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Make Your Money Hustle: Bond Investing
Explore how bonds can diversify your investments, filling the gap between cash and stocks.
Make Your Money Hustle: Bond Investing Explore how bonds can diversify your investments, filling the gap between cash and stocks. Bonds can be confusing, but we’re here to simplify them. Here’s the TL;DR: Bonds are loans you give to companies or governments who pay you back with interest. Bonds generally earn more return than high-yield savings accounts while taking on less risk than stocks. Bonds can be bought through several sources, including a broker, the U.S. government, or a diversified ETF like the multiple bond portfolios offered by Betterment. Congrats—you made it past the TL;DR. Next, we’ll dive deeper into how bonds may be able to bring balance to your investments, filling the gap between cash and stocks. In just a few minutes, you’ll walk away knowing: The basics of bonds The benefits of investing in bonds An easy way to buy bonds As interest rates begin to drop, bonds may be a good way to earn extra yield. The basics of bonds No need to read a book about bonds—here are three Q&As that give you the basics. Question 1: What is a bond? Answer: A bond is basically a loan that you provide to an entity such as a business or government that wants to raise money. You can buy and hold a bond directly from the issuer (e.g. buying US Treasury bonds from TreasuryDirect) or choose to buy and sell bonds on the secondary market (e.g. an online broker). Question 2: How does a bond work? Answer: After you “loan” your money to the entity issuing the bond, they agree to: Pay back your principal: The issuer promises to pay your initial money back, aka your principal, by a specified date called the bond’s maturity. Pay you interest: You’ll receive periodic interest payments based on the annual interest rate paid on a bond, called the coupon rate. These interest payments are either distributed to you or reinvested into your investment on a consistent schedule. Question 3: Are there risks to bond investing? Answer: Generally, bonds are less risky than stocks, but that doesn't mean they are without risk. Examples of these risks include: Credit risk: There’s a chance that a bond issuer won’t pay you back. Interest rate risk: There is a chance that the value of the bond will go down as interest rates go up. Long-term bonds have greater interest rate risk than short-term bonds. Most bonds are rated based on the bond issuer's financial strength and ability to pay a bond's principal and interest. Like stock investments, bonds with less risk offer less potential for return (aka lower yields). Less risky bonds include higher-quality bonds (more likely to be paid on time) or bonds with shorter maturities (length until full repayment). The benefits of investing in bonds For investors looking to put some of their cash to work but not wanting to go all-in on the stock market, here are three benefits that bonds can offer, making them complementary to cash and stock. 1) Bonds can help you avoid market volatility Unlike stocks, bonds don’t represent a share of ownership in a company. Because of this, you won’t see the value of a bond increase as much as a stock when a company grows, but you generally also won’t see it decrease as much as a stock when a company struggles. 2) Bonds can help you preserve wealth Bonds, especially short-maturity bonds, can be a good choice to help preserve your money while potentially earning more return than cash in a traditional savings account, money market account, or CD. 3) Bonds can help you generate income Because the entity issuing a bond typically pays the bondholder interest on some regular schedule, they can help generate consistent income with less risk than stock investing. An easy way to buy bonds Most bonds don't trade directly on centralized markets like stocks, making it more challenging to invest in individual bonds. You can buy individual bonds from a broker or directly from the US government, but both of those options require DIY knowledge and time to build a diversified portfolio. An easy way to invest in a diversified portfolio of bonds is to invest in a bond ETF. A bond ETF, or exchange-traded fund, trades on stock exchanges, like a stock ETF. In one purchase, a bond ETF offers investors a way to gain exposure to a diversified portfolio of bonds, which can include government, municipal, corporate, and international bonds. Bond ETFs aim to provide regular income through interest payments from the underlying bonds and offer the flexibility of buying and selling shares on an exchange throughout the trading day. Make your money hustle with a Betterment bond portfolio We’ve created two types of bond portfolios with different needs in mind: BlackRock Target Income portfolios What is it? The portfolios include a diverse set of bond ETFs with a range of risk levels, helping to mitigate exposure to volatility in the stock market, aiming to preserve wealth, while seeking to generate income. Who is it for? These portfolios may be better suited for investors looking for lower risk compared to stocks, with the option to choose one of four portfolio strategies targeting increasingly higher yields. The portfolio strategy should be selected based on your risk tolerance. Keep in mind, getting more income from a specific target portfolio also means taking on more risk. Goldman Sachs Tax-Smart Bonds portfolio What is it? This portfolio is built by Goldman Sachs using 100% short-term bond ETFs. Betterment then personalizes the portfolio based on your tax situation with the aim of generating after-tax yield. Who is it for? The portfolio is designed for higher-income individuals, especially in the 32% or greater federal tax bracket, looking for a potentially higher after-tax yield than a cash account with less risk than a traditional stock-and-bond investing portfolio. In both portfolios, all interest payments, also called dividends, are automatically reinvested to help grow the portfolio’s value. Ready to be invested? We make it simple to invest in a bond portfolio with three options: Make a one-time deposit. Set up recurring deposits from Betterment Checking or an external account. Schedule recurring transfers from your Betterment Cash Reserve account. -
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The Betterment Core portfolio strategy
We continually improve our portfolio construction methodology over time in line with our ...
