#381: Andy Rachleff on Wealthfront & The Future of Fintech

Andy Rachleff is a co-founder and Executive Chairman of Wealthfront. He also co-founded Benchmark Capital in 1995 and was a general partner until 2004. In this conversation, we discuss disruption theory, product-market fit, exponential organic growth, self-driving money, payment for order flow, and delight as the greatest form of virality. ============================= Athletic Greens is an all-in-one daily drink to support better health and peak performance. Even with a balanced diet, it’s difficult to cover all of your nutritional bases. That’s where Athletic Greens will help. Their daily drink is like nutritional insurance for your body that’s delivered straight to your door. You can get yours at https://athleticgreens.com/pomp ============================= EQUOS is a digital asset exchange built to institutional standards available to everyone. It is built with the highest-grade security and transparency principles to meet regulatory standards while paving the way for participation. Their diverse team brings together decades of experience building and operating global digital exchanges used by the world’s biggest financial institutions, including deep expertise in the design and implementation of low-latency matching engines and algorithms and strategies. https://equos.io/ ============================================================ Pomp writes a daily letter to over 50,000 investors about business, technology, and finance. He breaks down complex topics into easy to understand language, while sharing opinions on various aspects of each industry. You can subscribe at https://www.pompletter.com

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Anthony Pompliano?

  What's up everyone, this is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Let's kick this thing off. Andy Radcliffe is the co-founder and executive chairman of Wealthfront. He also co-founded Benchmark Capital in 1995 and was a general partner until 2004. In this conversation, we discussed disruption theory, product market fit, exponential organic growth, self-driving money, payment for order flow, and delight as the greatest form of virality. I really enjoyed this conversation with Andy, and I hope you do as well. Before we get into this episode, though, I want to quickly talk about our sponsors. The first is Athletic

• 0:43Anthony Pompliano?

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• 1:27Anthony Pompliano?

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• 2:10Anthony Pompliano?

  Again, that's athleticgreens.com/pomp. Go check it out and get healthy with Athletic Greens. Next up is EQOOS. It's a digital asset exchange built to institutional standards, but available to everybody. It is built with the highest grade security and transparency principles to meet regulatory standards while paving the way for participation. Their diverse teams brings together decades of experience building and operating global digital exchanges used by the world's biggest financial institutions, including deep expertise in the design and implementation of low latency, matching engines and algorithms and strategies. Go check out EQOOS if you want a digital asset exchange that has institutional standards

• 2:49Anthony Pompliano?

  available to everyone. That's E-Q-U-O-S.io. Again, E-Q-U-O-S.io. Go check them out. Lastly, don't forget that I write a daily letter to over 50,000 investors about business, technology and finance. I break down complex topics into easy to understand language while sharing my personal opinion on various aspects of each industry. You can subscribe at pompletter.com. Again, pompletter.com. All right, let's get into this episode with Andy. I hope you guys enjoy this.

• 3:22Speaker 01

  Anthony Pompliano is a partner at Morgan Creek Digital. All opinions expressed by Pomp or his guests on this podcast are solely their opinions and do not reflect the opinions of Morgan Creek Digital or Morgan Creek Capital Management. You should not treat any opinion expressed by Pomp as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his opinion. This podcast is for informational purposes only.

• 3:48Anthony Pompliano?

  All right, guys. Bang, bang. I've got Andy here with me. Thanks so much for doing this.

• 3:53Speaker 02

  Thank you for having me.

• 3:54Anthony Pompliano?

  For sure. So for the like two people who are watching this who don't know who you are, let's just start with your background and kind of what you did before you got to Wealthfront.

• 4:04Speaker 02

  Okay, well, I was a career venture capitalist for almost 25 years, the last 10 of which I co-founded and was a general partner of Benchmark Capital. And then I retired the beginning of '05 to teach at Stanford Graduate School of Business, where I've continued to teach. And then in December of 2011, we launched the Wealthfront service. So that was quite an accident. And I'm the founder and CEO, co-founder and CEO of Wealthfront.

• 4:32Anthony Pompliano?

  Awesome. So one of the things I'm personally interested in is what was the genesis for starting Benchmark? Right? You'd already spent a bunch of time in venture, but what was the idea or the impetus for when you guys started that?

• 4:46Speaker 02

  Well, I needed a job.

• 4:50Anthony Pompliano?

  That's a pretty good answer.

• 4:55Speaker 02

  I had the good fortune to have been a partner at another one of the, at what was then a premier firm in the venture business called Merrill Pickard, Anderson and I, or it was probably one of the top five or six firms in the business. And two of our five partners had reached an age where they wanted to retire. And that left three of us. And we could either have taken the franchise forward or we could start something new. And so two of, we decided on the latter. So we wound down Merrill Pickard. Our last fund, our 1989 fund was a 10x fund. And in 1989, that was a big deal.

• 5:38Speaker 02

  So in '95, actually, New Year's Eve '94, we, five of us shook hands to start Benchmark. So it was my partner, one of my partners from Merrill Pickard, Bruce Dunleavy and I, and three other people. The other partner, the third partner from Merrill Pickard, teamed up with two other people and started Foundation Capital. And at the same time, another one of the top five venture firms, TVI, had decided, had the same generational transition where the founding partner was going to retire. And one of their partners joined us, Bob Kegel, who was one of our co-founders. And that left two partners from TVI,

• 6:23Speaker 02

  and they teamed up with one other person and started August Capital. So from the two firms, were created three.

• 6:31Anthony Pompliano?

  That's awesome. And then the name Benchmark, there's a lot of speculation. What was the idea behind the name?

• 6:40Speaker 02

  Well, we wanted something, we had read a book that we were heavily influenced by at the time that we had come together called Built to Last. And so we wanted a name that evoked something that was built to last. We were looking for an architectural term, and believe it or not, Benchmark was initially the high point in a, in a building. And we also wanted something that had a technology connotation. And back in the days of hardware, you always benchmarked your products against everyone else's. So when we came upon that name, we just loved it because it had the double entendre. And that's, and the best part of all was

• 7:23Speaker 02

  the domain name was available in 1995. That was, you know, you could get a name like benchmark.com. So that was the, the final straw that led us to move forward.

• 7:34Anthony Pompliano?

  That's awesome. And obviously, the reputation speaks for itself in terms of you guys ended up going on and built one of, if not the number one venture capital firm in the technology industry. And you did it for about a decade, if I understand correctly. What was the fascination or kind of drew you to teaching? Right? I think a lot of people said, you know, hey, that is a natural progression. But what was it for you personally in terms of wanting to go do that?

• 8:01Speaker 02

  Well, I wanted to give back, you know, I have a life beyond anything that I ever could have imagined. And I wanted to give back to the institutions that made that possible. So I became a trustee of my undergrad alma mater, University of Pennsylvania, where I got to know Howard Marks, who we were discussing before we started very well. We actually served on the Endowment Investment Board together. And then I started teaching at Stanford Graduate School of Business, where I got my master's degree. I had, and then my wife and I started an innovative cancer research funding initiative. And so they were all things to give back. And teaching just sort of came naturally. I was at, I TA'd a lot of courses undergrad

• 8:46Speaker 02

  and grad. I was a guest lecturer for a number of classes. And I liked coaching. So it was something that I wanted to try and I absolutely fell in love with.

• 8:57Anthony Pompliano?

  How similar was it coaching or teaching students to dealing with founders on a daily basis?

