December 9, 2015
Online technology is amazing and makes our lives better. It connects us in a way that we would have never imagined as recently as 20 years ago. There is no going back to life offline and most of us will see more unimaginable advances during our lifetimes. However, an important lesson that we are surely not the first to learn, is that a business’ public online presence is largely dependent on who you choose to be responsible for crafting and applying that strategy if you aren’t capable of managing it yourself.
We at Smith Bruer Advisors recently realized that our chosen steward of online presence was unprepared to meet the obligations they pledged, and I feel fortunate that when we recognized that we had the dexterity to respond and adjust quickly. It is unfortunate that the disruption prevented regular blog entries. Regardless, the blog is back and I will again try to post frequently.
Financial technology, or “Fintech”, may be the fastest growing online industry. Traditional systems are being disrupted and replaced at an exceptional rate, making it difficult to dedicate the time to understand and evaluate each one.
I read this article recently and found myself shaking my head at the concept of the Robinhood app. Robinhood allows you to trade stocks listed in the U.S. for $0 cost after funding your account electronically from your checking account. Robinhood makes money by collecting interest on the sum of cash in users’ accounts that hasn’t yet been used to invest in stocks (with no cost to the users). They also collect fees on other services outside of a basic U.S. equity trade. It is a very interesting app and I can see it being very disruptive to online discount brokerage firms like Scottrade or E*Trade.
The part that has me shaking my head is that the entire experience is self-directed. In other words, the user is making buying and selling decisions. This model would work well if the average user understood how to create an efficient and well diversified portfolio that was constructed for the purpose of meeting well defined goals within the threshold of their own risk tolerance.
Granted, this is a tenuous model on all self-directed online trading platforms. Users are empowered with the ability to invest in any publicly traded stock and add it to their portfolio, with no requirement of license or education. I find myself wondering how people convince themselves that they can consistently pick stocks that are going to outperform the market. Even professional stock pickers can’t do that!
Yes, commission cost can absolutely eat into any performance gains and Robinhood has seemingly found a way to eliminate that drag. Let’s imagine that a Scottrade user makes an investment of $1,000 in a single stock which grows 5% in a year to $1,050 and the user would like to now sell. Prior to any capital gains tax considerations, according to the Scottrade website the user will pay $14 to make an online stock trade; $7 for the buy and $7 for the sale. The $50 gain has been cut 28% to $36. Granted, at higher dollar levels, this percentage will go down because the commission charge is static, but Robinhood is presenting itself as an investment platform for the “rest of us”, ostensibly non high net worth investors investing a few hundred dollars at a time. So if that is Robinhood’s intended audience I think it is reasonable to use $1,000 in the example. If that is the Robinhood target client they are likely to have a concentrated portfolio in only a few holdings and the volatility of the stock market is one of that client’s greatest enemies. Choosing one or several stocks to hold is a speculative strategy and one that generally does not prove to be a long term money maker. Volatility can cause a portfolio of just a few holdings to be significantly devalued in a short period of time, leading the user to make an emotionally charged decision to sell, booking a loss (as discussed as unforced errors in this prior blog post).
Generally speaking, the defense of volatility is diversification. This is where I see potential value in Robinhood’s model over other online trading platforms. Let’s go back to our prior example and purchase 100 different stocks in the name of diversification (still not necessarily diversified). Regardless of the price of each stock, the Scottrade user will need to spend $700, or 70% in commissions. Obviously this would be a prohibitive model that no investor would ever do. Using Robinhood, over time a “rest of us” investor could build a well-diversified equity portfolio of thousands of stocks covering a multitude of asset classes for free. However, Robinhood does not market that they provide any guidance in how to do that. That information is generally available to the public online, and the only cost to access it is time and time dedicated to tasks such as researching how to build a well-diversified portfolio can easily be derailed by myriad distractions on the internet (cat videos).
For the perilous aspects of online investing mentioned above, and anecdotes we’ve heard from clients and non-clients, Smith Bruer decided to look into a smart alternative. Over the past 8 months we have been working on the development of mPower, an online based investment platform that gives users access to the technology of Betterment with the advisor support of Smith Bruer Advisors. Visit the mPower website for a fully detailed explanation, but in summary this is what mPower does:
- Invests the user’s deposits into a diversified portfolio of equity and bond ETFs based on the goals of the user (retirement, saving for a house, vacation fund, etc)
- Provides access to licensed financial advisors at no additional cost (that’s George, Rene, and me)
- No minimum account balance
- Charges a very small fee at 0.55% annually of every dollar invested. That’s $5.50 a year of the $1,000 mentioned above.
- Auto-Rebalances (see this earlier blog post on rebalancing)
- Stays on the forefront of fintech (we have an amazing app)
So at first glance, new fintech can often seem incredibly smart and appealing, but remember that technology is evolving at a tremendous pace and you should explore all options thoroughly before making any decision on where to manage your invested assets.