The Exchanges

Q Why don't you talk a little bit about the framework that you use at Betterment? So someone's giving you a bunch of money, small amount, a large amount. Is there a suggested asset allocation methodology? How do you think about that issue of how do you invest this person's money?

A So we generally do stuff that I think is not conceptually that much. Crazy or groundbreaking. There's no amazingly advanced theory behind what we do, but the execution is just really strong. So we start with a market cap portfolio. We add in a slight small cap and value tilt in line with sort of long-term research on that. And then we do a fairly straightforward optimization to say, if we want to go up to 90% stocks, what should that portfolio look like? If we want to go down to 20% stocks, what should that portfolio look like? We're predominantly goals-based. So in order for us to give advice, the client has to say how long they're investing for and what the type of the goal is. So that might be retirement. It might be a house down payment. It might be an emergency fund. The big driving factor there is the schedule of liquidation. How many months or periods are you going to be liquidating it over? So we have a time period and a liquidation schedule. We do a very fairly straightforward liability driven investing thing where we say over this period of time, This is the return that we expect from stocks and bonds, and we're going to put you on a glide path that is appropriate for it. So it's again, um, not incredibly complicated. Nothing, nothing fancy. We don't do any stock picking or market timing of any form. There's no hedging or derivatives or anything. We just basically lin…

AI assessment note: “We start with a market cap portfolio. We add in a slight small cap and value tilt”

Q Over the last bunch of years, as your business has taken off, we've had a particular type of market environment. And I'm always curious with all the index fund movement, which, you know, we'll talk about in a sec. How do you know, right? When things are going up, it's a lot easier for people to stay the course.

A Definitely. Definitely. So I have the unlucky luck to have worked and lived through the 2008 nine financial crisis. I was at Barclays during it. And, uh, this was one of the big questions is who stays put? Um, how do things change? And I was working with Barclays stockbrokers at that point in time, who is a direct to retail brokerage platform. So a lot like each, uh, each trade here. And one of the most surprising things, uh, one of the things that actually crashed their website During some of the worst days was young people signing up. There is effectively, we don't think about it as much, but there are a lot of people out there with dry powder. They're sitting on a lot of cash. We don't see it. It's not on our platform waiting for a sufficiently convincing dip to put money in. So the first thing, this isn't going to solve it. Like if the market goes down, our portfolio is going to go down. You know, we don't have any magic there, but I think that we underestimate a number of factors. Number one, how much dry powder there is from people who are sitting on cash until The news and the markets make them notice that they can be putting it in cheap now. I also think that our business over time, it started out with direct retail, predominantly taxable and IRA accounts, but also now we have for one K's and advisors and that, that sort of shift towards longer term accounts. People in …

AI assessment note: “found through the 2008, 2009 financial crisis, something like 80% of them didn't touch”

Q So, what did you find from early last year?

A So, starting way back, starting with the Greek crisis, the first thing that we did was outbound emails to try and, you know, like, calm customers down. Did a randomized control trial, there were like three or four different arms to it, and there was a control. And what we learned is that most people are not worried about the market. You know, most people aren't following it, even if it's the front page of the news, they're worried about the presentation they're going to give to their boss or their, their kids grades. And by notifying those people who are not following it, that something was going on, we were actually causing a bit of stress. So what we want to do is we want to target the people who are following it and who are going to be stressed without hitting everybody else. So in the following one, we didn't send any emails, but if you came in and you logged in either on the web or on our, our smartphone app, We would show you this sort of like little takeover message that said, if you're worried about markets and what's going on right now, here's our thoughts on it. Here's what we think you should do. And that we, we looked at the behaviors right afterwards and we said, there are some bad behaviors like people changing their allocation or defunding their accounts. And there are good behaviors like depositing that lets us rebalance. And we found that that simple, easy thin…

AI assessment note: “reduced the bad behaviors by about 15% and increased deposits by about 10 or 12%”

Q And so do you have a new hypothesis that you're waiting to test, hopefully not on the big kahuna, but on the next sort of choppy period?