• 9:08Speaker 02

  You know, founders have always been young, but they were never as young as they are now. So they required more coaching than the founders that I worked with. That might be a little bit, that might not be as true today, but I think the founders today want less coaching than the founders did 20 years ago.

• 9:32Anthony Pompliano?

  Fair, fair point.

• 9:35Anthony Pompliano?

  Very fair point. And so obviously at some point you decide, I think you're actually still teaching now, correct?

• 9:42Speaker 02

  I am, yes.

• 9:43Anthony Pompliano?

  Okay, so you're going to continue to teach, but you ultimately end up starting a business. What was, was it just pulling you out of bed every day and you said, I gotta go do this? Or was there some other reason to?

• 9:54Speaker 02

  No, it was really quite accidental. So one of my responsibilities as a trustee at Penn was to sit on the Endowment Investment Board, and which I now chair. And I was sitting through a presentation on how the Endowment got its great returns. I'm a big believer that the premier university endowments are the best managed pools of capital. I mean, that's how your firm got started. That's what Mark did before he started his own firm. And, and what I noticed was that a lot of what they did was, all the premier endowments manage their money approximately the same way. You know, they were all investors in Benchmark and friends of mine are on all of their boards.

• 10:36Speaker 02

  So we all know what they do, but a lot of it is spreadsheet based and manual. And I thought, God, if you automate much of what they did, and if you actually implement it in software, you could deliver an 80/20 on the endowment experience. So it isn't quite as good, but it'd be radically better than what the average individual investor has available to them in the United States. And that struck me as an opportunity because.

• 11:09Speaker 02

  When I was a venture capitalist, many of the people that I had recruited in my portfolio companies who went on to financial success would come to me for investment advice. And I could never tell them to do what I do because I was fortunate to be able to afford better services with higher minimums. And so by doing this, it struck me that it was yet another social good. And I had really committed myself to social good after I had retired from venture capital. And little did I know how much work it was really going to take to build.

• 11:40Anthony Pompliano?

  That's awesome. And so talk us through in terms of as you guys got started, I was reading online, I actually didn't know this, the company had a different name at first and then kind of the Wealthfront story started in 2011. But what was kind of the pivot or the name change and kind of how you navigated that? And then what was that initial launch under the Wealthfront name in 2011?

• 12:02Speaker 02

  Sure. Well, everyone pivots. The one thing that most people don't understand is that literally every single successful technology company ended up pursuing a business plan different than the one that they set out to pursue. Now, they all revise history because consumers want to believe that you always intended to serve them. So we all changed the story. And so when we started, what we were trying to emulate from the endowments was the way that they choose public equity managers. So we built a marketplace of managers from which you could choose, who you could access

• 12:46Speaker 02

  with as little as $10,000 and typically it took a million dollars at least to attract, to be able to get into a separately managed account, outstanding investment manager. And we use the methodology or algorithms that premier endowments use to vet the managers. So what we were trying to do is find people who are likely to outperform and make them accessible, thus the democratization. Now, what we picked, ultimately we got to a marketplace of about 50 managers, all of whom were US public equity managers. And in the year and a half that we operated the marketplace where we had performance

• 13:27Speaker 02

  post-selection, our managers outperformed the S and P by 4% net of fees. So we did a great job and nobody cared. And what we learned when we dug in was that, as I said, we were really only appropriate for the US public equity portion of one's portfolio. And when we talked to people who chose not to open an account, the consistent message that we got, everyone used different words, but basically, we would rather that you manage all of my portfolio adequately and inexpensively than a portion of it superbly. And that was a lot easier to do. So we skinny

• 14:07Speaker 02

  the marketplace down to one manager, us, and we offered a diversified and rebalanced portfolio of low-cost index funds, and that immediately took off.

• 14:17Anthony Pompliano?

  Yeah, that's awesome. And so walk us through before today's announcement, kind of what the product itself looks like. So users come in under the promise that, you know, I think the popular terminology of robo-advisor, basically the computer and the algorithms are going to help me, you know, basically protect me from myself, right? It's going to do things that normally I would not do, or I wouldn't be disciplined to do, and I don't have to think about it. But what does that look like in a product format?

• 14:45Speaker 02

  Well, basically, what we've done is taken best practices in the financial advisory world and automated them. There's no proprietary algorithms. There's no quant element to what we do. The way that we diversify your portfolio was first conceived in 1958, and it won the Nobel Prize in 1990, and it's the basis on which all well-managed, large pools of capital diversify their holdings among asset classes. And there's a tremendous amount of research that's very consistent that shows that they're trying to pick managers to outperform the market is almost impossible over the long term. You're better off picking index funds

• 15:30Speaker 02

  to represent each of the asset classes. So basically, that's what we do on people's behalf, the way that you'd select the portfolios based on their risk tolerance, and only that. Most people overstate their tolerance for risk, and the problem is that, that the research is really clear that most individuals buy when the market goes up and sell when the market goes down. It's the opposite of what you should do, but it's what feels right. And nothing about good investing feels right. So if we can keep you invested, then that's going to earn you another one and a half to three and a half percent per year, based on the research of the way individual investors behave. So we want to make sure that we get a portfolio that's risky enough, but not too risky.

• 16:15Speaker 02

  It's sort of like Goldilocks. And if we can keep you invested in that diversified portfolio, you'll do well. So over the eight and a half years that we've offered that service, our gross return is about eight percent per year. Now, certainly, people can outperform that, but I don't think very many people over eight and a half years have earned more than eight percent compound. I really don't. And on top of that, we deliver a service called tax loss harvesting, which pays for our very modest fee of a quarter of a percent, anywhere from three to 13 times over.

• 16:57Speaker 02

  So amazingly, applying this methodology that typically has only been available to very wealthy people, that's selling an ETF when it goes down and replacing it with a similar one to maintain the risk and return characteristics of the portfolio, that adds after-tax for our average portfolio on the order of two percent of the portfolio value per year. But it ranges anywhere from three to 13 times the portfolio. This year, the tax loss harvesting will probably generate a value equal to 15 times our fee. And it's free, and it's deterministic.

• 17:38Speaker 02

  It's not, there's no timing of the market, there's no fancy algorithm, and so it's tremendous value. So we just kept improving it and improving it and adding more features to that, to the point that Dave Swann, who runs the Yale Endowment, who's probably the most famous endowment manager, a large pool of capital manager in the world, said to me, "I don't think there's anyone better than what you do, other than maybe a few of the top endowments." And we make it available to people with as little as $500. So over time, the way that we expanded was we came to realize that our value added, we started adding planning and advice to our suite of services.

• 18:23Speaker 02

  And we came to realize that the investments that we had made in automation in all the platform work, because we won't deliver a service unless it can be completely automated. And advice automation were the things that really stood out. So we said that our vision was to automate and optimize all of your personal finances. And then one of our engineers said, well, that's self-driving money. And that's a lot pithier way of saying it. We said, actually, yeah. So the vision is to get people to direct deposit their paycheck with us. We automatically pay their bills and then, and then even pay down their debts.

• 19:05Speaker 02

  And then take the remaining money and invest that in a way that's most appropriate for their situation and goals. And today, and so we launched initially a high-yield cash account, which was the minimum viable product of the account into which you would direct deposit. And then a couple of months ago, we added an entire suite of checking features, all of which are available for no fee and all much easier to use than a traditional bank app. It's a five-star rated app on the App Store and the Google Play Store. And then today we introduced autopilot, which is you can think of as a software-based financial assistant that automates your savings.

• 19:48Speaker 02

  And so we actually are now implementing our vision.

