Hello everyone and welcome to the sixth episode of Bogleheads on Investing. Today we're talking about behavioral finance. Our guest is Dan Egan, Director of Behavior Science and Investing at Betterment. My name is Rick Ferry and I'm the host of Bogleheads on Investing. This episode is brought to you by the John C.

Bogle Center for Financial Literacy, a 501(c)(3) corporation. Today we're talking with Dan Egan. Dan is a behavioral scientist who works at Betterment. Betterment is a robo-advisor who is using technology to help people invest better. And a lot of what Betterment is doing and the programs that they're running are based on behavioral science.

I've been following Dan's work for several years now and I find it extremely interesting how this company is, for lack of a better word, controlling their clients' behavior by analyzing client data and testing various hypotheses in a real lab of hundreds of thousands of clients to improve their investment performance.

Let's get right to Dan Egan. Welcome, Dan. Thank you very much for having me. I really appreciate you being on the show. You're an up-and-comer, if you will. What you're doing at Betterment as the Director of Behavioral Science and Investing is extremely interesting. And I thought it'd be great to have you on the show so you can talk with us about all the work that you're doing there and all the neat stuff.

It's like you're in this big lab in real world and you get to actually run experiments on real people and do real things as opposed to theory, sort of an ivory tower classroom setting. So can you tell us a little bit about who you are and how you ended up at Betterment?

It's a great place to be, but with great power comes great responsibility. I'll trace out so that I think it's actually useful for the path that I got here by. It's interesting that it explains my background a bit. I did my graduate degree in decision science, which is a combination of psychology and game theory and statistics.

So trying to figure out how to help people, real people, make better decisions. And I had never had any desire to go into finance or investing. But during that program, one of the people who I worked with said, why don't you come and work with my investment company for a little while?

And I thought, you know, I heard that these people get paid well and it sounds really interesting what they're doing. So I went and did that and I worked there for about a year and it was an incredible experience. Learning very quickly the difference between academic finance and real world finance.

And after doing that for a year, I realized that that specific kind of finance, a private equity firm, was not what I wanted to do. And this job came up at Barclays Wealth in the UK, which is a high net worth asset management firm, doing applied behavioral finance, trying to help advisors give better advice, not only in terms of it fitting to the client better, but also the client being more likely to adhere to it, to actually go through with it.

So I worked there for about six years with advisors, both building behavioral tweaks to the platforms as well as integrating it into their advice. And one of the things that kept striking me, as you've alluded to, is that there's this three body problem going on. So we have the end investor who's going to come with their specific circumstances, but also their psyche and their particular strengths and weaknesses as an individual.

Then you have the same thing for the advisor. And here's me sort of in the background trying to change the system, trying to change the system and the advisors and coach them and train them to see if we can help the end client be better off. And that's a very noisy environment to be in.

The feedback is delayed and noisy. You're never really sure if what you are doing is actually working. So I moved to the U.S. and I started looking at Betterment. It struck me as a great opportunity to improve upon both of these things. So number one, I, as a behavioral scientist, can try to improve things with clients, but test it in a rigorous fashion in the real world, see what impact it has on the behavior, and if it works, roll it out to all of them and have high confidence that it actually works rather than hope that it works.

So you were looking at Betterment as an option, and you liked the idea that it was a real-time experiment with real investors. At the time, the company was up and running and they were using index funds. Did you give it any thought to why John Stein had chosen index funds and why that was the focus of the investment philosophy behind Betterment?

I think there are a lot of reasons to go with index funds. Obviously, they tend to be much lower cost than more opaque or more actively managed funds. They're also more transparent about exactly what they're going to do and when and how. They scale very well in that generally you can put a lot of money into them and it's not going to negatively affect the performance of the fund, which is true of some active funds.

And we wanted to be able to say to clients that we were doing what there was a lot of good long-run evidence for, which is that lower-cost, systematic, index-based investing tends to do better. But you're using only ETFs as opposed to open-end, traditional mutual funds. Is that an operational reason, or do you think they're better than open-end funds?

I kind of want to go with one type of fund. I would definitely say an ETF is better. We manage a lot of taxable accounts, and ETFs are significantly more tax-efficient than mutual funds. They are able to trade throughout the course of the day. That's something that we can talk about and come back to about whether or not that's good or bad.

If you use them in a portfolio, it provides some services and functions that it's much harder to do with mutual funds. A very small example, in terms of transparency, is that a lot of mutual funds have 12(b)(1) and marketing fees embedded in them, which are not transparent to the end user, but is a way that third parties can be compensated for using those funds.