A I think there, there are two that things aren't completely in place for. One, which is looking at things called commitment mechanisms. So, effectively saying, what do you think that you, what do you think that you should do? Or, you know, like, what would you recommend that an average investor does if the market drops 30%? And most people will say, I would recommend that they stay put and they don't change everything. You say, alright, cool. Will you adhere to your own advice? I say, yes, I, you know, obviously, I'm a, this was good advice, so I'm going to adhere to it. And if something like that happens, you bring that back up. You say, like, your advice To you was to stay the course. Here's your signature. Maybe even link in something that involves a second party. Like you have to kind of like call, phone a friend and say like, just so you know, I am hitting the glass box. I'm freaking out right now. I'm breaking my own advice. So that's, that's one element. The other one is looking at actually preparing people for this. So they're more desensitized. So right now there's a ton of content Going around that's about, like, the market's never been higher. The last time valuations were like this, the market crashed this much, et cetera. And it's very hard to sort of warn people. It's easier to put them through it and say, here's what this is going to feel like, right? Like, if we …

AI assessment note: “I think there, there are two that things aren't completely in place for.”

Q And what are the breadth of markets that you'll put Your clients into?

A Basically most publicly listed world instruments. So you're looking at all U.S. stocks, international developed stocks, emerging market stocks. We also invest in domestic bonds, municipal bonds, emerging market bonds, corporate bonds, etc. So it is a, the trade-off there is usually about we want to give as much Diversification exposure as possible while actually making sure that the end client takes those returns home. So if an asset class has a very good gross profile, you know, if they, if it looks diversifying, et cetera, but the instruments that we would use to access it are expensive, we might exclude it. It's a good asset class, but there's no means of accessing that asset class. We don't do anything too crazy, but we do want to give them a good sort of good, really broad vanilla portfolio.

AI assessment note: “Basically most publicly listed world instruments. So you're looking at all U.S. stocks”

Q So, you know, you mentioned earlier about sort of beliefs and implementation of small cap and value bias. Can you talk a little bit about your perception, which may be the same as betterments or maybe slightly different, of active versus passive?

A So I think the best way of describing it is that it's a distraction for the vast majority of people. I think that the amount of thought and ink that has been spilled on it has just been, you know, like dead weight losses to the vast majority of investors. And, you know, if you're in a low cost fund that is systematic, you don't have a lot of like random tail risk, you don't have a lot of Madoff risk in it in whatever way, I think you're probably going to be fine. I think that most people, that the issue that comes up with it is, however many hours you spend trying to find the right manager, or trying to find the right strategy and understand what this stuff is doing, is not well spent unless you already have a very, very large asset base. I'm talking in the millions, at least. Most people are looking to get to the point where they have two million dollars so that they can retire. And in that case, the best use of your labor is figuring out how to make more money or save a bit more money. So one of our analysts, Michael Campos, did a great research piece where he said, let's think about an ordinary person who's confronted with two different things. They can either figure out how to save more, or they can put the money and their time and effort into finding a manager with alpha. And he specifically said, I'm going to pick a manager that has one percent alpha every single year. Th…

AI assessment note: “it's a distraction for the vast majority of people.”

Q And so did you at some point in time, take a step back as you're studying decision-making processes of people and say, Hmm, how come I can't make this decision?

A Absolutely. That's, that's part of the best part about you. You're always, Effectively reflecting, uh, you know, we talk about here at Betterment when we build software, dogfooding. You know, like, are you using the thing yourself such that you experience what works and what doesn't and what's annoying? And the amount of insight that you get where you read about something and then a day or two later you're like, oh, I just did exactly that thing. That, you know, kind of like little trick that we play on ourselves. It gives you a great lens to see the world. It doesn't stop you from having all of those issues. It doesn't stop you from making irrational decisions. Uh, it doesn't make you some sort of super rational person. It just does give you a framework of saying, okay, this is why this is happening. This is how this is happening. And then at some level you start saying, how can I build around myself systems or habits or patterns so that I minimize the really, the harmful ones.

AI assessment note: “Absolutely. That's, that's part of the best part about you. You're always, Effectively reflecting”

Q Yeah. I noticed that recently you've added financial planners, like live advisors to the platform from what was traditionally just an automated. What was the sort of, is there a behavioral thought process as part of that, or is it just adding on another piece of the broad financial picture that your clients were, were interested in?

