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Summary of Assumptions and Disclosure:
Our estimate of Betterment’s incremental value as 1.48% per year for a typical customer saving for retirement (“Incremental Value”) above the “Benchmark” (defined below) is based on a calculation of the expected future return of Betterment’s Core portfolio (using the Black-Litterman model) for a customer who uses the rebalancing algorithm, lot-sort algorithm, tax-loss harvesting feature and tax-coordinated portfolio feature.
The calculation assumes a customer invests in a mix of a Roth IRA, traditional IRA, and a taxable investment account. We assume an initial $120,000 investment split evenly into each account (“Initial Investment”), and monthly auto-deposits of $1,167, escalated 2% annually (to account for inflation and salary increases) split evenly between IRA accounts up to the contribution cap, with the remainder invested in the taxable account. We assumed that the customer is a single California resident making $120,000/year (federal tax rate: 24% on income, 24.3% tax rate on LTCG; state tax rate: 9.3%) who has no short-term capital gains for offset, only long-term capital gains and ordinary income (“Demographics”). All dividends and tax savings are assumed to be reinvested into the portfolio. The Incremental Value is net of Betterment’s Digital Fee of 0.25% which is charged quarterly based on the average daily balance over the previous quarter and the actual fees of the funds in Betterment’s core portfolio as of January 28th, 2019.
The analysis that produced this estimate used simulated market conditions over a future 30-year period, using Betterment’s allocation advice for a retirement goal for a client who invests from age 35 to age 65. The analysis assumed that the portfolio follows Betterment's retirement glide path (“Glide path”), meaning that the portfolio’s allocation starts at 90% stocks and 10% bonds, and over time, the allocation adjusts until the portfolio allocation reaches 56% stocks and 44% bonds at retirement. At the end of the period, we assumed a taxable liquidation of 50% (“Liquidation”). This assumption is a simplification of retirement drawdown behavior, and any Betterment customer’s actual retirement withdrawal pattern may vary.
The Benchmark is a hypothetical investment in simulated US equity and fixed income funds. Our simulated returns for these funds incorporated expected asset class returns adjusted based on the actual past performance of funds with exposure to those asset classes as identified in SPIVA’s 2018 Mid-Year report. For these two asset classes, funds underperformed their respective benchmarks, which is attributable to fund fees and other factors, such as potential drag from active management. We assumed the same Initial Investment, Demographics, Glide path and Liquidation as above, and that the Benchmark investor uses the same mix of account types as above. In contrast, we assumed that the Benchmark investor rebalances annually at year end only, using a First-In-First-Out approach to selecting which specific lots to sell when rebalancing. We assumed that the benchmark investor would not use any form of tax-loss harvesting and would maintain a constant asset allocation across all accounts rather than a tax-aware location of assets. The Benchmark assumes no management fees.
For each portfolio, we simulated hundreds of potential future markets based on our expected return and covariance estimates. We then calculated the Incremental Value by finding the mean internal rate of return (“IRR”) across the simulations, and compared the mean IRR for the simulations that used Betterment’s portfolio and features against the mean IRR for simulations that used the Benchmark. We assume that all transactions execute at the simulated closing price for each asset. Read more about these assumptions in our full methodology.
Simulated performance is no guarantee of future results. They are speculative and actual returns will differ year-to-year, often substantially. The analysis is not based on actual client trading history, and actual Betterment clients may experience different results. Other investments or assumptions not considered might have resulted in projected returns for Benchmark investors similar to or superior to those being analyzed. Factors that determine the actual benefit an investor may receive include, but are not limited to, market performance, the size of the portfolio, the stock exposure of the portfolio, the frequency and size of deposits into the portfolio, the availability of capital gains and income which can be offset by losses harvested, the tax rates applicable to the investor in a given tax year and in future years, the extent to which relevant assets in the portfolio are donated to charity or bequeathed to heirs, and the time elapsed before liquidation of any assets that are not disposed of in this manner. The information used as the foundation for our simulations was compiled from third-party sources, and while we believe the information provided here is reliable, we do not warrant its accuracy or completeness.
Nothing herein should be interpreted as tax advice, and Betterment does not represent in any manner that the tax consequences described herein will be obtained, or that any Betterment product will result in any particular tax consequences. Read more information about Betterment’s tax-loss harvesting methodology. For more information about Tax Coordination, see our Tax-Coordinated Portfolio methodology.
Read our full methodology on Betterment's added value.