Managing Your Allocation As Your Goal Approaches

Automatically adjusting your allocation is one area of advice where automation can play a particularly important role for investors.

Risk allocation meter

“Am I holding the right kind of investments in my portfolio?” “Am I taking on too much risk by staying invested in stocks?” “Am I being too conservative by holding bonds?”

These are questions that are often on the top of an investor’s mind. And rightly so, especially when a major life goal, like retirement, starts to feel closer than it used to.

Taking on too much market risk could lead to losses for investors who plan to use their money soon. But taking on too little risk may mean leaving possible returns on the table. It’s during the countdown of an investment’s time horizon when many investors begin to feel less certain of what their allocation should be. This is when professionally managed allocation advice can help you reach your desired outcome.

In this article, we will:

  • Describe how portfolio allocation advice works
  • Demonstrate how automation enables advisors—like Betterment—to implement more precise allocation advice
  • Illustrate how Betterment customers can stay on track by enabling us to auto-adjust their allocation as their investment approaches the date they wish to use the money.

The Essentials of Understanding Allocation Advice

Every account you hold has a portfolio, and that portfolio is defined by its asset allocation. That’s your specific weighting of stocks and bonds in your portfolio strategy, usually calibrated to control risk.

One of the most important roles an investment advisor can play is helping you tailor your allocation based on your investment goals. In a conventional advisory setting, changes to your allocation might occur periodically—perhaps once per year—leading to a stairstep-like fall of your allocation’s risk (i.e., more bonds and less stock over time).

At Betterment, adjusting an allocation is one area of advice where automation can play a particularly important role for investors. As long as you choose to follow Betterment’s advice, we will automatically adjust your allocation through time to control risk as you near the end of your goal’s investing timeline. Rather than downshifting risk every so often, leading to a series of stairsteps, Betterment’s automation makes incremental changes to your risk level, rendering a smoother path from a higher risk level to a lower one. The smoother the path, the closer you stay to your optimal allocation.

The below chart is an example that shows the target allocation for a Major Purchase goal that an investor would have if she updated her target allocation annually compared to more frequent monthly updates. As you can see, the size of any individual portfolio change is smaller when allocation is updated monthly.

Major Purchase Target Allocation through Time

automatically allocation adjustment

The quality of the allocation advice an advisor offers depends heavily on how effectively they enable you to execute on that advice. Betterment provides full transparency on how we’ve designed our allocation advice to work here, but more importantly, we help you execute the advice through automation.

Automation enables more precise allocations.

For most accounts, the ideal allocation is one that changes to reduce risk as you near your goal. While some investors prefer to make every allocation change themselves, automation can help adjust an allocation with as much efficiency as possible. Think of it like a plane’s automatic landing system; in weather conditions that can be hard for a pilot to navigate, the automatic landing system helps put a plane in position to land safely. Similarly, automatic adjustment of your allocation helps keep you on track to meet your goal.

Allocation advice should be personal.

The key with allocation advice is to base the advice on well-researched evidence for appropriate risk levels. At Betterment, for every account you open, we automatically provide allocation advice based on the type of goal assigned to an account and your investment horizon.

Different investment goals are used in very different ways. For example, a retirement goal generally has a long time horizon, and, once you reach retirement, you will potentially spend that money for the next 30 years or more. This requires a very different portfolio allocation than if you are saving for a major purchase, like a house, where the investment horizon is generally shorter and you will spend the full amount at once on your down payment.

Appropriate allocation advice will consider these factors for each goal and frequently reassess them to ensure risk remains in control.

Allocation advice should be executed tax-efficiently.

The problem with some forms of allocation advice is that they are not executed tax-efficiently. Any change to an allocation can involve selling investments, which may cause taxes. The ideal allocation advice adjusts the allocation in a manner that causes an investor to realize the fewest possible capital gains taxes.

For Betterment customers, we use the cash coming in and out of your account, as well as market changes, to help avoid sales that might cause taxes. Deposits, withdrawals, and dividends help us guide your portfolio toward the target allocation while minimizing the need to sell assets—which may result in taxes—to reach the right balance. Similarly, because our allocation advice allows a degree of drift from your target allocation, we can use changes in the market to help you balance your portfolio tax-efficiently and without unnecessary trading.

If selling some investments is necessary to adjust your allocation, we use our TaxMin algorithm to minimize any potential tax impact. When we sell an investment that is overweight, we first look for shares that have losses, which may be used to offset other taxes, then we sell shares with long-term capital gains, and lastly short-term capital gains.

To learn more about how Betterment approaches tax-efficient investing, please visit this resource.

By auto-adjusting allocations, Betterment helps save you time—and much more.

As explained before, your allocation advice is only as good as its capacity for implementation. If you plan to follow our allocation advice but adjust your allocation yourself, it can be time-consuming and a challenge to make the necessary changes as tax-efficiently as you might want to. By allowing Betterment to auto-adjust your allocation based on our advice, you not only save time but also gain the tax-efficiency of a smoother path from higher risk to lower risk.

Near the end of an investment’s term, when account balances are often at their highest, most investors want to feel certain about what their final balance will be. A market downturn at the end of your investment period will usually cause a worse dollar loss than a similar-sized downturn earlier on, when your balance was likely smaller. Auto-adjusting an allocation helps you gain greater certainty without having to worry about making major changes. It saves time and adds efficiency, but more importantly helps you gain peace of mind.

And even as you automate your allocation, you can always know exactly how your allocation will change because Betterment provides full transparency on how our allocation advice varies by goal, and your account will always detail what your current allocation is.

At Betterment, our goal is to help you feel confident that you are taking an appropriate amount of risk through the life of your investment and that, as allocations change in your account to control risk, they are being managed efficiently.