• 19:52Anthony Pompliano?

  Yeah. What's really interesting about this is much of, I think, personal finances. One, people just are very undereducated on it, right? A lot of people just don't have either access to the information. No one sat them down and said, you know, here's the basics. So I think that, you know, obviously being able to kind of impart that information to somebody's portfolio, whether you've got to tell them about it or you just do it for them, is a huge value. But also the second piece is even the people who are educated. On what to do, there's still a manual process, right? In terms of you've got to go into your account, you've got to do X, Y, and Z, uh, you know, and it's very easy to kind of break discipline, right? Oh, the stock market's going up today, you know, maybe I should put a couple extra percentage

• 20:35Anthony Pompliano?

  points in there or take it out or do whatever. And so to me, it seems like what you guys are really doing is just taking the best practice, writing it into code, and then preventing people from making all of the classic mistakes, right?

• 20:49Speaker 02

  That's all we do. It's really, really simple. You know, truly funny people, I've seen many people write about us that it's ideal for beginners, which makes absolutely no sense, because it's just as appropriate for really sophisticated people as beginners. And as a matter of fact, the early adopters of almost every one of our services are literally the most sophisticated people. So for example, with autopilot, uh, this is a feature, our first self-driving money feature that unifies banking and investing. So what it does is that you choose the account that you want it to monitor. If the balance goes above a threshold that you set by more than a hundred dollars, we will set up a transfer to an individual, either savings or investment

• 21:34Speaker 02

  account. We'll then send you an email so that you have 24 hours to say no. So we want you to be in complete control. That's what we call an assistant, not an advisor. You're in complete control of this thing. And, uh, and it basically just automates what people, what sophisticated people normally do. And over time, we'll monitor more and more source accounts and we'll route to more and more destination accounts in parallel. And so, and, and the beauty of it is if you bank with Wealthfront, all of this money transfer is immediate. We take all the float out of the system. And so there's a tremendous benefit from using both our banking and our investing.

• 22:18Anthony Pompliano?

  Yeah. And in that feature, um, it sounds like you guys are, uh, kind of start out with the minimum viable product, but you started to, uh, expand and there's kind of a greater vision there. I was told that you are, uh, the person who coined the term product market fit.

• 22:36Speaker 02

  Oh, yeah.

• 22:37Anthony Pompliano?

  Okay. So you're going to tell us the story of where that term comes from. And then I want to hear how you measure internally, you know, do each of these new features that you launch actually hit with product market fit? But where did that terminology come from initially?

• 22:51Speaker 02

  Well, as a venture capitalist, I always spent a lot of time trying to improve my craft. I always tried to get better. And one of the things that I did is I tried to study my competitors to understand what they did really well. And the firm that I most respected was Sequoia Capital. I just think they're unbelievable. And I think Don Valentine was brilliant. And Don had a methodology that's very unique to Sequoia. Don's point of view, and Don passed away in this past year. And he was probably one of the two greatest venture capitalists of all time. John Doerr is probably the other from Climate Pockets.

• 23:33Speaker 02

  Anyway, Don had this philosophy that if a startup can screw something up, they will. Because you're under-resourced, you're understaffed. It's not that you're not good, it's just that you have so little bandwidth to do so much. You're going to screw almost everything up. So the pull from the market has to be so strong for you to succeed. That that's all that matters. And so Don was famous for asking this question, who cares? Everything he focused on was who cares about your product and why? Why are they desperate? In order for a startup to succeed, consumers need to be desperate for what you offer.

• 24:19Speaker 02

  Because if there's a good enough alternative from an incumbent, consumers will buy from the good enough alternative because they trust it. Why would they buy from you? And so I tried to learn more and more about this to one of our partners.

• 24:35Speaker 02

  We recruited a partner to Benchmark who had Don as the chairman. He started a very successful digital video company, the first digital video company called CQ Microsystems. Don was his chairman. So I tried to learn from him about Don.

• 24:51Anthony Pompliano?

  Couldn't exactly call Don up and Don wouldn't tell you the secrets if you called him?

• 24:55Speaker 02

  No. But I was on the board of a number of companies. We worked with Sequoia a lot back in the days when we used to syndicate. And I would talk with my colleagues because there was a lot of mutual respect. And so I basically put a name to what Don had been doing for decades. So the idea of the market pulling the product out of your hands. I thought of as product market fit. And so I coined the term and I, I really spent a lot of time working on the concepts with Mark Andreessen because I sat on Mark's board at Opsware. And he was really interested in this. I actually gave them an idea.

• 25:40Speaker 02

  They pivoted from something called LoudCloud to Opsware based on some of the thoughts that I had put together on what was important to product market fit. And so together, we really tried to think that through. Mark wrote about it a lot, which is why a lot of people think that he coined the term, but he's always very kind to give me the credit. And about 12 years ago, I started teaching a course on it at Stanford. So every year I try to get a little bit better at trying to understand the issues. So back to your, your key question is how do you know if you have it? I think there are different heuristics for consumer companies and enterprise companies. For consumer companies, it's exponential organic growth.

• 26:26Speaker 02

  Because how do you know that people want your value proposition? Well, the only way that you can tell is if you get word of mouth. And the only measure of word of mouth is exponential organic growth. It's not growth in general because you can gain growth. You can buy growth uneconomically. And so a lot of people fall for that. But one of the things that you find if you talk to the premier venture firms is they're riveted on exponential organic growth.

• 26:54Anthony Pompliano?

  And then how about with the, the enterprise software?

• 26:59Speaker 02

  Well, there are two things, there are two heuristics that I've come to recommend for them. One of my teaching partners for another one of my courses, not the Product Market Fit course, was a fellow named Mark Leslie, who founded a phenomenal company called Veritas Software, that he grew to about a billion and a half dollars of revenue before he retired, which is an amazing accomplishment, and Mark's a great leader. Well, he published a paper with a Stanford Graduate School of Business professor named Chuck Holloway, called "The Sales Learning Curve", and basically it posited that sales has a learning curve just like manufacturing, that there's an S curve to selling a product.

• 27:42Speaker 02

  It starts out slow and then it ramps very quickly and then it starts to slow down again. And interestingly, the first knee of the curve in that S, where things really take off, the sales yield is equal to 1. So the sales yield is the contribution margin generated by a sales team as the numerator, and the cost in the denominator is the cost to field a sales team. So for an enterprise company, there's usually a direct salesperson, there is a, an SE, a sales engineer, who does the technical part of the sale, there's often an inside sales rep, or a portion of an inside sales rep,

• 28:27Speaker 02

  there is the management overhead, and when you add it all up, it adds up to about $600,000 per team. So that says, once a sales team is able to generate a gross profit in excess of $600,000, you know you've hit the recipe. You know you've figured it out. In the, the, the paper on sales learning curve, which you can easily Google, makes the point that the biggest mistake enterprise companies make is they ramp up their sales teams before they know whether or not their sales yield is greater than 1. And they do it thinking more sales reps means more sales. Well, it doesn't work that way. First, you have to figure out the recipe.

• 29:10Speaker 02

  And then you can ramp it. And that's where you waste most of your money. So that's one. And then the other one I learned from Doug Leoniet, who's the managing partner at Sequoia. Not surprisingly. And that is when an enterprise company starts. It usually has to do a trial as a proof of concept. And what you find is in order to qualify the the prospect, you say you make them sign a contract that says after thirty days, if the product does what you say it will do, what you represent, they'll buy the product. No one ever lives up to that contract. So what Doug does is he pulls, he tells the CEO, pull the trial after thirty days.