Structurally, that's just not possible with ETFs. The ETF doesn't know who owns it. So there's a level of transparency and an inability to have conflicts of interest that make ETFs preferable, as well as tax-efficient. The founder of the company, John Stein, made a comment that there would be no betterment without Bogle.

In fact, I think that was the title of the article that he wrote, and that Bogle was his idol. He was invited by Jack Bogle to go to Vanguard. He spent all day with Jack, and Jack was very encouraged by what he was doing. I can understand that, because to get young people, particularly interested in index fund investing at a young age, is something that I didn't have when I was growing up.

When I was in my 20s, there was one index fund, but unfortunately I didn't know about it. So what you're doing by getting the word out about index fund investing at a young age, I find it to be very encouraging and very good for society long term. John hopes to do for broader personal finance what Jack Bogle did for investing.

Jack was able to do well by doing good. He didn't compromise on his morals and what he thought was right, and his ability to be successful and to grow a very large company that serves millions of people, that's a perfect inspiration for what we're trying to do at Betterment.

I think that he created a little beachhead there in terms of investing and having low-cost funds that were owned as mutuals, but that is a very small component of what most people need in terms of help with their finances. They need the ability to plan for and manage cash flow better, the ability to use the correct account types if we're talking about a Roth or a traditional IRA or a 529.

Investing in personal finance is very complicated, especially if you want to do it, if you want to make the most out of all the possibilities out there. Making it easy for the vast majority of normal people to do that is John's mission. One of the things that I found fascinating about Betterment is your automation.

Do you truly believe that through automation you can get people to behave better? You talk a lot about bad behavior of investors and the cost of what's called the behavior gap or the investor gap, and there's different names for it, but you use the behavior gap. Can you first talk about the behavior gap and then talk about what Betterment is doing and the automation that you've created to get people to invest better?

Absolutely. The behavior gap most broadly is that we might know what it is that we are supposed to do in order to get some kind of an optimal outcome, but it's hard for us to actually execute on it. You can think about wanting to lose weight. It's fairly straightforward that you eat less and exercise more and you'll probably lose weight, but it's hard to actually get through with that, to actually stay the course and be consistent in it.

In investing, we see this come up in a number of different places. I think there's a lot of the studies transparently lead to investors try and do too much and do the wrong things at the wrong time. They trade more than they should, and every time they trade, they probably pay commissions and bid-ask spreads and possibly even taxes if they have any gains that they're realizing.

They hold much more concentrated portfolios, so they'll hold a few stocks of companies that they're familiar with or maybe they've done a little bit of research on, but they tend to not be very diversified or not intentionally diversified. These two or three things, which actually take a lot of work and thought on the part of the investor, end up with them underperforming a simple low-cost index portfolio.

There's this strange thing where they're doing worse because they're putting a lot more effort in, because they're trying harder. What we're trying to do is, number one, make it so that people are confident and comfortable that they are doing the right thing by investing in the diversified portfolio, by allowing us to manage it in a really transparent, systematic way for them.

That will help them be comfortable and reduce the kind of anxiety-provoked actions they might take, like selling out after the market goes down or trading a little bit too much every month. The interesting thing about your research is you have actual data. You have access to literally hundreds of thousands of accounts that you can drill down into.

You like to study quant and you're a programmer, and you can drill down into actual accounts, whereas other researchers at academics, they would have to ask companies for data. You have the data, and you can drill down, and you can look at what your investors are doing. You found that even in your own accounts that there is behavioral issues, even with your own investors.

Based on our research, about 70% of our clients are what I would consider like they get a 100 out of 100. The remaining 30% have very specific markers of when and why they are behaved badly. I'd actually take your statement and double down on it and say, not only do I have access to really good data, I really care about improving that data.

If I could put myself out of a job, that would be fantastic. Because when you look at that 30% of clients who are making specific mistakes, it's fairly predictable. They are going to trade too much. One of the things that we look at is the role that gender plays.

Men trade. They log in more. They trade more than women. Here's the neat thing. When they trade, they make much more extreme moves. Men are much more likely to go from 100% stocks to 0% stocks than these sort of whipsaws, whereas women are much more likely to go from 90% stocks down to 80% stocks if they're going to make an allocation change.

Looking at the things that predict people's bad investing behavior and then at the same time saying, "Okay, how could I improve that? How do I reduce this gap using this behavior?" and then going out and running scientific trials of those improvements, that's what I love doing. What have you found?

