The Betterment Portfolio Strategy: What Every Advisor Should Know
Betterment’s core portfolio strategy is continually improved.
One of the great strengths of Betterment for Advisors is how you, our advisors, are so naturally aligned to Betterment’s investing approach. More often than not, we find that advisors join Betterment for Advisors not just for the digital tools we offer, but because they believe in our investment philosophy: that investing advice is based on real-world evidence and formulated by unbiased decision-making.
In this article, we’ll provide an overview of how we continuously improve the Betterment Portfolio Strategy in line with our philosophy of ongoing research. Just as we’ve introduced new, improved portfolio strategies to the platform over time, we also continue to analyze and improve Betterment’s core portfolio strategy.
Whenever our Investment Committee decides on modifications to our portfolio strategies, we notify you prior to the start of trading execution. In order to ensure we achieve best execution of trades, the lead time and level of detail can vary based on the type of change.
How We Develop the Betterment Portfolio Strategy
Planning in Diversification
At its foundation, Betterment’s portfolio strategy is based on Modern Portfolio Theory. Betterment selects asset classes that represent the total investable global market—excluding commodities and private equity, which have unusually high costs in products accessible for retail investors, e.g., ETFs.
In traditional total market portfolio strategies, the “total market” was assumed to be the U.S., so only U.S. stocks and bonds were included. However, since 2011, Betterment has included equities from both developed and emerging markets. International developed market stocks, in particular, have been shown to outperform bonds on a risk-adjusted basis. Emerging market stocks have higher volatility but also higher expected returns.
The portfolio strategy has held a diverse array of bonds since 2013, when we added granularity to the bond basket by including ultra short-term treasury bonds, inflation protected bonds, investment-grade corporate bonds, international developed market bonds, and emerging market bonds. In 2014, we improved the tax profile of the portfolio strategy by including municipal bonds in taxable accounts.
Increasing the Value of Portfolios through Optimization
The involved process above encapsulates the Betterment Portfolio Strategy’s basic asset allocation, which represent the total market.
We then optimize the portfolio strategy by mathematically maximizing each portfolios’ forward-looking return given the correlated risk. In other words, we try to develop portfolio combinations with realistic alignment with the efficient frontier. While there are plenty of practical constraints involved with portfolio optimization, our process results in 101 different portfolios within the strategy.
In 2017, we updated our portfolio optimization techniques and updated the world market capitalization data which is a key input. This results in improved diversification in each individualized portfolio and better expression of portfolio tilts toward value and small capitalization. The main objective of these changes are higher expected returns.
The tilts of the Betterment Portfolio Strategy—toward value and small capitalization—arise of the landmark research of Fama-French, which demonstrate how the returns of equity securities are driven by three factors: market, value, and size. The underlying structure of the Betterment Portfolio Strategy ensures the market factor is incorporated, but to gain higher returns from value and size, we tilt the portfolios, using a framework known as Black Litterman. The final weights of each portfolio are also influenced by constraints imposed by the liquidity of the underlying fund and are controlled by our level of confidence in the views for each factor.
We’ll continue to improve the Betterment Portfolio Strategy
Our investment philosophy is to use rules-based decision-making whenever we see evidence that Betterment for Advisors’ available investment strategies can be improved. We’re committed to always improving the strategies you offer your clients.
Over time, we continue to stay up on new portfolio construction research and carry out our own research. You and your clients will continue to benefit from this investment as we roll out future improvements to our strategies. With any change to a portfolio strategy, we’ll notify you as we implement the changes.
For more information about the Betterment Portfolio Strategy, check out our full paper here.