The Betterment Core portfolio strategy We continually improve our portfolio construction methodology over time in line with our research-focused investment philosophy. TABLE OF CONTENTS Introduction Global Diversification and Asset Allocation Portfolio Optimization Tax Management Using Municipal Bonds The Value Tilt Portfolio Strategy Innovative Technology Portfolio Strategy Conclusion Citations I. Introduction Betterment builds investment portfolios designed to help you make the most of your money so you can live the life you want. Our investment philosophy forms the basis for how we pursue that objective: Betterment uses real-world evidence and systematic decision-making to help increase our customers’ wealth. In building our platform and offering individualized advice, Betterment’s philosophy is actualized by our five investing principles. Regardless of one’s assets or specific situation, Betterment believes all investors should: Make a personalized plan. Build in discipline. Maintain diversification. Balance cost and value. Manage taxes. To align with Betterment’s investing principles, a portfolio strategy must enable personalized planning and built-in discipline for investors. The Betterment Core portfolio strategy contains 101 individualized risk levels (each with a different percentage of the portfolio invested in stocks vs. bonds, informed by your financial goals, time horizon and risk tolerance), in part, because that level of granularity in allocation management provides the flexibility to align to multiple goals with different timelines and circumstances. In this guide to the Betterment Core portfolio strategy construction process, our goal is to demonstrate how the methodology, in both its application and development, embodies Betterment’s investing principles. When developing a portfolio strategy, any investment manager faces two main tasks: asset class selection and portfolio optimization. Fund selection is also guided by our investing principles, and is covered separately in our Investment Selection Methodology paper. II. Global Diversification and Asset Allocation An optimal asset allocation is one that lies on the efficient frontier, which is a set of portfolios that seek to achieve the maximum objective for any given feasible level of risk. The objective of most long-term portfolio strategies is to maximize return for a given level of risk, which is measured in terms of volatility—the dispersion of those returns. In line with our investment philosophy of making systematic decisions backed by research, Betterment’s asset allocation is based on a theory by economist Harry Markowitz called Modern Portfolio Theory.1 A major tenet of Modern Portfolio Theory is that any asset included in a portfolio should not be assessed by itself, but rather, its potential risk and return should be analyzed as a contribution to the whole portfolio. Modern Portfolio Theory seeks to maximize expected return given an expected risk level or, equivalently, minimize expected risk given an expected return. Other forms of portfolio construction may legitimately pursue other objectives, such as optimizing for income, or minimizing loss of principal. Asset Classes Selected for Betterment’s Core Portfolio Strategy The Betterment Core portfolio strategy’s asset allocation starts with a universe of investable assets, which for us could be thought of as the “global market portfolio.”2 To capture the exposures of the asset classes for the global market portfolio, Betterment evaluates available exchange-traded funds (ETFs) that represent each class in the theoretical market portfolio. We base our asset class selection on ETFs because this aligns portfolio construction with our investment selection methodology. Betterment’s portfolios are constructed of the following asset classes: Equities U.S. equities International developed market equities Emerging market equities Bonds U.S. short-term treasury bonds U.S. inflation-protected bonds U.S. investment-grade bonds U.S. municipal bonds International developed market bonds Emerging market bonds We select U.S. and international developed market equities as a core part of the portfolio. Historically, equities exhibit a high degree of volatility, but provide some degree of inflation protection. Even though significant historical drawdowns, such as the global financial crisis in 2008 and pandemic outbreak in 2020, demonstrate the possible risk of investing in equities, longer-term historical data and our forward expected returns calculations suggest that developed market equities remain a core part of any asset allocation aimed at achieving positive returns. This is because, over the long term, developed market equities have tended to outperform bonds on a risk-adjusted basis. To achieve a global market portfolio, we also include equities from less developed economies, called emerging markets. Generally, emerging market equities tend to be more volatile than U.S. and international developed equities. And while our research shows high correlation between this asset class and developed market equities, their inclusion on a risk-adjusted basis is important for global diversification. Note that Betterment excludes frontier markets, which are even smaller than emerging markets, due to their widely varying definition, extreme volatility, small contribution to global market capitalization, and cost to access. The Betterment Core portfolio strategy incorporates bond exposure because, historically, bonds have a low correlation with equities, and they remain an important way to dial down the overall risk of a portfolio. To promote diversification and leverage