What have you done to help that 30% who are making the mistakes? One component of it, which is neat, is knowing who's really paying attention to the markets. If you take 100 people and the market is going down and it's generating a lot of news, a standard traditional financial advisor, especially because of the client base they work with, might be tempted to say, "Well, I need to get in touch with all my clients and tell them what I think about what's going on in markets right now." What we found, again, running randomized control trials, is that the vast majority of people really aren't paying that much attention to what's going on in markets.

There are things in their lives that are far more important. If you do send out a blast communication or email of some kind, you're actually going to generate more anxiety than you are going to resolve because you're hitting a lot of people who weren't worried about it. Dan, I completely agree with you when you talk about alerting clients that the market is going down so not to worry that that causes anxiety.

I recall several times in my career when we would have a downturn in the market and some of the advisors who worked with me would say, "Look, we need to send out a letter to a client to tell them everything's okay." I would say, "No, we don't. If it's not okay, they'll call us.

If it is okay, then let's not make them worry because anytime we send out a letter that says, 'Don't worry,' they worry." One of the things that when we saw this issue, we said, "Okay, so what we need to do, much like as if you're a doctor, is that you don't treat everybody for a disease.

You only treat the people who are afflicted by it." We want to be able to identify just the people who are really engaged with markets, who are most likely to be anxious about what's going on in the markets. Rather than sending out blast emails, when you log in, we would send you a targeted notification with different messages to try and see if different messages resonate differently with different kinds of people.

Some messages will be highly factual and relate to the market. Other messages will be very personal. They'll say, "You're doing a great job, and you're still on track for retirement. Keep going." They'll be positive and affirming of things. In testing those messages, we found that, number one, the targeting rather than the shotgun blast is much, much more effective.

It means that we get much fewer false positives. Number two, tailoring the message so that it is more relevant to the way a person thinks about it and that it's going to be more positive and affirming for them personally is much more effective. Generally speaking, when we run experiments to learn this, we see the people who get those messages have about a 15% to 20% improvement in their behavior, meaning that they're less likely to make allocation changes or withdraw all their money.

Do you happen to go as far as sending a different message to men than you do to women or different age groups? We haven't intentionally targeted it quite that way yet. One of the reasons is that, generally, we use broad archetypal variables like age and gender because we don't have a better measure of some underlying thing, like how engaged you are with markets.

If I can use a variable like the client's login rate, how often they log in, how often they log in on mobile versus how long they log in on web, that's generally like a higher fidelity signal about how engaged they are with markets, whereas a lot of other researchers will say, "Well, young men tend to be the most engaged with markets." I would even go down to an individual level metric that lets me see, what does this person look like they're doing?

You wrote a paper called the Mercat Effect where you found that on both positive and negative market days, big days, big up days, big down days, more people do have a tendency to log in and look at their accounts. But once they do log in, you're trying to ensure that they don't do something about it.

Yeah, this is an interesting thing that I think it's worth taking a step back on to give better context to. One of the things I've learned over the years is that the same person will look and think fundamentally differently depending upon what platform they are. Take a person who has a 401(k) through their employer.

They are going to treat that 401(k) in terms of trading and log-ons and management very differently than they're going to treat their Betterment account, which is very different than they're going to treat their online brokerage playing account. The Mercat Effect study was done on an online discount brokerage where a lot of people had highly concentrated portfolios and logged into trade.

And I think that behavior might be localized a bit to the platform that you're on. You don't go to Vegas to have a quiet time. And I think that the behavior that we're going to see, depending upon the data set, the same person who has a brokerage account is going to act differently inside that brokerage account than they're going to act on the Betterment platform.

Us and Vanguard have done studies looking at our clients, looking at the same when do people pay attention to their accounts and to markets. And you see we're a little bit closer to Vanguard in that when people have some inkling that the market is down and that they're going to be unhappy about their accounts, they're less likely to log in.

Dan, I found it was interesting in listening to one of your presentations that the 30% of the people who will get on the Betterment website and trade, that if you show them how much they're going to have to pay in taxes if they do this trade that they're thinking about, that it almost stops them in their tracks from doing the trade.

Can you talk about how taxes or the prospect of having to pay taxes affect people's decisions? Definitely. And I'm going to, again, take a step back and give a little bit of broader context about why this is so interesting for end consumers. Most of us will have interacted with our finances through websites that are set up by brokers.