A Sure. So I'll give you a two part answer. One is, The, the short term and the other one is the long term. So one of the components of it, we've had the, the employee who I work with the most, uh, is a CFP who's been here about a month longer than me. And so from the beginning, we've had planners involved in the process. It was mostly a matter of talking to them and pulling out whatever algorithm was in their brain and then putting it into software. Now, one of the things that we, you know, we've, we've been doing that pretty well, but one of the things that we hit is that We want a better understanding of what are the next things for that our customers need from us? And what are the questions that they have that mean that they can't get over the hill to committing to us? Like they can't really completely pull the trigger. So I would say five times out of 10, the questions that customers ask us are like, here's my situation. Am I okay? That's not something that's easy for an algorithm to answer, but an advisor can go through it pretty quickly and get them to a comfortable point. In the longer term, to be clear, We are going to keep automating a large part of that. So it is not simply a matter of, oh, we hit some brick wall and we had, you know, we ended up having to use advisors. Every single financial planner or licensed expert on our platform is doing this so that they can fig…

AI assessment note: “That's not something that's easy for an algorithm to answer, but an advisor can”

Q I mean, is that, is that the core of a lot of the little sophisticated processes and the ways people, the way people's minds work? You end up with do less.

A Less. I think less is usually not do nothing, do less. The more that we can build systems around people that push their focus out to the future and further and further into the future, that reduce the emotional impact of recent history, That kind of, like, work with their brains and don't say, like, just get frustrated. I'm going to not tell you, but here's this thing that you can do. Here's something that's going to give you a bit of catharsis. A brilliant thing that I would love to do is something along the lines of, if somebody's worried, don't let them trade their portfolio. Let them just, like, put on a two-week downside hedge that costs them a little bit of money. And, like, after they've done that five or six times, let them know, like, just so you know, like, we're paying for insurance here. So work with them.

AI assessment note: “Less. I think less is usually not do nothing, do less.”

Q of teams. I mean, something that comes up in a lot of my conversations that the asset management industry is not known for being great people managers. I don't know so much about technology. You do here in corporate America, there's a lot more experience in sort of managing people and being a little more holistic about their life and their experience within a company. How does it work here?

A So this is one area where I'm going to say this is not my strength, and I would say that it's something we are actively figuring out on the fly. So it's kind of neat because you're seeing the culture. I was with Betterment from about, um, While, uh, the culture that kind of binds us hasn't changed that much over time, the scale, the difference, the diversity of people definitely has. And so we're kind of figuring that out. I think our, you know, most of our employees are probably under the age of 35, and so we are quite literally growing into those management roles as we go. One of the things that I think is underestimated is, number one, how valuable diversity, and like true diversity, not kind of like superficial diversity, but Having people who really fundamentally disagree with you is, but also how hard it is to manage that. So I've been responsible for hiring probably about eight or nine people here, and I would guess that only two or three of them align with me on like, 90% of stuff. We have people who came from hedge funds, who came from quant prop trading shops, brokerages, and they have their own opinions about active versus passive, or whether or not we should be volatile timing the market and various things. I think the hardest part, like we, we're going to disagree. They're smart. Like this is, this is, you know, like if I get into an argument with them, there's a g…

AI assessment note: “it's something we are actively figuring out on the fly”

Q That's great. If you weren't a behavioral finance specialist at Betterment, what profession would you want to try?

A I think these are a little bit related, but I'll say them anyway. One is a venture capitalist. There's a An old quote by Abraham Lincoln, uh, the best way to predict the future is to create it. I think we sometimes lose track of that. Like you can put your money where your mouth is literally in terms of, I want to fund this thing that I want to see in the world, Kickstarter and various things. Um, I love the collaborative fund because they have that element of if you think it should exist, make it. So, and that's from a finance perspective, even closer to home. I actually, um, Elon Musk has a company that he's just started up called Neuralink. That basically is trying to help figure out how you can allow computer or machine brain interfaces. So for people who have lost limbs, or disabled in other ways, or can't talk, but they're, you know, they're literally inside their head. The long-term potential for that, for us as a species, of figuring out how do we help computers work with us inside of our heads, so that we can learn faster, right? Like imagine if like the way that you learned algebra wasn't Horrifically boring in a classroom that's hot and you want to do anything else, but simply saying, like, okay, you know, like, you're gonna, you're gonna get this upload into your head, and then you're gonna have to practice it for half an hour, and then you're gonna actually know al…

AI assessment note: “One is a venture capitalist.”