• 29:51Speaker 02

  Now, most companies don't start the trial until one or two weeks into the stated thirty day period. But Doug's point is if they don't scream and pay you, they were never going to pay you anyway. Because if they don't scream, they weren't desperate. And if they're not desperate, they're not going to pay you. So pull the trial. Now, this drives entrepreneurs nuts. Because they, the worst word in the English language for entrepreneurs is maybe. Maybe is no with hope. When someone says maybe, they're never going to say yes. But you want them, you want to believe it's hope. You want to believe they're going to say yes. So if you pull the trial, you learn whether it's yes or no.

• 30:36Speaker 02

  And if it's yeah, if it's no, then you try to, you don't just keep trying more trials. You try to figure out why was that customer not desperate? What are the characteristics that would cause someone to be desperate? And you test the new hypothesis. And that's where you apply the lean startup methodology.

• 30:56Anthony Pompliano?

  Yeah, one of the things that's really interesting, you know, again, you've co-founded one of the absolute best venture capital firms in the world today. You've built a very big business with Wealthfront. But what you're talking about, when you're talking about kind of formulas and algorithms and things like that, is you were talking about the decision-making of the endowment pool managers or financial advisors. But venture capital and company building has many of those same, you know, either formulas or decision-making processes and kind of lessons learned over the years. They just might not be as clear because they're not as quantitative, right?

• 31:33Speaker 02

  They're clearly not as quantitative, yeah.

• 31:36Anthony Pompliano?

  Yeah, but but very similar in terms of if you understand this stuff, it is very easy, one, to recognize, and then, two, as the founder of a company, it's easy to focus on, here are the important things, right? The exponential organic growth is much more important than going and sinking a bunch of money into digital ads, for example.

• 31:53Speaker 02

  I wish that knowing how to judge made a difference to actually creating a product that succeeded at those things. Those are two very different issues. So, yes, I have a, I think I have an unfair advantage in knowing what to look for, but unfortunately, that doesn't help you conceive compelling products.

• 32:16Anthony Pompliano?

  I love the honesty. One of the things that has happened over the last, you know, six, seven months is obviously COVID-19, a very large impact to the public markets, and then kind of a macro environment that I think a lot of people are just scratching their heads, right? So we don't have to get into kind of why has a lot of this happened? But there's obviously been a lot of volatility in the market. Talk a little bit about the impact that that volatility has had on Wealthfront users, and then maybe some of the positive things that Wealthfront has allowed people to do that, you know, data is suggesting, for example, a lot of older clients in the financial advisor world sold stocks at the

• 33:01Anthony Pompliano?

  bottom of the market in March, right? Because of short time horizons. So maybe just talk kind of the macro environment in COVID-19, how that's impacted Wealthfront.

• 33:10Speaker 02

  Okay, well, first of all, yeah, as context, you should know that we target young professionals as our customers. So millennials who save. And so today millennials are 25 to 40.

• 33:26Speaker 02

  They like us because as they tell us, we pay you not to talk to us. We don't have any advisors. Our customer support reps are licensed as financial advisors, but you don't need them. And their job is actually more focused on figuring out what to do to the product to keep someone from reaching out to them than it is providing technical support, even though they provide great technical support. So the thing that's most surprising about our customer base is our withdrawals are not at all correlated with market performance. This shocks people. Now, I don't know if that's because they, you know, we offer a passive investing solution, an index-based solution.

• 34:10Speaker 02

  And maybe to use us, you've already bought into passive investing. And if you understand passive investing, you know, you can't time the market, so you shouldn't try. So our withdrawals are much more impacted by life events like getting married or buying a home than the state of the markets. Now, the add-on deposit rate is affected by the performance of the market. And that thing that I referenced earlier about how people chase the market up and down. So they don't withdraw, but they can't quite bring themselves to add more money when the market goes down.

• 34:45Speaker 02

  So we're going along just fine. I mean, we're growing at our, our normal pace. But I would say that right now, the day trading is exploding. And you see that in, in companies like Robinhood. Now, every 15 years or so, something happens that causes an explosion in day trading. And then people lose their money and then they learn their lesson. But you know, it's like kids, teenagers with parents, no amount of telling someone the research that you shouldn't day trade is going to get them to not do it because it's also a lot of fun.

• 35:25Speaker 02

  So we see people, and it's really funny that we, because people link all of their accounts to us so that we can automate the movement of money and such. We see where the money is going and they're allocating, our clients are allocating a bunch of more money to trading, which literally makes no sense. But it's what they want to do and they're welcome to do what they want to do.

• 35:52Anthony Pompliano?

  What's so interesting to me is you get the market volatility, right? To your point, there's probably some longer term trends. Just now's about the right time for day trading to come back because people who, you know, learned their lesson back 10 to 20 years ago, they've kind of aged out of the phase of wanting to do it. And so there's a whole nother crop of people that need to learn the lesson.

• 36:12Speaker 02

  Exactly.

• 36:12Anthony Pompliano?

  But, but the other thing that's really interesting is sports completely disappeared, right? And so one of the things that is fascinating to me is many of my friends who were always betting on sports, right? Through whether it was kind of the fantasy stuff like the DraftKings of the world, etc., or just, you know, kind of more amateur.

• 36:30Speaker 02

  What's the name of the guy from Barstool Sports who's promoting day trading that you can't lose money trading? What's his name?

• 36:35Anthony Pompliano?

  Dave Portnoy.

• 36:36Speaker 02

  Yeah, Dave Portnoy. You know, the thing that reinforces it too, Anthony, is that, you know, if you look at the S and P since the bottom, what are we up 50 or 60%?

• 36:46Anthony Pompliano?

  Something like that.

• 36:46Speaker 02

  So, so if you started investing then post shelter in place, and you're up 30%, you think you're brilliant. Because historically, if you were up 30% in six months, you're a god. But if you're up 30% in the last, in the last four or five months, you're terrible. I mean, you would have been far better off buying a market index. But it doesn't feel that way. I mean, you can brag to your friends, I'm up 30%. I'm really good at this. And so I think that has reinforced this idea that, that the other periods of great day

• 37:30Speaker 02

  trading coincided with very large increases. It wasn't so much about volatility. It was about a large increase in a short period of time, which led people who had historically reasonable performance to think that they were doing a good job. And we were talking about how it marks it before. In one of his recent letters, he pointed out that if the S and P 500 is up 50%, you know, the six biggest tech companies are up more. And the other 494 companies that comprise the S and P 500 are down 10 or 15%.

• 38:17Speaker 02

  What does that tell you? So if you invested in one of those, a momentum investor to me is not a brilliant investor. They're a lucky investor.

• 38:27Anthony Pompliano?

  Yeah, well, I think also it goes to this belief that human nature is whenever something happens, whether that means prices go up or down, just something is happening. The feeling of control unfortunately comes from people doing things, right? So it's like, oh, I see a price movement. I need to buy or sell because that's how I almost convince myself I'm in control. And what obviously all the research shows is maybe being in control is not the thing that needs to happen, right?

• 38:59Speaker 02

  We're the boring choice, but you know,

• 39:03Speaker 02

  the people, all we can do is encourage people to limit their play money to a reasonably small percentage of their total net worth. Go have fun. You know, Bert Malkiel is our chief investment officer and Bert invented the index fund and wrote the seminal book on the subject called A Random Walk Down Wall Street. He was a professor for many, many years at Princeton University. And I'll never forget, soon after we launched, we had an event for our local clients in the Bay Area and we invited Bert to to a fireside chat and then we opened it up to questions. And a wise ass in the audience said, Bert, do you own any stocks? And Bert said,

• 39:46Speaker 02

  as a matter of fact, I do, and I also love going to the dog track.

