Reminiscences of building a Fintech Startup
Our journey into the world of creating a consumer-facing online investing service is a bit unusual. It wasn’t our first intention, nor was it a smooth process. The purpose of this post is to share our story with the next generation of founders and to illustrate that launching a company is about more than lucky timing or a great idea. Rather, it’s about feeling frustrated with a status quo and being eager to tackle it, it’s about listening to prospective users and responding to their needs. Most importantly, it’s about being prepared for a frustratingly long and volatile journey rather than a swift and glamorous one.
Four years ago we made the decision to quit our jobs and start a new kind of investment company: one driven by the needs of people, rather than profit. At the time, Nutmeg and other similar services were already a few years into their respective journeys in digital investing. With the clock ticking, we got started by trademarking two names: WealthKernel and WealthSmart. The first name, WealthKernel, could be used for a business-facing proposition, while the second, WealthSmart, could be used for a consumer-facing solution. Because we weren’t the first to enter this space, we felt our efforts were best focused on collaborating with existing businesses, i.e., a B2B offering. Our goal was to empower them with a hybrid service, one where we would improve the efficiency of financial advice using technology, yet still retain a human element to the process. Our view was and remains that humans are indispensable to provide the reassurance and support needed by clients with their investments.
Tired of the status-quo
Two years after launching WealthKernel, we witnessed little progress amongst online investment tools. Most still required users to answer a series of question and get assigned to a risk profile between 1 and 5 - an ancient approach that directly mirrored its paper analog prior to the information age. To make matters more frustrating, these propositions had gained the catchy title of “robo-advice,” alluding to the fact that some kind of advice was being provided by clever algorithms. In reality, the robo was nothing more than a linear series of questions latched onto a weighted average calculation.
Out of frustration and now armed with WealthKernel, a company able to spin-up a fintech startup in a matter of months, we decided the time had come to use the WealthSmart brand.
That was the idea anyway...
An unexpected twist
It wasn’t long before we realised someone else was planning to launch a service with a similar name. And not just any someone else, but the world’s largest bank: UBS.
To provide a bit of context, we wanted to first explain why WealthSmart is a name we care about. The Cambridge English Dictionary defines “wealth” as “a plentiful supply of a particular desirable thing.” The closest word to “wealth” can be traced to before 1250 AD where it started as weal and meant “well-being.” Today, the word “wealth” almost universally means prosperity and riches. To us, WealthSmart meant being enlightened about the true meaning of wealth in our daily lives. For example, being able to work from home to see your children more often, or retiring early to pursue a lifelong passion. The true meaning of wealth is specific to each individual and our hope was to create a brand whose purpose would be to remind people of this.
Given how important the name is to us, our hearts sank when we saw the “coming soon” UBS SmartWealth site. We had minimal funds in our bank account and lacked a live online proposition to point to as leverage. All we had was a UK trademark filing that took place before UBS’ filing, and a huge desire to build a brand we believed in. And so, we embarked on a lengthy dispute over the similarity of our names: UBS SmartWealth vs. WealthSmart. We stood our ground in court and came close to settling on a few occasions.
We’re presently exploring alternative solutions to end this dispute in way that benefits customers rather than the legal sector. Feel free to reach out if you have an idea. We’ll provide more details about this saga in our next post, but for now, back to our main story: building WealthSmart!
Make no assumptions
At the onset of building WealthSmart, we decided not to make any assumptions about what consumers wanted. Most members in our team have a deep-rooted background in financial services. This meant that our ideas were likely to be biased by our experience, and that we would lack empathy for people’s feelings about investing. To mitigate this, we bought a stack of coffee vouchers and went to meet potential users in London’s main techhub, Campus London. These users were most probably not representative of the average population, but they would give us a good starting point for people with no professional experience in the financial industry. Our conversations were centered around understanding their relationship with finances and investing.
The first key finding was that everyone unanimously distrusted the financial industry and showed a great deal of skepticism towards it. This finding served as our starting point. Our service would need to tangibly align its interests with that of its customers. In an era of social media, true authenticity was needed to achieve organic growth (the only growth we could afford). Actions speak louder than words, so we floated the idea of only charging customers if they were profitable. After further rounds of coffee-sponsored feedback sessions at Campus London, it was clear that prospective customers approved of this new approach to charging for an investment service. You can read more about how we charge our users in our previous blog post, People, not profits.
One problem fixed, another appears
With the decision made to charge fees only to customers with profitable accounts, we modeled the viability of this strategy at the business level and realised that we had bitten off more than we could chew. In moments of poor market performance, a traditional approach to investing left our company unprofitable for extended amounts of time. This would be untenable, especially for a young company that would rely on future growth.
Our new goal was therefore clear: we needed to create a portfolio that lowered the possibility of loss early on (the point in time where it was most at risk of being unprofitable). Operating this way had the benefit of fixing a major pain point for our prospective customers. For most, the risk of loss earlier on is the principal reason preventing them from investing. Thankfully, this was a problem we were well equipped to solve. With our team’s combined industry experience fetching nearly 100 years, we turned to our portfolio managers and let them solve this interesting puzzle. A few weeks later, they were ready to present their solution to the team.