And brokers, if you think about it, they have very specific incentives. They make money when you transact, when you trade, or you buy or sell a fund. And they also make money when you hold cash. And that means that a lot of the interfaces we're used to, in a very subtle way, encourage those two things.

They're going to encourage us to trade and they're going to encourage us to hold cash. It might be by using red and green to indicate things going up and down, which excites us emotionally. Cash always feels safe. Here's a neat thing. If you want to get rid of red on your holdings, you can sell it.

And it just simply goes away. It's like you never had that loss. And you go back to feeling like you're safe in cash. And one of the things that's different about Betterment is that we are a fiduciary advisor, and we make money when clients grow their money more. So we're kind of aligned in that way.

We don't have these incentives to have people trade more or hold cash. And one of the things that we were noticing is that people were trading, and it looked like they weren't taking into account the fact that they were going to owe tax because they were realizing capital gains.

And taxes work like a really, really bad credit card. In that, in February, if you get worried about the markets and you sell out of everything and you realize a $1,000 short-term capital gain, nobody tells you about it, and you don't owe any money right then. You have to wait until the following April when you do your taxes with the IRS to find out that actually you didn't make a $1,000 gain.

You made a $500 gain because the IRS is going to keep half of it. So it was important to us to say, well, we don't make money when people trade. And maybe people are trading because they're not taking into consideration all of the important factors, like how much this is going to be worth after they pay the taxes on it.

So we were able to, in real time, they say, like, I would like to go from 90% stocks to 0% stocks, where we calculate how much that's going to realize in short-term and long-term capital gains and put up an estimate of that impact in front of them. And what we saw is that people who were given that information, if they were going to owe more than $50 in taxes, regardless of how big their account was, there was less than a 1 in 10 chance of them going through with the allocation change.

So the first component of it, which I think is important, is that it looks like people didn't know or weren't considering that when they do this thing now, they're going to owe a lot of tax because of the transaction. And simply by putting important information in front of them at that point in time, we were able to reduce how much they were market timing.

You said if they were going to pay $50 in taxes, regardless of the size of the account, I mean, I could understand that if it's a small account. But people had millions of dollars. I mean, $50 is nothing. But you found that it didn't matter. Yeah, this is one of the interesting things.

So I actually ended up writing an academic paper on this. People's aversion to taxes isn't rational. It is just a "I really don't like taxes." There are a number of papers that find that people will pay more than a dollar to avoid a dollar's worth of taxes. Dan, another piece of research that you wrote or participated in writing for the Journal of Economic Behavior and Organization talked about second-order beliefs.

In other words, if everybody around you is optimistic, thinking that the market is going up, that even though you've done all this great work to determine what your risk allocation should be, what your optimal asset allocation should be for your situation, people have a tendency to increase that and add more equity and perhaps getting them over their tolerance for risk unintentionally.

There's a saying by John Maynard Keynes that the stock market is like a beauty contest. It's not really necessarily that you're trying to say, like, if the market's overvalued or undervalued, but what do other people think? You know, if you want to be able to speculate effectively, it's not a matter of being right in an absolute sense.

It's a matter of just being ahead of the crowd. So we went out and looked at how much people thought they knew what other people were thinking, how accurate they were in those beliefs, and how comfortable they were being different from the herd. And so one of the first things that we picked up on is that everybody thinks that the crowd agrees with them more than they actually do.

So if you're really bearish for the next quarter, you're going to believe that most people are very bearish too. If you're very bullish for the next quarter, you're going to believe that too. And one of the nice things that we found was that the more self-aware a person was about when their views diverged from the crowd.

So you have two things. You have how good are you at understanding what the broad sentiment of the market is? And are you accurate at conveying that? And number two, do you know that you are being a maverick by having a different view? That sense of self-perspective and crowd perspective, there were very few people that had it and the people who had it tended to have better performance.

Dan, in one of your presentations you gave to a CFA group, you talked about how exocortex of a brain, the part of our brain that does the logic and the thinking and comes up with asset allocations and so forth, that through artificial intelligence and other technology tools, we are taking a lot of the decision making and we are letting computers do it, letting machines do it, and that this is a good thing.

And that there's a lot of things out there in personal finance that used to take a lot of thought and advisors and individuals take up a lot of time and quite frankly made a lot of mistakes, that by outsourcing it, if you will, to machines, behavior is getting better.