• 39:52Speaker 02

  He said, but I consider that entertainment. But I don't consider that investing and I keep it to less than 10% of my net worth. I enjoy it and I do it, but I know exactly what it is.

• 40:07Anthony Pompliano?

  So yeah, that's a great way.

• 40:08Speaker 02

  We're the, we're the, we're the boring alternative.

• 40:11Anthony Pompliano?

  That's awesome. Obviously, there's a lot of questions now about 60-40 portfolio construction, passive investing. How do you think about kind of shifts in the modern portfolio theory? Like, a lot of these core concepts that financial advisors for sure have built a lot of their business on and done very well over the years. Do you think that any of that is changing? Or is a lot of that conversation just people, basically, they're wishing that something would change because they don't like the idea that, you know, the same principles have worked decade after decade after decade, and that's going to continue?

• 40:50Speaker 02

  Well, practically speaking, I think the latter. I think that's a very good question. Technically speaking, there have been advances in factor-based analysis, and that's led to products like Smart Beta. And there was a Nobel Prize awarded for that in 2019, or 2013. So 23 years after modern portfolio theory. So there are more modern ways to construct a portfolio. There are limitations to modern portfolio theory. And as I said before, we view ourselves as an 80/20 on the university endowment portfolio. We're not quite as good. But for someone who doesn't have the money to invest that way, you know,

• 41:34Speaker 02

  who isn't worth hundreds of millions of dollars, I think net of fees after taxes, nothing can come close. So yeah, it is really boring to have a portfolio with maybe, maybe not 60-40, but maybe six asset classes in it. And the thing that we can really add value on is the tax savings that a traditional financial advisor can't do because it's too complicated. You know, if you think about all the tax lots, especially with dividend reinvesting from the index funds, that's too hard for an advisor to perform other than at year end. But computers don't care about number of clients or number of tax lots.

• 42:15Speaker 02

  So we can do it dynamically every day, and that leads to far greater value creation, not because we're so much better, just because computers are better at doing things like that. So, you know, why don't advisors use really inexpensive index funds? I think they need to try to justify their fees to their clients. You know, we only charge a quarter of a percent and nothing for the tax loss harvesting. But the average financial advisor charges 1%. And if you outsource some of the portfolio for tax loss harvesting to parametric associates, they charge another half a percent. So people, people have to justify the fees with more action.

• 42:58Speaker 02

  The problem is more action leads to destruction of portfolio value, not addition, not creation of portfolio value. But that's not a fun narrative.

• 43:09Anthony Pompliano?

  For sure. And, and one of the things in the University of Endowment, so many people listening to this are probably not familiar with endowment investing, obviously. Having a partner in Mark Yusko, who spent a lot of time doing that. I've gotten

• 43:22Speaker 02

  Very well, exceptionally well, yes.

• 43:25Anthony Pompliano?

  Yeah, I've gotten the crash course many, many times. And for the people can go, Andy mentioned Dave Swenson. He's written a great book about kind of portfolio allocation and construction. But one of the key pieces to the endowment model is the use of alternatives. And so how do you think about that in a world where you can use quantitative models and algorithms and software really to, you know, again, just help people do the good things, right? Not necessarily do anything crazy special, but just the good things. Where, where do you see the alternatives fitting into that?

• 44:02Speaker 02

  Well, the dirty little secret is almost no quant funds make money. And by I say might make, almost no quant funds outperform the market. Renaissance has for decades. And everyone holds them up as an example. And maybe two sigma has as well. But I can't name more than five that outperform the market net of fees. So logically, one should be able to create a quant fund that, that can do the things that you say, but they can't. And that's why the plain vanilla makes sense. So, and look, if you have access to the premier hedge funds and private equity funds.

• 44:50Speaker 02

  Then there are a few that are two sigma from the mean. You know, in the venture business, something like 20 firms or 3% of the venture capital firms generate 95% of the realized returns of the industry. Now, there have been a bunch of studies of late, how they don't represent nearly as much of the returns of the industry, but the only thing that matters are the realized returns. Markups don't matter. So if you can get access to those 20 firms, man, by all means, you should, but none of those firms want you as an investor. They want people who are going to be there for decades. And where there's continuity of management and the people are just going to say yes,

• 45:35Speaker 02

  and they have extremely long timeframes, and they are not worried at all about the state of the public markets. So when, they don't want investors who, when the markets go down, worry about whether or not they should make a new commitment. So if you can't get access to the premier hedge funds or private equity firms, you shouldn't do it. Because investing in the others are value destroying exercises. And the number one thing that private wealth managers sell to justify their high fees is access to alternatives. The problem is the old Groucho Marx line, never join a club that would have you as a member. If a brokerage firm can get access to an alternative asset, the only reason they can

• 46:18Speaker 02

  get access is because they can't raise money through the best investors. Why would they accept individual investors as investors? That's stupid. So be careful what you're being offered.

• 46:33Anthony Pompliano?

  It's funny to hear you say, the realized returns, because that only comes from somebody who has been around long enough to see the realized returns and understand that that's actually the ultimate goal of this game, is that you have to get the money back.

• 46:48Speaker 02

  Exactly. And markups are great, but you know, there's a lot of unicorns that won't ever return a penny.

• 46:56Anthony Pompliano?

  We've definitely seen that already. And something tells me there are more to come. Talk a little bit about the, there's a counter argument to basically what you guys are doing. There's kind of the critic who would say, oh, there's just this massive passive investing bubble. Now, there are tons of what I'll call the uneducated critic, which is just a kind of a, you know, a swipe of the, of the brush and just say it's all bad. Then there's very educated kind of critiques. But how do you see whether there could be a passive investing bubble or not? And how you think about kind of navigating that?

• 47:36Speaker 02

  You know, I draw an analogy to climate change. If you look at the peer reviewed research, something like 90%, 98% of the scholars who do research agree that there is a problem with climate change. Now, if you go online, it's not 98%.

• 47:58Speaker 02

  I remember in John Oliver's first season, he did a bit where he said, you know, all of these point counterpoint news shows have debates on the subject where they have one person representing each side, which makes you believe that it's a 50 50 argument. He said, that totally misrepresents it. So I'm going to, I'm going to populate my desk in the relationship of the actual research. And so he had 98 scientists sit on one side of the desk and one scientist sit on the other. So among academics, there's no debate on this topic.

• 48:39Speaker 02

  It's very, very clear. There's tremendous debate among individual investors because they don't want it to be true because no one wants to believe that they can't do it. You know, it's really funny to me that you never pick up a scalpel and think, I could perform heart surgery, but you can look at a Yahoo finance page and think I can pick stocks? Both of which take years and years of apprenticeship and learning to do exceptionally well, but for some reason, people think they can, they can pick up investing very, very quickly. And, and I've never understood, you know, I'm a pretty good investor. I don't invest my own

• 49:22Speaker 02

  money because I'm not doing it all the time and I'm not totally on top of it. So I'm going to delegate it to people who know what they're doing. Bert, now, now to address the specific point you made about, uh, is there a bubble in, in passive? You know, I think just last year, passive funds total capital passed actively managed funds total capital. You know, and that's after, and I think Vanguard sold their first, uh, index fund in 1974. So it's taken a long, long time to get to 50%. Bert Malkiel's point of view, and he

• 50:04Speaker 02

  actually wrote a blog post about this on the Wealthfront blog, was that, uh, is that until passive is 90 or 95%, we don't have any problems. Because as long as there's 5% of the market that's actively investing, you can accurately price securities. You know, think about if you have 40 trillion invested in, in equities, do you need more than 2 trillion to accurately price a security? I don't think so. So that's why we are a long, long way from passive getting in the way of accurately pricing securities. Because

• 50:45Speaker 02

  as long as a security, as long as there is $2 trillion of money chasing it, if something gets mispriced terribly, someone's going to jump in.