Q So, why don't you talk a little bit about how you got to the seat where you are today?

A Definitely. I think the two points that led to it, and I know this is cliche, but it's really true, I actually have a lot of gratitude for it, Is luck. I think I was incredibly lucky. I think of it like surfing and that I happened to be at the right place at the right time and doing the right things. And I just happened to catch a wave that a lot of people would love to be on. And I was just very lucky to be there. Of course, you got to do the swimming out bit. And so for me, that consisted of, even as an undergraduate, I remember trying to decide if my major was going to be economics or psychology. And the reason was the same. I was very interested in how people make decisions, and society is just a whole bunch of people making a decision, and economics is a whole bunch of people making a decision about how they're going to allocate resources, how they're going to, how they're going to kind of economically manage themselves. So at some point I realized that the job prospects were a heck of a lot better if you have an economics degree, and you can usually study most of the psychology You can, you can understand the methodologies. You can understand why they're doing what they're doing, but the statistical and mathematical requirements for economics was harder. So I said, okay, I'm going to major as an economics undergrad, but I'm going to minor in psychology, specifically cogni…

AI assessment note: “I'm going to major as an economics undergrad, but I'm going to minor in psychology”

Q And that compared to what in a normal taxable account?

A It's a great question. I think there were tremendous trades. I think if you just look at profit numbers for people like E-Trade, uh, et cetera, during those periods, we are not where you're going to go to trade. We are not that fun. There are now apps out there that make it really fun and interesting and free to trade single line stocks into market time. We are wonderfully boring when it comes to it. So I think we're I hope that we are selecting for investors. When it hits, we're going to try and guide them towards doing less extreme things. So the worst thing you can ever do if somebody's freaking out to say, stop, don't do anything, sit still, et cetera. You have to take that anxiety and that energy and redirect it towards more positive things. So it's going to be, okay, take your 80% stock portfolio and let's shift it down to 60% and wait for a little while longer. Let's, let's reduce the extremity of the action. Let's focus on the plan and see whether or not you're on or off track from your plan. There's a lot of little things we can do that are about refocusing the investor at that point in time that do work. So, um, again, the experimental thing, people forget that we've had about, we've had five corrections over the five years that I've been here, and we had one 20% drawdown, I think in January and February of last year. Everybody hates drawdowns except for perma-bearers…

AI assessment note: “if you just look at profit numbers for people like E-Trade”

Q So you started as one hypothesis of tax loss harvesting, which, you know, I think A lot of professional managers understand, but certainly individuals don't. What are some of the other core tenets of what you've put in to improve investor behavior?

A I think the, the key thing there is actually flipping the conversation from being about how investments perform to being about how stable you are as an investor. What are you taking home? What growth are you, you accessing? And a lot of that comes out of you talk to people about how they pick investments. It's going to be performance chasing, It's going to be what they heard or what's on the news. And it's very hard to be a good advisor, especially if you're just a sort of interface based advisor to pull people away from that natural way of thinking. So what we want to start talking about is things where we know they have certainty. If they or we put our time and effort into researching and improving something, there's a very certain outcome that's going to be better for them. So tax loss harvesting is a great example. You talk about like Stock picking or asset allocation, usually there's somebody else on the other side of the table when you're buying or selling something who is another strategic actioner. There's a zero sum game there. Tax loss harvesting, there's not, right? It's, it's the, the US government and the IRS, and they do not move quickly, and they're going to declare their rules before they change them. But it's a form of tax management where we say, we are going to reduce effectively how much tax you pay now, this year, and some of it's going to be deferred into …

AI assessment note: “flipping the conversation from being about how investments perform to being about how stable”