The Self-Driving Portfolio
Before we spill the secret sauce, we felt it would be fair to ground you in a reality. Any type of investment can lead to a loss - no matter how experienced, smart or well-spoken the people investing your money are. The risk of losing money is an unavoidable consequence of trying to generate an income from your nest-egg. In the financial industry, we call this the “no free lunch paradigm.” It serves as a reminder that you never get something for nothing. If you want more reward, you will need to take more risk. Conversely, if you want to play it safe and benefit from certainty, you will get less reward.
But enough of industry jargon, back to the real story! The whole team sat eagerly behind their laptops (WealthSmart is a remote company) as we waited for the portfolio managers to present their solution. They called it the Smart Portfolio: a portfolio that would strive to emulate the convenience of a self-driving car. This sounded very ambitious, but they reassured everyone that the principles behind it were simple.
Each user would have a unique portfolio specific to the time they invested. The portfolio would start by being entirely invested in lower risk, and therefore lower growth, investments such as High Grade Corporate Bonds. The goal of this traditional strategy often used in private banking (our portfolio managers’ backgrounds) is wealth preservation, essentially, to minimise the risk of loss while generating small returns. As this strategy generated profits, the portfolio would then slowly pivot towards a secondary goal: long-term growth. This meant shifting the lower risk investments into higher risk, and therefore higher growth, investments such as company stocks & shares. As the portfolio grew further yet, so would its allocation to higher risk investments. If this were a self-driving car, this would be similar to safely increasing its speed as the road opened up and traffic diminished. If a moment of severe market instability struck, the portfolio would shift back towards lower risk investments, much like a self-driving car lowering its speed as it approaches heavy traffic or encountered rain.
The result was a portfolio that would return significantly less than what competing services were advertising. The forecasted annual returns over a 3, 5 and 10-year timespan were 3%, 4% and 5% respectively. As we mentioned earlier, there is “no free lunch” in finance - lower risk means lower returns. However, we concluded that this was the right approach for us. Not only would it enable us to move forward with our interest-aligned fee model, it had the potential to make the daunting investing process more palatable for un-invested users standing on the sidelines.
Sustainable, so long as it doesn’t cost
Unsurprisingly, another key finding from our interviews was that people were enthusiastic about sustainable investing, but not at the expense of their investments’ performance. To this end, we would strive to reduce our portfolios’ overall carbon footprint while also enhancing their overall investment performance. Our future users did not want these two preferences to be mutually exclusive. Was this even possible? Were we foolish to even consider this?
Before we answer the above, let’s look at some research. In a recent study by The Harvard Business School, the performance of 90 high-sustainability companies was compared to 90 low-sustainability companies. The study considers high-sustainability as “having a substantial number of environmental and social policies adopted for a significant number of years” and low-sustainability as “firms that adopted almost none of these policies.” It concludes that over an 18-year period, the former outperformed the latter by 4.8% per annum. Why? Among the key reasons cited, sustainable companies are more successful at attracting and keeping better and more committed employees and have more loyal customers. Not to mention companies with poor sustainability practices often pay a hefty price for them at some point in time.
As more scholars cover this topic, the evidence is starting to stack up in favor of companies that give due regard to social and environmental concerns. The failure to have a culture of sustainability is becoming a source of competitive disadvantage. The financial sector is paying attention and slowly starting to adapt. CEOs of key finance institutions are speaking out in favor of this trend. In 2017, $2.9 billion flowed into sustainable funds. A study by Barron's (we highly recommend this short easy read) found that in recent years a higher proportion of sustainable funds beat the overall market than actively managed funds (funds where experienced professionals actively buy and sell investments in an effort to outperform the market, rather than passively buy and hold).
For WealthSmart, all this was encouraging. We decided we would tackle this pragmatically, by slowly ratcheting up our exposure to high-sustainability companies as investment products made it affordable to do so (as a portfolio manager you pay a fee when you invest in a fund and socially responsible funds charge higher fees than average). Our first goal would be to make sure our portfolios had a substantially lower carbon footprint that the industry norm. As things progressed, we would keep striving to lower this footprint until hopefully one day we could become carbon neutral.
The first step is to get started
Most people we interviewed were in their early-30s and all mentioned insufficient funds as the reason preventing them from investing today. This led us to drop our minimum investment to the lowest feasible amount of £100. We realised this would still be a lot of money for many people, but would aim to lower it further as WealthSmart blossomed. Our view was that with investing, provided you don’t have high-interest debt to pay off, the best thing to do is just to get started. The total amount doesn’t really matter, so long as you’re exposed to the emotions of seeing your money rise and fall on daily basis. With time, investors’ ability to stomach market movement improves and so does their expected performance over the long run. A small account today serves as the perfect training ground for building good habits towards a larger account tomorrow.
Building WealthSmart has been an incredible journey into understanding how most people feel about the finance industry and investing. Despite starting with only a name, the simple process of engaging with potential users answered many of our questions about what to build early on and challenged our long-held industry beliefs. More importantly, it enabled us to find purpose in what we do for living. WealthSmart has taught us that all hope is not lost and that fair and finance are not oxymorons. It’s early days and therefore hard to predict where we’re headed with this service. But one thing we can say for sure is that our guiding principle will always be to work on behalf of people, not profit.
Interested in a clear and concise overview of what we do? Read our short Introduction to WealthSmart blog post.