• 50:54Anthony Pompliano?

  Yeah. It, it's funny to hear you talk about, uh, the individuals who are debating, uh, passive, uh, versus active, because I think you are right that, uh, it's, uh, people want to believe that they can, uh,

• 51:05Speaker 02

  I don't blame them. But I don't think I can pick up a scalpel and perform heart surgery.

• 51:13Anthony Pompliano?

  Absolutely. Talk a little bit about how you overcome that psychology, right? So obviously.

• 51:18Speaker 02

  You don't.

• 51:19Anthony Pompliano?

  Okay.

• 51:19Speaker 02

  You preach to the converted.

• 51:21Anthony Pompliano?

  Explain that a little bit more.

• 51:23Speaker 02

  So the first rule of entrepreneurship is you can only sell to people who want to buy. That startups can't educate. I have to let Vanguard educate people on passive investing. And then they come to realize that we offer a better form of passive because our taxless harvesting more than pays for our fees. So if you like Vanguard, you'll love Wealthfront. But I let Vanguard do all of that work. I can only preach to the converted. I can't, I can't, I can't do missionary work. I have to leave that to big companies.

• 51:56Anthony Pompliano?

  And is that?

• 51:56Speaker 02

  And that's, that's not just true of Wealthfront. That's true of all startups.

• 52:01Anthony Pompliano?

  Is that a resource constraint? Or what exactly is driving?

• 52:05Speaker 02

  Takes too much time.

• 52:06Anthony Pompliano?

  Time.

• 52:06Speaker 02

  Just time and effort.

• 52:09Anthony Pompliano?

  Got it. Talk a little bit about the fee based model. So I saw a couple of people tweeted at us asking, basically saying, how do you grow AUM? Is there things you can do with the business model that could help or hinder that that growth? And how you just think about an AUM based fee versus maybe some of the other business models that people are trying?

• 52:32Speaker 02

  But like what?

• 52:33Anthony Pompliano?

  Well, so mainly in the more active stock brokerage, right? So they'll go no fees and kind of try other things. In passive, it's a little bit harder, right? But, but I still think.

• 52:45Speaker 02

  I, I, I hope that your viewers and listeners realize that Robinhood makes a rather large multiple of revenue relative to us annually. They get more revenue from you than we do for their free trading. And that's just because it's hidden. It's called payment for order flow. The exchanges are paying them to place the trade. And the reason the exchanges pay Robinhood to place the trade is because the exchanges then sell that data to high frequency traders

• 53:28Speaker 02

  who front run your trade and make a penny a transaction. Now, I don't understand why this is legal, but it is. But to me, it's insider trading. It's enabling insider trading.

• 53:41Speaker 02

  So

• 53:42Anthony Pompliano?

  And just so I'm clear, because actually I've never heard anyone make that argument. It's the idea that the exchange is selling it is the part that you don't like? Or the part where Robin Hood's selling it to the exchange? Or just the whole?

• 53:54Speaker 02

  Well, I didn't say I don't like. I'm just saying that if you, let's say I'm, I'm a brokerage firm. And you say, I want to sell 100 shares of Netflix. With Netflix at $500, that's a lot of money. So I'm just trying to make this easy. So as the broker, I then electronically place that on an exchange for someone to buy. Instead of me having to pay the exchange to make the trade, the exchange pays me to place the change, the shares on their exchange to be purchased.

• 54:38Speaker 02

  So instead of me paying the marketplace, the marketplace pays me. And the reason that the exchange is willing to pay me is they then take the data, the information that, and they don't know that it's Andy Rachleff. They just know that an individual wants to sell 100 shares of Apple. And they sell that to a high frequency trader. So if the market for, for Netflix is a bid ask spread of 50150 and 50175, they'll jump

• 55:20Speaker 02

  in and buy it at 50150 and sell it at 50175. So before you have a chance to sell it, they know you want to sell, they buy, they jump in and then they sell it to you. And they do this in milliseconds. And so the high frequency trader, every year they get a smaller and smaller time period to front run your trade. So what's the name of the guy who wrote?

• 55:59Speaker 02

  Blindside?

• 56:03Speaker 02

  And Moneyball. Oh.

• 56:08Speaker 02

  Michael Lewis. Michael Lewis. So he wrote a great book on this called Flash Boys, if you really want to understand it. So that's why, and so Robinhood makes all of this money. And then it really is a commission. They just don't call it a commission. And today, there was a, the Wall Street Journal published a report that the SEC is likely to fine them more than $10 million for not disclosing that they do this. Yeah. So what we do is we charge a percentage of assets, which actually is a lot lower than the fee that you're paying to Robinhood. You just, it's just overt. People don't like overt fees. And as I've said before, we feel good about what we do because the value of our tax loss harvesting

• 56:53Speaker 02

  more than pays for that fee many, many times over. And the reason that we're able to do this is if you delight your customer, they tell their friends. So we grow through word of mouth. So I was on the board of Reed Hastings', previous company, Pure Software, and he taught me that virality is the greatest form, that delight is the greatest form of virality. So if you delight people, they, they keep giving you more money. And one of the unique things about Wealthfront is that we, our average customer generates 30% more revenue to us each year by one, giving us more deposits into adopting more of our services.

• 57:36Speaker 02

  If we were a SaaS company, that would be in the top quartile. They call it dollar-based net expansion ratio. And you only do it if you really delight your customers. And the highest valued companies are the ones that do this. For a consumer company, net of churn, to generate more than 100% of last year's revenues is exceptionally unusual.

• 58:00Anthony Pompliano?

  Yeah. And is this where you see something like a Netflix being able to increase the price and not have increased churn?

• 58:08Speaker 02

  Yeah, because they delight their customers. They give you more and more value.

• 58:12Anthony Pompliano?

  Yeah, it's fascinating. I think that when you start to use comparisons on the consumer side with the SaaS, very quantitative model too, right? You can really start to unpack, I think, hey, is this working? Right? And goes all back to the product market fit.

• 58:28Speaker 02

  But it all goes back to Debitner. It all goes back to this dollar-based net expansion ratio. You know, Datadog is something like 1.7 or 170%. That means a customer that they acquired last year, it's like same-store sales. The same-store sales are 1.7X what they were last year. Can you imagine a retailer with same-store sales of 170%? They're happy if they get 104%. And so Datadog does something like 170%. Snowflake, which is coming public, is something like 160%. The top quartile of SaaS companies are 125%, and we're at 130. I challenge you to find another consumer company above 100.

• 59:14Anthony Pompliano?

  Yeah. Well, and what's interesting too is your model, like you're talking about here, right? So Netflix has to go and make a corporate decision to raise prices, right?

• 59:22Speaker 02

  Or they give you more services, but in the case of Netflix, they don't have more services.

• 59:27Anthony Pompliano?