Could you talk about that whole concept and what can be outsourced to a machine these days? One of our key advantages as a species is our ability to not only sort of use tools, but also imagine and design new tools for us to use. And for a lot of history, you can think about like cameras and steam engines and so on.

These were physical tools that we built outside of ourselves. And we're just now starting to build and really explore the use of logical tools that are able to make decisions in the real world for us. We're still the ones building and designing them. Computers aren't building and designing themselves quite yet.

That allows me to do a lot more because I can kind of like outsource a lot of my thinking and monitoring to software. So I don't actually know what I'm doing after this call, but I'm sure that my calendar knows. My calendar is going to notify me with what I need to do next.

But we're still the ones who need to say, well, what do we want this technology to do for us? How do we want it to expand our capability? Something you keep coming back to is that the things that computers are really good at are things that we are not good at.

They're incredibly good at doing the same thing over and over again, hundreds of thousands of times. They're very good at math. They're very good at statistics. What they're not good at is non-routine, creative, imaginative labor that understands human beings and understands the circumstances that they find themselves in. So there's a really nice symbiosis, a yin and yang going on right there, where we can take the things that are boring and routine, things like processing trades and calculating how much to put in each asset class and looking at whether or not the taxes are going to be worth changing it compared to the fees.

We can program a computer to do that. And the programming itself, the thinking and designing of how we would go about that decision, is very creative and very sort of challenging. But once we've done it, we can have a computer execute it for lots and lots of people. And I sort of think this in terms of how it dovetails with advisors, is that there was a period of time where advisors had to, because we didn't have the kind of exocortex doing things for us, had to figure out how much each asset class should be bought in order to rebalance or where the money should come from in terms of tax efficiency when you're doing retirement planning.

We knew what the answers were. We just needed to implement that thought process in a machine. And now that frees up advisors to spend more time with clients on the things that the computers are not going to be able to do. Sitting down with a couple and having a conversation with them about how they're going to actually spend time in retirement, how much they're going to spend every year, what the budget constraints mean, what they're comfortable with, that's something that you still need human-to-human back and forth on.

Knowing when somebody says something but doesn't really mean it and being able to detect that and being a good coach, a personal finance coach for them, that's somewhere where advisors are going to excel for a long time. And so I really like where we're coming to now, where advisors are letting go of, well, I need to be the one to place the trades and to do due diligence on all of the indices and so on, really sort of like detailed in the weeds labor.

And they're getting freed up to do that, which means that they are spending more time having better, higher-quality conversations and doing more quality planning with the people on the other side of the table, with their clients. I completely agree with that as far as a lot of the execution and the implementation of portfolios, tax-loss harvesting, which has now become automated.

Back in the day when I was doing it 10 years ago, you had to do it by hand. So a lot of the things that we used to have to do by hand as advisors, machines can do it much better, more accurate, and I don't have to spend time doing that.

But not only that, human beings are expensive, an expensive commodity. So you can outsource this to technology. The advisor can spend more time where it's really needed, which is on the behavioral side. So that's all good. One of the areas that I actually think advisors don't give themselves enough credit for is the communicating of different things to different people.

So when a person comes to a website, it's very hard for the website to know ahead of time that a football analogy would work very well for them. But advisors know that different people, they can track those different people's interests and know what kind of analogies or explanations are going to really resonate with them such that they get a point, whereas a lot of times technology has, in terms of communicating things, a one-size-fits-all dimension, especially during the educational and onboarding component of advising a client.

Advisors have a real advantage in that they will communicate more effectively and more efficiently with each individual client because they can change the way they talk on the fly. Hey, I can give you a story about that. I was talking with a client several years ago, and I made a golf analogy, and I was talking about index funds.

And I said, "Let's say you went out on the golf course, and every time you went out on the golf course, you shot par every single time. That would be great, wouldn't it?" And I was asking this woman, and she said, "I don't play golf, and I have no idea what you're talking about." Yep.

But you're right. I mean, if we have a questionnaire where it says, you know, "What are your hobbies?" and somebody wrote down "golf," I could use that analogy with that person. Dan, one of the other things that you do at Betterment, which I find very interesting, and I learned a lot from listening to one of your presentations, is that when you're talking about goals with clients, in other words, what do you want your money to do for you, where do you want to go, that people have a really difficult time articulating or defining what their goals are.

So you sort of reversed all that. You've come to the realization that most people have common goals, and that it's better to have them eliminate goals rather than say what the goal is. Can you talk about how you came to that conclusion? Yeah, I think there's two inputs to this, or two reasons we ended up here.

