E*Trade's Online Advisor Hopes to Lure DIY Investors

There is no doubt we are witnessing a wholesale exodus of assets out of full-service brokers like Merrill Lynch and Smith Barney. These assets seem to be finding two very different types of homes:

1. Boutique investment advisory houses: Built by brokers/advisors who themselves have defected from the large wirehouses, these firms take service and advice very seriously. In some sense, they’re a further move into full-service. They are competing head-on with traditional brokerages by upping the ante on technology, service and investment advice. Investors who feel slighted by their advisor and want the extra hand-holding find this model really attractive. It’s interesting to note that many of these firms are being founded/built by traditional brokers evolving to this model.
2. Online brokerages: Firms like E*Trade (ETFC) and Ameritrade (AMTD) are taking the bulk of this business. In the wake of the financial tsunami, some investors are looking to take back investment decisions and don’t want to pay someone else for underperformance. Proof of this is in capital flowing to online brokerages. E*Trade reported that it had net new accounts of almost 30,000 in the first quarter of 2009 with $3.5 billion in net new customer assets.

I’ve written about the emergent trend towards high end investment advisors and how traditional stock brokers are resurrecting themselves and building smaller, nimbler firms with their billion-dollar books of business. I’ve spent less time discussing how online brokers are luring assets.

Online Advisor

I had the opportunity last night to have a guided demo of a recently-launched E*Trade product, Online Advisor, with E*Trade’s Liat Rorer, VP of Investment Products. Online Advisor, developed as part of E*Trade’s newly-minted Investor Resource Center, is a nifty little financial planner-in-a-box.

In a quick and easy 4-step process, Online Advisor:

1. Analyzes an investor’s current portfolio and financial goals: Using some java functionality, these are short questions guided by an easy-to-understand wizard. The questions were easy to answer — you could see that someone put a lot of thought into this stage of the process. Investors can be weighed-down by varying types and lengths of questions and it’s clear at all stages through the process just how much further a user must go to complete the exercise. E*Trade accomplishes this via judicious use of a progress bar and collapsible question forms. It’s a double-edged sword here – E*Trade’s quick and dirty financial planner doesn’t ask detailed income sheet (income and spending) information, a really important (and hard to do!) facet of a formal financial plan but it’s clear that this was designed to get the information quickly and not too onerously for the end user.
2. Suggests a recommended asset allocation: By juxtaposing an investor’s current portfolio against an optimized (a la the Efficient Frontier) asset allocation model (that uses benchmarks provided by leading financial planning software package, Financeware, and managed by E*Trade Capital Markets), this stage explicitly shows an investor where they are currently and where they should be by displaying two clickable pie graphs.
3. Displays the solution: Here, it’s clear — and E*Trade’s Rorer emphasized — that the firm is really providing an open platform and not pushing any particular solution to investors. That’s not exactly true — investors are given the choice of “mutual funds or ETF portfolios, with or without ongoing portfolio management”. Only one managed ETF portfolio is offered at this point and it’s run by an affiliate of E*Trade. But what Rorer meant and what investors will see is that E*Trade’s recommendations are made up of different ETF and mutual fund families. E*Trade’s open marketplace of 8000 funds means that E*Trade is attempting to provide the right securities for the right allocation without being beholden to one ETF provider or mutual fund family.
4. Allows investors to quickly invest: No more research is really needed for an investor to implement the financial planning recommendations. After playing around with a sample portfolio, I was recommended a portfolio of 5 securities which included 2 US market cap ETFs, a bond ETF, a global stock ETF and an Asia-Pacific ETF. Investors can make just a click or two and rebalance their entire portfolios to implement the suggestions in one basket trade with applicable associated brokerage fees or decide to get professional help at this stage.

The New Rules Take: What it all means

1. Tools like Online Advisor further blur the line between full-service brokers and online investing: While the Online Advisor tool was only recently launched, it has been in development for some time. Its launch is fortuitous in that it coincides with this growing trend of DIY investors moving online and requiring more than just a trading account to help them make informed, responsible trading decisions. Expect more internally developed tools from online brokers to deliver automated professional-grade investment guidance
   