  Yep. But it's just hard to do that year in, year out, right? There's fatigue for the customer, et cetera. For you guys, it is based on you make more money as the user deposits more money with you.

• 59:38Speaker 02

  But we make more money with you, not from you.

• 59:41Anthony Pompliano?

  Exactly.

• 59:42Speaker 02

  By automating it, by only delivering services that we can automate, we lower the cost of delivering the service and we share the economics with our customer. And they really, really value that. So, you know, first we offered investment services and then we offered the fastest, easiest and cheapest way to borrow money with our portfolio line of credit. Our customers who use that are our most satisfied customers. Then we offered a high-yield cash account that's free. We make a little net interest margin on it, but we make money that way. Then we offered checking services with a debit card. So we make interchange revenues on the debit card.

• 1:00:26Speaker 02

  And then in the future, we'll offer mortgages. Again, we'll share the economics with our clients. So they'll get better rates than they would from any other bank, but we'll still make a spot. We can do just fine with much lower prices because of our automation.

• 1:00:43Anthony Pompliano?

  Yeah, I love that.

• 1:00:44Speaker 02

  And the nice thing is the autopilot brings it all together. That imagine, you know, you don't have to learn how to drive a manual transmission or a stick shift car before you learn how to drive an automatic, do you?

• 1:01:00Anthony Pompliano?

  You do not.

• 1:01:01Speaker 02

  But you never see anybody online say, well, before you drive an automatic, you better learn how to drive a stick. But for some reason, earlier you talked about financial education. With Wealthfront, you don't need any financial education. We do it all for you. We literally do it all for you. So you don't have to learn how to drive that stick shift car.

• 1:01:25Anthony Pompliano?

  That's awesome. The last thing I want to talk about before we get into some rapid fire questions to finish up is you are very well versed and spent a lot of time in the endowment world. So there these large pools of capital. One of the more, I'll call it controversial or debated topics has been, there are a couple of managers. I think the one of the Nevada pension managers has basically said, nope, I'm not going to play this game of managing the endowment. I'm instead going to go into all low cost indexes, right? Basically, he walked in and I'm paraphrasing, but I think he basically fired like 90% of the staff and he put it all on low cost indexes, shows up every day and like reads the newspaper, right?

• 1:02:07Speaker 02

  Yes.

• 1:02:08Anthony Pompliano?

  Doesn't do too much. Do you think, one, that trend will become more popular at the large pools of capital? And two, do you think that maybe some portion of what they do can be automated? So you guys are doing this for consumers today, but can this kind of go upstream to the larger pools of capital as well?

• 1:02:24Speaker 02

  Sure. It's exactly what we do. And it makes a tremendous amount of sense. Remember I said earlier that if you can't get access to the premier alternatives, you shouldn't try. Well, guess what? The, the.

• 1:02:39Speaker 02

  The non-premier in limited partners, the non-premier endowments or pension funds can't get access. So it's sort of a fool's errand for them to continue to try. It doesn't, for most of them, it doesn't stop them from still investing, from getting an allocation to hedge funds or private equity or venture capital. But they shouldn't. It's, you know, the, the average return of the venture capital asset class is horrible. It's really a dumb asset class to invest in if you can't get into one of the top 20 firms. That doesn't stop people from doing it for ego reasons. So as a matter of fact,

• 1:03:21Speaker 02

  we have a debate at the Penn Endowment about whether or not we should index US public equities. Because we, one of the things the endowments are good at is figuring out how to choose managers, they're in that, you know, two sigma from the mean group, there are always an unusual set of outliers who are able to identify managers who outperform the market. Those were the algorithms that we used when we started Ka-Ching, the predecessor to Wealth Fund. And, and we're still really good at picking international managers and generating

• 1:04:00Speaker 02

  alpha that way, but we haven't been at US. And so it's a really controversial decision, should we index? Because, you know, real, real investment managers don't index.

• 1:04:16Speaker 02

  So if it's, if the discussion is going on at the seventh largest endowment in, in the university world and one of the best managed ones, I, I think it should go on in one of the lesser.

• 1:04:29Anthony Pompliano?

  It's so fascinating to me because for the most part, when you bring most money managers into a room, they're incredibly intelligent, they're very, very focused on kind of truth seeking and generally have sound decision.

• 1:04:44Speaker 02

  Except about themselves.

• 1:04:46Anthony Pompliano?

  Well, that's what I was gonna say is basically when it comes to their decision, it ends up being they completely throw math out of the window, right? All the research, it's just, it's so fascinating to me how somebody can be so intelligent and completely from an emotional standpoint, write off certain conversations or certain options. And it's just a human thing.

• 1:05:06Speaker 02

  You know, the best explanation I've heard for why it's so hard to outperform the market came from a member of our advisory committee, who's a legend in the investment world named Charlie Ellis. Charlie founded the premier financial services consulting firm called Greenwich Associates. And for many years, he was the chairman of the Yale Endowment, which I think is the best managed pool of capital. He's been an instructor at Harvard and Yale Schools of Management, and he was on the Vanguard board for 20 years as well. And so the way that he describes the challenge is he said, look, 40 years ago, the vast majority of the money invested in the stock market was

• 1:05:50Speaker 02

  invested by individuals. And as I mentioned earlier, individual investors consistently buy when the market goes up and sell when the market goes down. So he said, you can think of it like a poker table. The one institutional investor at the poker table with a bunch of individual investors was like playing poker with a bunch of rubes. All you did was take the other side of that trade. And by taking the other side of the trade, you could outperform by one and a half to three and a half percent. You know, it's a zero sum game, the amount by which the individuals were losing by chasing the market. Well, fast forward 20 years, and almost all the money is now in the

• 1:06:34Speaker 02

  hands of institutions, not individuals. So now everyone at the poker table is a really good poker player. Well, it's really hard to win consistently if everyone at the poker table is a really good

• 1:06:51Speaker 02

  But it's really hard to admit when you used to be the star at the table, that you're now one of many stars at the table. And I think that's what leads to that cognitive dissonance.

• 1:07:03Anthony Pompliano?

  Yeah, that's a fantastic explanation. I never thought of it that way, but it makes a whole lot of sense.

• 1:07:08Speaker 02

  Charlie is, I mean, people love Charlie because he explains complex issues so simply.

• 1:07:14Anthony Pompliano?

  Yeah. And I also think it's, you know, the other part of the endowment model that's so fascinating to me is, you know, you don't sit at Penn by yourself making decisions, right? There's a room full of intelligent people. And I love to always ask the individual stock investor, who's your, you know, kind of your advisory board? Who's on your board, right? Who's on your investment team? And the dog doesn't count.

• 1:07:42Anthony Pompliano?

  And so it's just, you know, naturally, we get lost in our own thoughts. We're very emotional. You don't have somebody there to kind of talk with and stuff. So I think that, you know, it's pretty clear. It's just do people buy in? I love your idea of kind of only preach to the converted.

• 1:07:56Speaker 02

  Yeah.

• 1:07:57Anthony Pompliano?

  Makes a lot of sense.

• 1:07:58Speaker 02

  And people want, they want an advantage if they're only, you know, I have a friend who's a professional poker player. And he only plays in tournaments in out of the way places.

• 1:08:12Speaker 02

  Now, the pot's much smaller, but he wants to play against a bunch of rooms. So he goes to Oklahoma City and he goes to, and he goes to, you know, Champaign, Illinois. He goes to all these weird places, but he doesn't go to the World Series. He plays in the World Series of Poker, just because everybody does. But that's not where he makes his money. He makes his money by playing against a bunch of rooms.