One is just the general idea that we can learn a lot from each other. One of my favorite books that I've read over the last year was "30 Lessons for Living from the Oldest Americans." They speak to 70-, 80-, 90-year-olds about what they think went well in their life and what didn't go well, and what they would go back and change across career and marriage and being a parent.

And I think we really need to do a better job of learning from each other and using the wisdom that's available to us from a wide array of other people. One of the things that we've been doing is looking at how clients use our platform, looking at what goals our CFPs recommend to people.

And rather than trying to reinvent the wheel every single time for each client and putting the weight upon them to do it, I said, "Well, wait, we know what goals our CFPs are going to recommend for somebody who's in their early 20s, and we know how they would go through a budgeting plan.

We know that they're the ones if you are in your mid-20s and not yet married, maybe you need to start thinking ahead to the kind of goals that come up later, whereas if you're in your mid-50s and you've already kicked the kids out of the house, you have a different set of goals." The other element of it, when you start with it, we have a really good, kind of like wise set of goals that come up from the experiences of lots of people through time.

The other element of it is that, as you said, people have a hard time coming up with those goals themselves when they're in the future. I could go back now and tell 25-year-old me things he should be thinking about, but 25-year-old me would feel it was very hard for him to think ahead.

So rather than have people try and come up with and imagine and brainstorm the things that they might need to spend money on over the next 5, 10, 15, 20 years, we put them there in front of them and say, "These seem like they're the things that you need to be thinking about.

Why don't you remove any that you know aren't applicable to you?" And we can work through prioritizing the rest of them. That's a lot less effort on the individual. Generally speaking, people who are given a kind of master list of goals that they remove from end up with twice as many goals that they want to be planning for compared to somebody who you force to start from scratch.

So it's a very effective way of helping people identify what goals they think they should be planning for based on the wisdom of the crowd. And it also means that those people are better set up to invest intelligently for the future. Because instead of saying, "Well, I'm going to assess performance by whether or not my account went up and down," they say, "Well, I'm going to assess performance based on whether or not I'm on track to hit these personal finance goals that I have." One of the questions I have for the future of fintech, using technology to become better investors, is the shift that is going on with the—and if you don't mind me saying robo-advisors, I don't know how you feel about that phrase being that you— Go for it.

Okay. Is that, you know, they're set up for young people who are just getting started in, you know, how to do a budget, put a few bucks a month away, get them into index funds, all that's very good. Get them investing. They're going to need to learn how to invest, and this is a great way of doing it.

But one of the things that I always found lacking, at least at the beginning of all of the robo-advisors, is it was for that other generation. It was for the millennials. It wasn't really for my generation, which is the baby boomer generation, who are retiring. So a lot of the tools that were created were for the accumulation of assets.

And I believe the next phase of all this is how do you provide tools for people like me, who are 60 years old, and the distribution of our assets in retirement? It seems to me that that's the next phase of this whole robo-advising world. It's definitely going to happen, I would say, for three reasons.

One is that myself and the current crop of people, we get one year older every year, and that's steady march. We're good at building for ourselves because we kind of know what we need at this point in our life. The closer we get to retirement, the more that we hear about and want those sets of tools for ourselves.

I already have these discussions with my parents, and understanding what they need is really important. On the flip side of the market is the consumers. Our parents are very uncomfortable with the idea of just using a digital investment solution because they want to be able to talk to somebody, because they want to have them communicate in one person that they can go face-to-face to.

Younger generations, you know, they go both ways. I think there's a mix of it, but they're more likely to be comfortable with a purely digital solution and less feel like they need a face-to-face contact. That might change over time as the cohort gets older. Either way, I think that we're going to see greater adoption of sort of decumulation in retirement software and planning as people who grew up with computers and who have been using them their entire white-collar professional life are going to want that same thing in retirement, as opposed to a generation who might not have.

And I think, to your point, there are more people who are, even right now, starting up companies that are focused on retirees to try and help them make those decisions. One of the interesting components of it is when you look at a business that has a target customer that is accumulating money over time, they kind of have positive growth curves built into their customers.

A retiree-focused product is looking at specifically customers who are reducing their wealth over time. So I think there's going to be an interesting kind of like they're going to want to look at different compensation models for that kind of advice to dovetail better with the incentive schemes that are present specifically for retirees and how they are going to be spending their money and managing their assets.

