Custom Portfolio Disclosure

Advisors who use Betterment’s Custom Portfolios (“Custom Portfolios”) should consider the following information before using any of the features, and for communicating this information, as necessary, to their clients.

A. Overview

Betterment’s Custom Portfolio feature provides Advisors with a menu of investment products in Betterment’s interface to construct custom model portfolios for their clients. Investment products may, but will not necessarily, include exchange-traded funds (“ETFs”), mutual funds, other similar equity related index funds, stocks, bonds, money market funds, U.S. treasury funds, cash sweep accounts, and other liquid cash and cash-like vehicles. If an Advisor would like to include any additional investment products that are not already supported in Betterment’s interface, the Advisor may request Betterment review such additional products, but Betterment is not obligated to support any Product for inclusion in a Custom Portfolio other than those available in the Interface.

Advisors who construct Custom Portfolios for their clients are responsible for determining the primary, secondary and/or tertiary tickers (e.g., an IRA secondary ticker, or a sell-only substitute (as described below)) for each security group in the Custom Portfolio. Security groups are groupings of ETFs that include a primary ticker, and may include secondary and/or secondary IRA tickers designed to help avoid wash sales and allow for tax-loss harvesting opportunities. A “sell-only” substitute is a ticker assigned to a security group within a Custom Portfolio that contributes to a security group’s weight and may be sold during rebalancing if the security group is overweight. Advisors, on their client’s behalf, can transfer the ticker into the client’s account and define it as a sell-only substitute. After defining a ticker as a sell-only substitute in a Custom Portfolio and transferring positions in that ticker from another custodian into the client's Betterment account, Betterment’s portfolio management system will then incorporate and manage the position in the portfolio. Sell-only substitutes behave differently with rebalancing, as described below in “Rebalancing and Smart Transitions”. 

Advisors also are responsible for supplying the relative asset allocations when constructing each Custom Portfolio. Betterment supports a set number of asset allocations for each Custom Portfolio. If an Advisor would like to incorporate more asset allocations for its Custom Portfolio than Betterment currently supports, the Advisor may request Betterment review such additional allocations, but Betterment is not obligated to support such additional asset allocations. 

Advisors are also responsible for providing expected return and volatility assumptions (collectively, “capital markets assumptions”) for each asset allocation level (i.e. risk level) that the Advisor includes in a Custom Portfolio. Betterment may provide default capital market assumptions at the asset allocation level. In that case, Advisors may use Betterment’s default capital market assumptions or may elect to provide Betterment with its own capital market assumptions. Advisors are responsible for verifying the accuracy and reasonableness of all Capital Markets Assumptions with respect to any Custom Portfolio, including any default Capital Market Assumptions provided by Betterment, and Betterment does not evaluate or otherwise provide Advisors with feedback regarding whether the Capital Market Assumptions and resulting Client projections are accurate or reasonable. 

Advisors can modify Custom Portfolios through Betterment’s interface, including by making adjustments to security groups, asset allocations, capital market assumptions, and Advisor-designated drift thresholds. Modifications to Custom Portfolios can cause trading in all client accounts assigned to the Custom Portfolio. To the extent an Advisor is modifying a Custom Portfolio, the Advisor is responsible for specifying a migration strategy for each impacted client account. Advisors should review information about Betterment’s portfolio migration strategies before submitting a client’s portfolio change. Advisors are responsible for any modifications to Custom Portfolios, and Betterment is not responsible for any resulting client account trading activity, including resulting taxes and transaction fees.

B. Betterment’s Portfolio Management Tools

Advisors should be aware of how Custom Portfolios interact with other Betterment portfolio management features, including rebalancing, tax loss harvesting, tax coordination, and smart transitions, as well as the other features and limitations described in the Custom Portfolio agreement. Betterment’s auto-adjust feature is not compatible with Custom Portfolios.

i. Rebalancing and Smart Transitions

Custom Portfolios are compatible with Betterment’s rebalancing features, as described in Betterment’s rebalancing disclosure, and smart transition features, as described in Betterment’s smart transitions disclosure. Betterment’s rebalancing functions differently with a Custom Portfolio and Advisors should explain these limitations to Clients.

Unless an Advisor disables rebalancing or elects to use any of Betterment’s tax smart transition features, Custom Portfolios will automatically be eligible for rebalancing following Betterment’s or the Advisor’s existing drift thresholds for the particular client and Betterment’s tax minimization-based rebalancing algorithms. As a part of a Custom Portfolio, Advisors can set customized drift thresholds for rebalancing for a particular client’s goal, and Betterment evaluates the Custom Portfolio’s drift at the security group level. As noted above, security groups contain a primary ticker, and may include secondary and/or IRA secondary tickers designed to help avoid wash sales and allow for tax-loss harvesting opportunities, as well as a sell-only substitute. 

Advisors should also be aware that Betterment’s rebalancing feature will work differently with a sell-only substitute. If a security group becomes overweight and portfolio drift exceeds the designated threshold, Betterment’s rebalancing feature will aim to sell shares from the overweight group to help manage overall risk. When determining which shares of the security group should be sold, all primary, secondary, and sell-only substitute positions are evaluated. Rebalancing is also calibrated to avoid frequent small rebalance transactions and to seek tax-efficient outcomes, such as reducing wash sales and minimizing short-term capital gains.