• 1:08:37Anthony Pompliano?

  I have a couple of friends who do the same thing. They're very good at poker, have played professionally or online in kind of a full time basis. And I was shocked when I heard that's what they were all doing. And basically, they were like, look, all the money to be made is to basically find these big fish that want to play private games, right? And they said, because they got a lot of money and they're not very good at poker. And so, you know, there's a

• 1:08:59Speaker 02

  Good combination. Really good combination.

• 1:09:03Anthony Pompliano?

  Only, only if you're the guy who's good at poker, right?

• 1:09:07Anthony Pompliano?

  Andy, before I let you go, ask everyone the same two questions, and then you'll get to ask me one to end it. But the first question is just, what is the most important book that you've ever read?

• 1:09:22Speaker 02

  The one that changed my perspective on technology was the innovator's dilemma.

• 1:09:31Anthony Pompliano?

  Okay.

• 1:09:32Speaker 02

  I think the disruption theory from Clay Christensen is worthy of a Nobel Prize.

• 1:09:39Anthony Pompliano?

  Explain a little bit more why that was so foundational or kind of mind changing for you.

• 1:09:46Speaker 02

  Well, disruption is perhaps the most commonly misused term in technology. So Clay Christensen, who passed away last year, was a professor at Harvard Business School. And he coined the term disruption theory. And it it had a precise definition. Unfortunately, reporters and others have come to represent disruption as anything that's new or different. But what Clay found from his research was that

• 1:10:27Speaker 02

  if a company can come along and deliver something that's simpler, cheaper, and more convenient than the incumbents,

• 1:10:40Speaker 02

  such that it is uneconomic for the incumbent to address. It's an almost impossible advantage to overcome.

• 1:10:52Speaker 02

  So there are two and there are two forms of disruption, new market disruption and low end disruption. So an example of new market disruption is where you serve nonconsumers. The people cannot consume the incumbents' services. So think Sotheby's and eBay. You couldn't sell, you know, your leftover items from a garage sale at Sotheby's because they only sold things for $30,000 or more.

• 1:11:20Speaker 02

  Now eBay was able to build a profitable business facilitating the sale of $20 items. Now, over time, they were able to move up market. And because of the breadth of their market, they really ate into the profitability of all other retailers. So that's an example of a new market disruption. Now, it's called an innova- and then a low end disruption is when you serve the over-served. In every market case, people start adding more and more features to the point that people can't use them all. You know, think about office phones. You know, there are all these features on an office phone that you've never used.

• 1:12:04Speaker 02

  So there's an opportunity for come up with something simpler, cheaper, and more convenient. A great example of that was Dell with versus Compaq. When Dell got started, Compaq sold computers to resellers, who then sold it to companies and individuals. Compaq had a 40% gross margin and the retailer had a 20% gross margin, you know, resale margin. Dell sold direct to consumers at a 25% gross margin. Now, their cost of goods sold was higher than Compaq, which was a multi-billion dollar company, but not that much higher. So Dell was selling computers directly to individuals at a price lower than what the retailer was paying for Compaq.

• 1:12:49Speaker 02

  Now, Compaq could not, so the problem with a disruption is it's uneconomic for the incumbent to address. So if Compaq tried to sell direct, they would have pissed off their channel and lost their channel. Now, as a company with $5 billion of revenue and publicly traded, that would have destroyed their stock price. So it's called an innovator's dilemma because you're damned if you do and you're damned if you don't. If you ignore the innovator, they move up market like eBay did and Dell did. And if you go after them, you kill your economics. So you're screwed either way.

• 1:13:30Speaker 02

  And so a truly disruptive company that's able to deliver something simpler, cheaper, more convenient, either to the over-served or non-consumers, is almost impossible to stop.

• 1:13:44Speaker 02

  That's what Netflix did to cable companies. So that's why it's so powerful. And, and so I wish I, the book came out in 97. I, I retired in 2005. I would have been a radically better venture capitalist that I understood these issues.

• 1:14:01Anthony Pompliano?

  Think you did all right for yourself, Andy. No worries.

• 1:14:05Anthony Pompliano?

  The second question is a little bit more fun. Aliens, are you a believer or a non believer?

• 1:14:11Speaker 02

  None.

• 1:14:12Anthony Pompliano?

  None. What, what is the rationale for not believing?

• 1:14:17Speaker 02

  I haven't seen any proof.

• 1:14:19Anthony Pompliano?

  So I've asked hundreds of people this question, and the two most popular answers are either the world is, you know, the universe is so big, just probability wise, I'm gonna throw a flyer and say that there's something out there.

• 1:14:33Speaker 02

  Not reasonable.

• 1:14:34Anthony Pompliano?

  And the most popular no answer is, I believe when I see one.

• 1:14:41Anthony Pompliano?

  So it's so funny. There's very few questions you can ask hundreds and hundreds of people and get the same answers depending on yes or no, but.

• 1:14:48Speaker 02

  I think I'm a data driven guy, so I want to see the data.

• 1:14:53Anthony Pompliano?

  I love that. You could ask me one question to finish up. What's the one question you have for me?

• 1:14:57Speaker 02

  What was most different from what you expected in today's discussion?

• 1:15:02Anthony Pompliano?

  Ooh, um, most different.

• 1:15:09Anthony Pompliano?

  I, I don't think that I've ever heard somebody talk as much about, obviously, your background is a venture capitalist. You're going to understand a lot of kind of data points in terms of things to look for in companies, measuring growth, you know, sustainable growth versus something that looks more manipulated. All of that is kind of expected and to be good at it. You've got to really, really understand it. I've never heard anyone talk about the consumer metrics, benchmarking, and no pun intended, against the SaaS metric.

• 1:15:38Speaker 02

  What do you mean? It is a pun intended.

• 1:15:42Anthony Pompliano?

  No, but I, but I think that this idea of like the same source sales, right? The, that, that margin expansion or the dollar expansion that you talked about, but applying that to consumer businesses. I just had never thought of it that way. And as we were kind of talking, I started to think of, you know, Netflix is one example. But there's actually a lot of businesses where when you align.

• 1:16:01Speaker 02

  Amazon.

• 1:16:03Speaker 02

  Amazon's net expansion ratio is phenomenal.

• 1:16:06Anthony Pompliano?

  Yeah, and it's just aligning incentives, right? It's the true measure of if you can align your incentive with your user, that user or customer is going to use your product more, you'll make more money, but it will actually become much more valuable to them. Right? It almost kind of digs them deeper and deeper in and the retention goes through the roof because they'll never leave.

• 1:16:23Speaker 02

  Yeah. So this was a lot of fun. Thank you so much for hosting me.

• 1:16:27Anthony Pompliano?

  Listen, thank you so much for spending the time. It's, if people walk away from this and they didn't learn something, they weren't listening. So I appreciate your, your time and obviously you've had a stellar career and hopefully that will continue. Where can we send people to find either you on the internet if they want to ask any questions? Or if they want to learn more about Wealth Fund?

• 1:16:50Speaker 02

  Well, my Twitter handles A R A C H L E F F and Wealth Fund is at W E A L T H F R O N T dot com.

• 1:16:59Anthony Pompliano?

  Awesome. Thank you so much, Andy.

• 1:17:01Speaker 02

  Plenty of information there.

• 1:17:02Anthony Pompliano?

  We'll have to do it again in the future.

• 1:17:04Speaker 02

  Thank you.