I completely agree with you. The company that I'm starting is hourly-based advice, where I'm not actually going to be implementing anything. I'm just going to be talking with people and getting paid for that intellectual property. And when it comes to the actual implementation, use these tools, such as Betterment and others, to actually implement the client's portfolios at a very low cost.

So it's getting back to what you're saying. At some point, people need or want that human interaction. They want that second opinion. They want to run it by somebody and get input. But it doesn't need to be ongoing. It doesn't need to be every quarter or every year. So the pricing model on that type of advice needs to reflect the way it's used, as opposed to, say, just assets under management.

There's advisors that are charging 1% per year, and clients are not utilizing 1% per year worth of advice. They might use it one year, but for the next two or three years, they don't need it. So I think the pricing models and the way it's delivered, there's going to be a separation between the advice givers, who get paid for the advice, and the implementers, who get paid for managing the portfolios, as a difference in the way that the services are delivered.

And Betterment has already started to go down this path, because now you've implemented a financial planning and advisory model. Betterment started out just charging 25 basis points to our retail clients. And over the years, we learned that, number one, some people wanted more of a CFP engagement. We found that there's a lot of upfront costs.

So we have to get to know them, gather all their data, understand their circumstances, and then have one or two calls with them. And then they didn't want to start again from scratch later. So we started offering what we called Betterment Premium, which was 40 basis points instead of 25 basis points.

And it was an annual fee, so that you were kind of locked in for one year at 40 basis points rather than 25. And the uptake on that was just of a very specific person who wanted kind of like that ongoing relationship, where they wanted to be able to call us anytime, which was a subset of people.

I think a lot of people think like you think, which is, well, actually, I just have this specific question that I want an answer and some guidance on, and I don't want that to translate into this long ongoing relationship. So about six months or a year ago, we started offering what we call Advice Packages, which are modular little a la carte packages you can buy, like I'm getting married, and I want to understand what's involved in merging our finances and the options there, or planning for a kid's college education, or optimizing Social Security in retirement.

These are questions that the person doesn't feel like they need advice tied to their assets in any way, but they do want, as you said, a conversation with an expert, somebody to take a look at it, check their work, make sure that they're doing the right thing. And then once they have that confidence, maybe help them set up a bit of the execution for it, maybe set up goals in their betterment account.

And we found that that's been very effective. The most common package that people buy is actually an initial getting set up and check up package, where they're just going to pay us, I think, something like $200 for us to look at their information, set up their betterment account the right way, check that everything's right, have a conversation with them and their spouse about it, and then they're confident.

Then they're ready to have it run on the 25 basis points for the rest of the time. So I think that that kind of giving people the option to buy the level of service and the type of service that they feel is appropriate for what they want is very important.

I think that there's room for both of them. I think there are people who want to pay an extra 25 basis points to have an ongoing relationship and feel like you're going to be monitoring and looking at it, and they can call you anytime. But there are also people who know that they have specific, discreet questions, and there's no reason for them to have an annual fee to get them answered.

I think that's great. Giving people options on how they pay for the advice that they're getting is a great concept. Again, I used to be on the all asset management side. We used to give some advice. Now, just giving people different options as to how they can pay for the advice going forward, whether they're going to roll it into an asset management fee, whether they're going to just pay for it a la carte, which is what you're talking about.

They could pay for it through a ongoing retainer that they're paying directly to advisors, such as XY Planners, a company that is doing subscription-based type planning. I mean, there's lots of different options available to people out there now, and it's just getting better. It all better aligns the services that are being provided to the clients with the fees that are being charged to clients.

I didn't know about your a la carte offering, and I'm happy to hear that it's going well. It does seem to be a very good way of doing things. The next level in this that I'd like to see at some point is a fee arrangement that is based upon the success of the client.

So, number one, I wish advisors were a little bit more incentivized to take a look at clients ahead of time and see what value they could add and say, "I think that I can wring an extra $50,000 out of your retirement savings if we tweak things and change them.

And if I help you adhere to this plan over the next 10 years, would you be willing to take me on as kind of a profit share? Because I want to see you succeed, and you want to see you succeed. So, let's figure out a way where advisors, even going further down that incentive alignment chain, where advisors are kind of equity holders in their client's success.

And I would want to know that I'm going to get paid not only for knowing the financial planning details, but actually helping the client execute on those plans. Yeah, I don't know how the SEC, the Security Exchange Commission, is going to feel about that. Participating in any way in any of the client's profits, aside from AUM, which is a way of participating in their profits, is something the regulators have always looked at very negatively, because it creates incentives to the advisor to take more risk in the client account.

