last year. It’s actually coming up on our one year anniversary so we’ll be putting out additional data in the coming weeks. But if you actually look at the white paper that we pushed out when we published it, we actually did analyze its algorithm over a number over a number of growing historical periods and compared it with original S&P 500 products like SPY, the most famous ETF in the category. And if you frequently research that with a little bit more of tracking error, with a little bit more of volatility in terms of the difference on how it tracks the S&P 500, you can actually generate a significant amount of cash savings— more than two percent in tax savings (in the example that we used). That’s a huge advantage.
Rob: With two percent, does that mean that I will have tax losses of $2,000 for every $100, 000 invested? Or am I using the two percent wrong?
Adam Nash: Remember, they’re averages. Markets are different every year. We looked, in full, at 10-year periods and averaged them. But that’s relatively the right map. The only caveat I will give you is, remember that this is for the US equity portion of your portfolio. You’re still using ETFs score, your diversified portfolio on Unibond, on international stocks, emerging markets or on real estate. For our average client, we tend to have them somewhere between a third to 40 percent of the portfolio.
Rob: Effectively, you would have tax losses of some amount every year even when the S&P is up by 20 percent. You still have losses?
Adam Nash: Absolutely. This year is a perfect example. No, I’m not a big client of the service but even though the S&P is up… Actually, it’s surprising many people that the S&P 500 is up significant this year. When you look at the year to date performance of S&P 500, you might say, “Well, there wasn’t much opportunity for tax loss harvesting in S&P 500 stocks,” but then there’s so much volatility in individual stocks that actually, this has been a fantastic year for tax loss harvesting. You really get into the heart of why these services are so valuable. Index funds tend to hide a lot of the underlying turn and movement in the stock market. The S&P 500, for many people, may be too volatile these days. But fundamentally, it goes up and down but it tends to be an aggregate of 500 stocks. The total US market— like Vanguard total market, DTI, you’re talking about over 3,000 stocks. But there’s so much volatility under the covers. What the Wealthfront 500 does is it takes advantage of the fact that the way our tax system works is that taxes are due this year, only on the transactions that are done this year. So taking a loss really does have short-term value especially if you can keep your portfolio diversified and reinvest that wealth for the long-term.
Rob: Yes. I think I read that the minimum balance you need is $500,000. Is that right?
Adam Nash: That’s right. The current minimum for Wealthfront 500 is an account of $500,000.
Rob: Is that $500,000 across all of your accounts with Wealthfront or just the amount that’s allocated to the Wealthfront 500?
Adam Nash: The S&P 500 is actually reported as a taxable account, yes. The Wealthfront 500 doesn’t make sense— tax loss harvesting doesn’t make sense for retirement accounts. It turns out there is actually is 501 stocks in the S&P 500. Its share of Apple really is—I don’t actually know what it is these days. It’s higher than it used to be. Google is something like $500 a share.
Rob: Apple is $115.
Adam Nash: Yeah, if you do the math, if you do a market weighted portfolio, particularly for smaller companies, you need a certain amount of money to actually do a good job of mimicking the index. Remember the numbers I mentioned earlier? For $500,000 account, you might have a third of that account in US equities and that turns out to be enough money to do the Wealthfront 500.
Rob: So I guess that’s really my question. The $500,000 will be in taxable account and only some portion of that will be allocated to the Waelthfront 500. The rest would go to international bonds and everything else?
Adam Nash: That’s right. The Wealthfront 500 is like the S&P 500. The S&P 500 actually turns out to be 80 percent of the market capital today. We use Vanguard’s ETFs as a completion index to make sure you still have the proper exposure to mid-caps and small-caps that you would normally have with DTI.
Rob: So if someone moves half a million to a taxable account, does Wealthfront automatically do this? Or is there some sort of option for that client as to whether they want to go that route versus just an ETF? I don’t know why they wouldn’t want to use it. But—
Adam Nash: It’s a very important point with us. We have a fiduciary responsibility on our clients as a registered investment advisor. We do recommend the service because we think, for our clients, it’s the right idea. However, we never make these new investment features, required, in a Wealthfront account. When join Wealthfront or if you are an existing client of Wealthfront, there’s a switch that you can turn on the service, if you want the service. It’s the same thing that we use for Wealthfront 500. You can have a large account at Wealthfront and not use the service if you don’t want to. It’s probably not surprising that most of our clients use the service.
Rob: Actually, I think it’s a fabulous service.
Adam Nash: The thing about this, is like I said, it wouldn’t be practical to do things like these at this cost. Remember the rating of Wealthfront 500 is that there’s no product cost. The ETF fee disappears. So for 25 basis point, getting the value really wouldn’t be possible without automated software.
Rob: Yes, because there’s no transaction costs beyond the 25 basis points, right?
Adam Nash: For us, but we don’t charge commission.
Rob: That’s what I mean. The client pays the 25 basis points but they don’t pay the individual transaction costs each time the Wealthfront 500 trades?
Adam Nash: That’s right. Like mutual funds and other services we can do a lot of optimization on our end on how we trade that volume of stocks. But, I have to be honest with you, as a software problem, these problems are not even tackled by large pools of money the wealthy use. They just haven’t been available for the individual investors. And we are very excited about doing this technology down.
Rob: It’s a great feature. When I started sort of investing almost 25 years ago, you didn’t care about taxes because we didn’t have enough to matter. Even in a taxable account. But after you do it for awhile, taxes are huge. Okay. I appreciate your time. I want to ask you one or two more questions before I let you go, if that’s okay?