2. Watch for online brokers to move into more open architecture and develop trading platforms: like Apple’s iPhone and the Google App store, brokerages are beginning to open up their platforms for 3rd party plug-ins to also support investment decisions (see my post on SmartStops). While privacy and security remain high-level concerns, this works for everyone involved:
   • investors get access to a marketplace of 3rd party apps developed independently
   • online brokerages get to leverage applications and services but developed using external resources. This also opens up a new revenue stream as online brokerages manage the customer relationships and provide a matchmaking service to apps — the beginnings of a true investing (not just trading) platform
   • 3rd party services and apps struggle to scale because it’s hard to get investors to adopt solutions outside of a traditional online brokerage login. As online brokerage opens up, app developers will be granted the keys to the castle. We should see a tremendous amount of innovation in this space.
3. Smaller investors also get access: By using ETFs, E*Trade can create a well-diversified portfolio for investors with as little as $10,000. It’s been my experience — I don’t have facts to prove it — that even actively managed ETF portfolio managers have been lowering their minimum account size to compete for assets. This furthers the leveling of the investor playing field.
4. Online brokers continue to build out financial advisor platforms: When I asked Rorer if there were any plans to provide financial advisors using the E*Trade platform access to Online Advisor users, she professionally quipped that “E*Trade is looking at a lot of things.” Fair enough, but if E*Trade can develop application/services like Online Advisor and get significant take up on their usage, this is another channel to connect DIY investors who like managing just part of the investment process and desire professional input.
   • Step 4 above is a clear funnel to channel investors looking for an actively managed account (via the SMA, or separately managed account structure) which allows E*Trade account holders to both manage their own accounts as well as get access to institutional money managers.
   • This jives with an interview I conducted a few weeks back with Sean Hannon of EPIC Advisors, one of the top performing money managers on Covestor, who opined that he believed the market is headed towards more blended models of asset management. Investors want more control but also recognize that they need valued, professional input at certain parts of the investment process.

It’s not clear how much Online Advisor really moves the needle for an online broker as large as E*Trade. I think its development and launch are significant for the 4 reasons I mention above and I’m excited to see more products like this that automate delivery of professional investment advice and further blur the boundaries between full-service financial advice and DIY investing.

Disclosure: No position in stocks mentioned

Comments

[Geoff Consi...:]

Zack:

Nice article. This is a timely piece and I hope to see more discussion of this kind of emerging solution. One thing I am surprised you did not mention: Where do you see FinancialEngines.com in this space? Their goal has always been to provide online portfolio guidance using their tools, and they have been around for quite a while.

Regards,

Geoff

Jun 09 02:57 PM

[Zack Miller:]

Hi Geoff,
Thanks for the nice feedback. This was by no means an exhaustive piece on the space. Rather, I saw it as a product review which I tried to put into context.

Clearly, FinancialEngines and your work are much more rigorous in this space. Online Advisor is a tool that fits well into E*Trades larger platform. E*Trade has approached this exactly this product as a service they've layered on top of a trading platform. FinancialEngines -- at its heart -- is providing portfolio guidance.

Jun 09 04:07 PM

[Henry Buttal:]

Zack - Good notes here. It will be interested to see how sophisticated these offerings from E-Trade et al become.

After my experienced and well Internet-advertised high net worth advisor missed the call in a big way last year, I have elected to move my asset management to Schwab to save money on fees (which after a 60% loss had suddenly become a bigger issue). While Schwab has been working on improving their advisor offerings post U.S. Trust over the past few years, they still are a) limited b) mostly unautomated and c) relatively uncoordinated by resources in Schwab.

As a result, I still think there are tremendous opportunities for Geoff's tools, and the partnerships and off-shoots thereoff.

The first discount house that gets it right, though, stands to pull a LOT of assets.

Jun 09 10:48 PM

[Zack Miller:]

Thanks for the comment, Henry. I tend to agree with you. These tools are still in their infancy, especially consumer-facing ones and the trick is integration. The first discount house -- by the way, they should now be seen as investment platforms -- to get providing professional-grade advice through automation should reap a lot of assets. It'll be interesting.

Jun 10 01:17 AM

[Mitch Tuchman:]

Zack: I'd welcome you to try our service which has been reviewed here in SeekingAlpha and also is truly "open source" as we're not affiliated with any online brokers or ETF providers. Contact me at [e-mail] and I'll take you through it.

Jun 24 07:06 PM

[CharlieH:]

I'd like to hear how people think this newish development fits into the overall history of these tools existence over the past 10 years or so (like the Financial Engines mention above). I worked on the development of very similar tools at 2 online brokerages 10 and 5 years ago, and am wondering how the latest development builds on previous versions? I personally think the biggest question here is how and when we'll see significant adoption.

Jul 16 02:55 PM