I understand what you're saying, to be an equity holder in the client's success, but what's the downside? In other words, what if it doesn't work? Are you also, you know... Are you on the hook? Are you on the hook? Yeah. Yeah, there are a number of companies now. My wife happens to be doing one of them, which is sort of doing a career change into being a software engineer.

And a lot of them are set up where they're going to train you for three to six months, and they only get paid when you are making more than $80,000 a year in a tech job, and then they can make up to sort of $40,000. So I'm seeing more and more incentive-aligned or success-incentive-aligned commercial relationships, and it's interesting to think about and ponder how you could legally also do that for personal finance.

Yeah, so what you're doing is deferring the fee. In other words, you know what the fee is going to be. You're just deferring it until you have success, and if you don't have success, then the fee that you owe me would be less or maybe nonexistent. So I could understand that where the fee is up front.

This is our fee. We're just not going to collect it. We're just going to collect a little bit now, and we're going to collect the rest of it later on down the road when you are successful. I think that would be an intelligent approach rather than just kind of a profit-sharing where we're going to get more if you're more successful later on down the road.

It's all interesting. Dan, generally in the financial services industry, we separate people between delegators and do-it-yourself investors. The delegators will go out and hire an advisor, have somebody manage their portfolio because their free time is important to them. Either they don't want to do it or they can't do it, but to them, they'd rather not do it.

They'd rather go do something else, and their free time is important. The do-it-yourself investors, though, they might like it as a hobby. They might prefer to save the money of the advisor because the delegators do have to pay something, as you say, 25 basis points, fair fee. But on the do-it-yourself side, there's also a cost, and that's the behavioral cost, as we talked about.

Can you talk about the difference between the delegators, the do-it-yourself investors, and how to maybe get more do-it-yourself investors to see that the value of delegating is really worth the cost? If you're a delegator or if you're a do-it-yourselfer, it's easy to see the pros for your side of things, and I think it's easy to not see the cons.

To be fair, if you're a delegator, maybe you don't really understand everything that's going on in your portfolio, and maybe you're not completely on top of it. Maybe there's a higher chance that somebody might have you invested in a not-great fund or a high-fee fund, so there are costs to being completely hands-off.

At the same time, there are huge costs, I think, to being very hands-on. I do not tune up my car or my bike myself. I don't try and be my own plumber or my own electrician, and I think that the people who spend a lot of their own time being their own portfolio manager, they might be missing out on that number one.

They're kind of valuing their free time at zero when they should have a really high value of it, and they could be using that time to help other people profitably themselves more. I really enjoy building out portfolio management algorithms and working with the teams and designing them well, and I kind of think of that as my contribution to society.

If I'm a liver cell, this is the role that the liver cell plays, and I rely upon all the other cells to do right by me. And if we try and be all things, and if we try and be a portfolio manager and be our own financial advisor, we're probably not going to do as good a job at it as somebody who dedicates their entire life to doing that thing.

And it also means that we're spending that time not playing with our kids, not developing our own skill sets, our own professional network in some way, that would be more advantageous to us as a whole. So I think that DIYers, they might enjoy it, it might be a good hobby, but I think they often miss out on the costs that they don't see, that they are paying by virtue of not delegating it.

I've started to note when people are a little bit cost averse in an irrational way too. So I think that Jack Bogle did a great job of making us very conscious of costs, but the idea that the cheaper one is definitively better when the difference in costs is so low isn't quite true.

I have this thing where I cut my hair at home so that I can save money, and then I realized that I actually am not as good as a professional at it, and I need to go out and get a professional to cut my hair sort of every other month so that it doesn't look too silly.

And I worry about people a little bit like being too tax averse. Even though the costs are small, the costs are something that they can avoid, and so they're becoming kind of irrationally cost averse too, where they're not considering the value that they get for the cost. They're just looking at cost as a way to make the decision.

Well, Dan, this has been really an interesting discussion with you, and I really appreciate you giving us all the insights that you've gathered, seeing real people managing their money over at Betterment, and we're looking for great things from you in the future. So thanks for being on the show.

Thank you very much for having me. It's been a pleasure. This concludes the sixth episode of Bogleheads on Investing. I'm your host, Rick Ferry. Join us each month to hear a new special guest. In the meantime, visit bogleheads.org and the Bogleheads Wiki. Participate in the forum and help others find the forum.

Thanks for listening.