At a recent investing seminar at LinkedIn, a young engineer asked a question I’ve heard repeatedly over the past year: Why do Private Wealth Managers have such high account minimums?

Financial advisors typically earn handsome livings, especially Private Wealth Managers who work for the big Wall Street firms. Those Private Wealth Managers can easily make $500,000. The top Private Wealth Managers make about $900,000, and that doesn’t include their recruiting bonuses, which often are in the millions. I don’t want to comment on whether this is justified. It’s just the market rate firms pay to attract people to the job, which in most cases means applying Modern Portfolio Theory to a client’s assets.

If you assume an average Private Wealth Manager can actively support 50 client portfolios, and she charges an annual fee of 1% of assets under management, then she needs to attract at least $1 million per client just so the company breaks even on her compensation ($500k/50 *1%).  Add in support staff and corporate overhead, and the breakeven grows to at least $1.5 million per account. Most businesses need to earn a 50% gross margin to take selling and market costs into account; Private Wealth Managers are no different. That means they need at least $3 million to achieve their business model.

The top Private Wealth Managers make about $900,000 annually.

Now you can understand how the better-paid Private Wealth Managers, like the ones you might find at Goldman Sachs, Morgan Stanley and JPMorgan Chase, might require $10 million account minimums.

In his popular WSJ contributed column, “Why Software Is Eating The World,” Marc Andreessen argues that every industry will be disrupted by software. The disruption happens when software eliminates an expensive middleman with no discernable loss of quality. Financial Services, Health Care and Education are some of the last remaining industries to be disrupted. I addressed the reasons why in a column I wrote for PandoDaily.

By eliminating a middleman – the highly paid Private Wealth Manager – Wealthfront can offer a comparable Modern Portfolio Theory-based investment service, with only a $5,000 account minimum.  High account minimums have nothing to do with the quality of the service, and everything to do with the underlying business model.

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About the author(s)

Andy Rachleff is Wealthfront's co-founder and Executive Chairman. He serves as a member of the board of trustees and chairman of the endowment investment committee for University of Pennsylvania and as a member of the faculty at Stanford Graduate School of Business, where he teaches courses on technology entrepreneurship. Prior to Wealthfront, Andy co-founded and was general partner of Benchmark Capital, where he was responsible for investing in a number of successful companies including Equinix, Juniper Networks, and Opsware. He also spent ten years as a general partner with Merrill, Pickard, Anderson & Eyre (MPAE). Andy earned his BS from University of Pennsylvania and his MBA from Stanford Graduate School of Business. View all posts by Andy Rachleff