Adam Nash: Sure, of course.
Rob: The first is the primary one. To the extent that you can share with us, what is the future of Wealthfront? I know there are probably some things you can’t tell us, but where do you see Wealthfront in this industry headed in the next year or two?
Adam Nash: We spend a lot of time at Wealthfront, trying not to be obsessed with the short-term, but we’re really focusing on the long-term value we think a company like this can bring to the industry. I mean, it turns out that every generation has had an opportunity to build new important businesses in financial services that change the quality and cost of investment products and materials for individuals. We often point to Charles Schwab, founded it in the mid-70s, initially offering direct brokerage services for the young people, in their 20s and 30s at a low cost. Now Charles Schwab manages two and a half trillion dollars, offers a supermarket of financial services and it really has forced the entire industry to shift how they handle financial services and brokerage. I don’t need to remind you that there are other firms like this. Vanguard is another great example. We see Wealthfront as having that same opportunity. The big difference is that those companies were largely built on the asset growth of the baby boom generation which now has 15 trillion liquid in the US. The millennial generations don’t have nearly that much money which is why they’re not getting a lot of attention from these traditional providers. For new companies like us, they’ll try out. The idea is building a service that really optimizes and what good software can do for the individual investors particularly the millennial investor. We don’t see this as a one or two year problem but a multi-decade problem. Schwab is going on for 40 years and they’re still incredibly strong and growing even to this day. You can put it in a camp that is incredibly bullish about the future of this generation. I know there’s a lot of economic struggles right now. We’ve seen on our data that more and more young people are finding their way on the world. The good news is, they’re not buying into this idea that you can somehow beat the market by picking stocks, etc. They like the idea of passive and nesting and they’re very conscious about fees. They grew up with software. So we think that’s a powerful combination on which to build a great company. When it comes to thinking about the next couple of years, what I’m really most proud of about this company is— you have to remember, I was a client at Wealthfront a year before I joined the company. I opened my account a few weeks after it was launched. But we’ve come so far in less than three years. Look at all the features we’ve rolled out. We started with the basic diversified portfolio. We added tax loss harvesting. We added asset allocation. We’ve added Wealthfront.org, the single software diversification service— the Wealthfront 500. And we will keep throwing out new, innovative features because we really feel a responsibility as the leader in this category to help the client enjoy the features and services and costs that, frankly, we figure our investors deserve. So over the next couple of years I hope what you’ll see from Wealthfront is a continued stream of innovative new features that challenges the idea that everyone really deserves sophisticated financial advice. We think we can make that powerful and possible with our software.
Rob: That’s terrific. I’m going to put in my vote on an individual 401K option and a defined benefit plan option. One last question since I know your time is short. Both Wealthfront and the whole industry, this whole automated investment service industry, has grown up in the time of an incredible market. We really haven’t have a bad market since these firms have existed. And we will. Well, we’re going to have a bad markets and who knows, maybe sooner rather than later. How do you think services like Wealthfront will fare when the market goes down 20 or 30 percent a couple years in a row?
Adam Nash: There’s been a lot of anxiety in the US economy and stock market performance. It’s safe to say the 2008 financial crisis wasn’t your run-of-the-mill financial crisis. It’s half a decade later and we’re still feeling the aftermath. The truth is, one of the biggest things going for the millennial investors is that actually, in their short lives, they’ve lived through not one, but two market crashes. Frankly, I think that’s what makes many of them skeptical and almost cynical about this idea that either you can beat the market or that someone will protect you in a downturn. When I talk to our clients or look at our data, millennia’s seem is incredibly focused on their careers, on their family, their friends and experiences. We can make this long list of things they’re focused on. Managing their money hasn’t been one of them. And I think that’s because the idea of automating your investment makes sense to them because they know that on a daily basis they don’t have the time to do all the things they’re supposed to do. And, they think most of their long-term success is going to come from their careers. Like doctors think they’ll be great doctors and engineers think they’ll be great engineers. Entrepreneurs who are starting their businesses think that’s how they’re going to make their money so they really like this idea of an automated service. We actually did have some market turbulence this year, in September and October. We also has some more back in 2013. We are still a young company but if we’ve looked at the data and Vanguard has some fantastic data that we published on our blog that shows pretty inclusively that half of the investors, index fund investors, don’t seem to panic the same way that active investors do when there’s market volatility. More importantly, our data suggests that young people, while they’re unhappy when the market goes down, don’t seem to panic the same way as well. No one likes to see their accounts go down but if you are 28 and you think that most of the money that’s going to be worth in the future is not coming from your investment account but from your future career, it doesn’t lead to the same sort of panic that you may have if you’re 60 and you’re worried about your entire life plan of retirement being thrown around by being invested in the market. We are very optimistic about this generation. We think that young investors have been jaded a lot about this idea that they can beat the market. Actually, they’re in the right camp in the aggregate. They actually want to save quite early. They want to put their money on a long-term investments. They know that they are the best practices that they should be doing. They’re also self-aware enough to know that they won’t do that. They like this idea of delegating that to a service. And they also like the idea of that service being in the ‘cloud’ running 24-7. They believe that computers are rational and consistent and they seem to like services like Wealthfront.
Rob: Yeah. Great. I really appreciate your time. Wealthfront has obviously built a fantastic service for folks and I appreciate your time today sharing it with us.
Adam Nash: Yeah. Happy to do it.