Betterment can rebalance your portfolio when it drifts beyond your target allocation threshold using several different methods.
Cash Flow Rebalancing
This method involves either buying or selling—but not both at the same time—and is preferable when cash flows into or out of the portfolio are happening anyway. Every cash flow (e.g. deposit, dividend reinvestment, or withdrawal) is used to rebalance your portfolio. Fractional shares allow us to allocate these cash flows with precision to the penny.
Inflows: You are rebalanced whenever you make a deposit, including when you auto-deposit or receive dividends in your account. We use the inflow to buy the asset classes you are currently underweight in, reducing your drift. The result is that the need to sell in order to rebalance is reduced. With sufficient inflows, the need to sell is eliminated completely. No sales means no capital gains, which means no taxes will be owed.
This method is so desirable that we've built it directly into your Portfolio tab. Whenever your drift reaches 2% or higher, we calculate the deposit required to reduce your drift, and make it easy for you to make the deposit.
Outflows: Outflows (e.g. withdrawals) are likewise used to rebalance, by first selling asset classes which are overweight. Once we have sold all assets classes that you are overweight in, we sell all asset classes equally to keep you balanced. We employ a sophisticated lot selection algorithm called TaxMin within asset classes to minimize the tax impact as much as possible in taxable accounts.
In the absence of cash flows, or when they are not sufficient to keep your portfolio’s drift within a certain tolerance, we rebalance by selling and buying. We sell just enough of the overweight asset classes, and use the proceeds to buy into the underweight asset classes to reshuffle the assets in the portfolio and reduce the drift.
Sell/Buy rebalancing is automatically triggered whenever the portfolio drift reaches 3%. Our algorithms check your drift approximately once per day, and rebalances if necessary.
It’s possible for your drift to stay above 3% if you have no long-term lots to sell (usually due to the account being less than a year old) and there is an absence of cash flows.
That’s because with any sell trade, TaxMin selects the lowest tax impact lots, but will stop before selling any lots that would realize short-term capital gains, which are taxed at a higher rate than long-term capital gains. This way, we can achieve higher after-tax outcome by simply waiting for those lots to become long-term before rebalancing, if it’s still necessary at that point.
If you’d like to turn off automated sell/buy rebalancing so that we only rebalance your portfolio in response to cash flows (e.g. deposits, withdrawals, or dividend reinvestments) and not by reshuffling assets already in the portfolio, please email us.
Allocation Change Rebalancing
Manually adjusting the target allocation will also trigger a rebalance. This sells securities and could possibly realize capital gains. Moreover, if you change your allocation even by 1%, you will be rebalanced entirely to match your new desired target allocation, regardless of tax consequences. As with all sell trades, we will utilize TaxMin to reduce the tax impact as much as possible, and you will see a Tax Impact Preview before finalizing the change.