• Betterment’s rebalancing algorithm decides which holdings to sell within the security group by picking the lots that will minimize the tax cost of the rebalance. Primary, secondary and sell-only substitute tickers are all evaluated by the rebalancing algorithm.
• For example, rebalancing may prioritize selling the primary or secondary security of an overweight security group, rather than the sell-only substitute, particularly if the sale of the sell-only substitute would have a higher tax impact relative to the other holdings in the security group (even if the sale of the sell-only substitute would result in realizing long-term capital gains). While this behavior seeks to minimize the tax impact of rebalancing transactions, it can result in the Advisor’s client’s portfolio retaining the sell-only substitute rather than selling out of the sell-only substitute.
• Rebalancing will not buy additional shares of a sell-only substitute if its security group becomes underweight relative to the target allocation in the Custom Portfolio.

For more information about rebalancing and Custom Portfolio trading behavior, please review Betterment’s rebalancing disclosures and smart transitions disclosures.

ii. Tax Loss Harvesting (“TLH”)

Advisor-constructed Custom Portfolios are compatible with Betterment’s TLH feature, as described in Betterment’s Tax Loss Harvesting disclosure, but Advisors should understand that TLH functions differently in a Custom Portfolio and should explain these limitations to Clients.

If an Advisor elects to enable TLH for a client’s account with a Custom Portfolio, the Advisor should understand that the number of harvesting opportunities and effectiveness of TLH depend on the number of secondary and tertiary tickers the Advisor has assigned to security groups in their Custom Portfolio. Constructing a Custom Portfolio with fewer secondary and tertiary ticker assignments in security groups may reduce opportunities to harvest tax losses.

Further, Advisors should understand that Betterment’s TLH feature may be less effective for a Custom Portfolio relative to the Betterment Core portfolio and may identify fewer harvesting opportunities for a Custom Portfolio that contains Mutual Funds relative to those that contain exclusively ETFs. In particular, if a Custom Portfolio security group contains a Mutual Fund as its primary ticker, the security group containing the mutual fund will not be eligible for TLH, and Advisors are not able to elect Mutual Funds as secondary tickers for any security group.

Advisors should also understand how the inclusion of a sell-only substitute or mutual fund in a Custom Portfolio impacts the operation of TLH. Betterment’s TLH feature does not consider sell-only substitutes when evaluating shares of a security group to be sold in a tax loss harvest. This means that Betterment’s TLH feature does not harvest unrealized losses for sell-only substitutes, and that there may be fewer opportunities to harvest losses in a Custom Portfolio that contains a sell-only substitute relative to other portfolio strategies that Betterment supports. However, if a ticker is designated as a sell-only substitute in a particular Custom Portfolio, and the client holds the same ticker designated as a primary or secondary security in another portfolio of the same legal account type (e.g., if that ticker is the primary ticker in a Betterment-constructed portfolio that the client uses in a different goal), Betterment’s TLH feature will evaluate that ticker to sell for potential harvests. If a security group contains a mutual fund as its primary ticker or as a sell-only substitute, the security group containing the mutual fund will not be eligible for TLH, and Advisors are not able to elect mutual funds as secondary or tertiary tickers for any security group, unless the mutual fund is defined as a sell-only substitute.

Electing different portfolio strategies for multiple Betterment goals (including electing multiple Custom Portfolio strategies or a Custom Portfolio strategy and a Betterment or third-party model portfolio strategy) may cause TLH to identify fewer opportunities to harvest losses than it might if you elect the same portfolio strategy for all of your Betterment goals. This is because there could be overlapping tickers in certain asset classes of the portfolio strategies you elected. TLH does not harvest losses in any asset classes with overlap (excluding sell-only substitutes of the asset class) to minimize the risk of wash sales and/or permanently disallowed losses.

Betterment has calibrated TLH in a way that Betterment believes optimizes its effectiveness given expected future returns and volatility. Betterment does not alter that calibration to optimize the effectiveness of TLH for any particular Custom Portfolio, and other calibrations could result in more frequent harvests or better results depending on the tickers in a particular Custom Portfolio and actual market conditions.

See Betterment’s Tax Loss Harvesting+ disclosures for further detail.

iii. Tax Coordination

If an Advisor or Client elects to use a Custom Portfolio in conjunction with Betterment’s asset location feature (“Tax Coordination”), the Advisor understands that Betterment will supply, for each ticker, its qualified dividend income, non-qualified dividend income, expected returns, and expense ratio for purposes of implementing automated asset location software strategies. Betterment is unable to incorporate any of an Advisor’s capital markets assumptions into its Tax Coordination feature, which may result in inconsistencies between Tax Coordination and the other features and experiences that rely on the Advisor’s capital markets assumptions.

Advisors should also be aware that Custom Portfolios that incorporate “target date” mutual funds are not eligible for Tax Coordination if the client’s goal includes a taxable component.  

See Betterment’s Tax Coordination disclosures for further detail.

iv. In-Kind Transfers

Subject to the terms and conditions of Betterment’s Automated Customer Account Transfer Service (“ACATS”) disclosure, Betterment supports in-kind transfers to goals using Custom Portfolios.