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Silicon Valley’s plan to replace wealth managers

FutureAdvisor—just one among a new breed of online investment-management platforms that has captivated Silicon Valley—announced Wednesday it has raised $15.5 million in a Series B round led by Canvas Venture Fund with participation from existing investors, including Sequoia Capital. That brings its total VC funding to $20.5 million.

FutureAdvisor's free advisory service tracks $11.4 billion in assets. Its digital investment-management service launched in September 2013, with $13 million in assets, has grown roughly 900 percent to more than $110 million in assets over the past nine months. Its algorithm recommends low-cost index funds and ETFs to optimize personal asset allocation on a tax and fee basis.

Bo Lu, FutureAdvisor CEO and a former Microsoft engineer, spoke with CNBC about why robo-advisors are no fad. Lu said they are here to stayand may even steal Wall Street private banks' lunch. The following is an edited version of the interview.

Henrick Jonsson | E+ | Getty Images

CNBC: Back in the 1990s, during the first dot-com bubble, online investment platforms, including FOLIOfn and Marketocracy, launched with a lot of fanfare but didn't have success on the level predicted. Why would this time be any different?

Lu: I think the fact that companies like us are getting large rounds of investment goes to show the early proof that this is indeed a mass-market play.

We had our own epiphany moment when we released our discretionary asset-management product in September 2013. When we talked to the first couple of hundred customers, they were airline pilots and military officers and such. We could see through to the other thousands out there just like them who existed across the U.S. but were not yet customers.

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Digital natives have disposable income now, and that was not the case in the 1990s, when some of the earliest companies here failed.

Some of the earlier companies also had to hire a bunch of humans. That's why MyCFO failed. Too much overhead. Humans are always a big choke point. We exist because most of America is currently excluded from human services.

CNBC: Excluded in what sense?

Lu: There are 32 million mass-affluent Americans—with assets between $100,000 and $1 million—and only 20 percent have an advisor. Sixty percent of families with more than $1 million in investable assets already work with a financial advisor. Eighty percent of our clients never have had an advisor. No ecosystem has ever served these people. That's a big gap that's artificial and made by economics. We want to bring the penetration up to where it is for affluent, and that is a 14-million-household opportunity.

Private advisors are today almost all using algorithms that do monitoring and rebalancing. That's already happening—those human advisors aren't doing it by hand.

"There is a big wealth transfer going on now. Money will move to people rather than people moving to money, and if they already have assets with us, they will pull assets into the digital experience rather than picking up the guy at Morgan Stanley." -Bo Lu, FutureAdvisor CEO

CNBC: So you are working with the mutual fund companies and brokerage custodians to steal the next generation of business from financial advisors?

Lu: Think of investment management as three layers. The manufacturing layer is the mutual funds and ETFs. Then there are the custodians, such as Fidelity Investments and TD Ameritrade, both of whom we work with. The third layer is the advisor—for example, LPL Financial or Raymond James and, at the highest end, Goldman Sachs and other Wall Street private bank groups. We are additive to that topmost layer. We are disrupting advisors. We don't compete in custody or manufacturing.

We take your existing investments and manage holistically at the household level with tax efficiency and to find the lowest-cost investment alternatives. The average customer already has four accounts at three different institutions, and we aren't asking you to open another account. We are asking you to say, 'Tell us about your 401(k) from a former employer you haven't looked at for months' rather than saying, 'Give us your new cash.'

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We know your assets are already everywhere—mutual funds you bought years ago and don't want to sell. We will bring our algorithm to where your money is today and look over all of it, and should you choose to hire us, we will make requisite adjustments where the assets are today.

As the cycle rate of people's jobs becomes faster, they can roll over into lower-cost and controllable IRA accounts. People may use a current employer plan to accumulate assets, but over time it's going to be IRAs that make up the bulk of your wealth, and that does need to be managed.

CNBC: One classic definition of disruption is going after the clients being ignored by the status quo. You are building your business around that, but do you ultimately go after the clients that the advisors and private banks covet?

Lu: Think of the history of the steel industry. The U.S. steel players didn't want to produce pig iron anymore, because it didn't make them any money. Advisors and private banks don't want to be dealing with people who have saved less than $500,000. Our clients are pig iron to traditional wealth managers. The pig-iron players weren't going head-to-head with U.S. steel until later. We can build a profitable business from the pig iron. The head-to-head battle with advisors and private banks is years down the road.

Our clients are 20 to 25 years younger than wealth manager and private bank clients. There is a big wealth transfer going on now. Money will move to people rather than people moving to money, and if they already have assets with us, they will pull assets into the digital experience rather than picking up the guy at Morgan Stanley.

CNBC: So what can't a computer do when it comes to finance advisory services? Can a computer get a CFP designation and do it all?

Lu: The travel industry is a common reference point. If I want an east-to-west around-the-world plane ticket, I'm still not buying that on Kayak. I'm still talking to someone, and that will be true for investment advisory. I expect we will keep talking to financial advisors, but rather than a generic one, we will talk to one uniquely versed in estate planning or currency exchange—whatever it is.

It's not that computers do something humans do; they do something humans never did and then translate it back to a human context. What that will be for mass-market investing is to be vertically integrated financial services, so it takes your money and manages it all. It is kind of ridiculous we ask American families today to bucket their money between IRAs, insurance and banking, etc. Those decisions should be computer-made. We no longer need the artificial distinctions.

CNBC: So who acquires FutureAdvisor ultimately, or who do you become?

Lu: No one acquires us. We become the next-generation financial advisor. You would have asked the same question to Charles Schwab in 1975. Schwab became Schwab.

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