various risk and reward tradeoffs, the Betterment Core portfolio strategy includes exposure to several asset classes of bonds. Asset Classes Excluded from the Betterment Core Portfolio Strategy While Modern Portfolio Theory would have us craft a portfolio to represent the total market, including all available asset classes, we exclude some asset classes whose cost and/or lack of data outweighs the potential benefit gained from their inclusion. The Betterment Core portfolio construction process excludes commodities and natural resources asset classes. Specifically, while commodities represent an investable asset class in the global financial market, we have excluded commodities ETFs because of their low contribution to a global stock/bond portfolio's risk-adjusted return. In addition, real estate investment trusts (REITs), which tend to be well marketed as a separate asset class, are not explicitly included in the Core portfolio strategy. Betterment does provide exposure to real estate, but as a sector within equities. Adding additional real estate exposure by including a REIT asset class would overweight the exposure to real estate relative to the overall market. Incorporating awareness of a benchmark Before 2024, we managed the Core portfolio strategy in a “benchmark agnostic” manner, meaning we did not incorporate consideration of global stock and bond indices in our portfolio optimization, though we have always sought to optimize the expected risk-adjusted return of the portfolios we construct for clients. The “risk” element of this statement represents volatility and the related drawdown potential of the portfolio, but it could also represent the risk in the deviation of the portfolio’s performance relative to a benchmark. In an evolution of our investment process, in 2024 we updated our portfolio construction methodology to become “benchmark aware,” as we now calibrate our exposures based on a custom benchmark that expresses our preference for diversifying across global stocks and bonds. A benchmark, which comes in the form of a broad-based market index or a combination of indices, serves as a reference point when approaching asset allocation, understanding investment performance, and aligning the expectations of portfolio managers and clients. In our case, we created a custom benchmark that most closely aligns with our future expectations for global markets. The custom benchmark we have selected is composed of (1) the MSCI All Country World stock index (MSCI ACWI), (2) the Bloomberg Global Aggregate Bond index, and (3) at low risk levels, the ICE US Treasury 1-3 Year Index. Our custom benchmark is composed of 101 risk levels of varying percentage weightings of the stock and bond indexes, which correspond to the 101 risk level allocations in our Core portfolio. At low risk levels (allocations that are less than 40% stocks), we layer an allocation to the ICE US Treasury 1-3 Year index, which represents short-term bonds, into the blended benchmark. We believe that incorporating this custom benchmark into our process reinforces the discipline of carefully evaluating the ways in which our portfolios’ performance could veer from global market indices and deviate from our clients’ expectations. We have customized the benchmark with 101 risk levels so that it serves clients’ varying investment goals and risk tolerances. As we will explore in the following section, establishing a benchmark allows us to apply constraints to our portfolio optimization that ensures the portfolio strategy’s asset allocation does not vary significantly from the geographic and market-capitalization size exposures of a sound benchmark. Our benchmark selection also makes explicit that the portfolio strategy delivers global diversification rather than the more narrowly concentrated and home-biased exposures of other possible benchmarks such as the S&P 500. III. Portfolio Optimization As an asset manager, we fine-tune the investments our clients hold with us, seeking to maximize return potential for the appropriate amount of risk each client can tolerate. We base this effort on a foundation of established techniques in the industry and our own rigorous research and analysis. While most asset managers offer a limited set of model portfolios at a defined risk scale, the Betterment Core portfolio strategy is designed to give customers more granularity and control over how much risk they want to take on. Instead of offering a conventional set of three portfolio choices—aggressive, moderate, and conservative—our portfolio optimization methods enable the Core portfolio strategy to contain 101 different risk levels. Optimizing Portfolios Modern Portfolio Theory requires estimating variables such as expected-returns, covariances, and volatilities to optimize for portfolios that sit along an efficient frontier. We refer to these variables as capital market assumptions (CMAs), and they provide quantitative inputs for our process to derive favorable asset class weights for the portfolio strategy. While we could use historical averages to estimate future returns, this is inherently unreliable because historical returns do not necessarily represent future expectations. A better way is to utilize the Capital Asset Pricing Model (CAPM) along with a utility function which allows us to optimize for the portfolio with a higher return for the risk that the investor is willing to accept. Computing Forward-Looking Return Inputs Under CAPM assumptions, the global market portfolio is the optimal portfolio. Since we know the weights of the global market portfolio and can reasonably estimate the covariance of those assets, we can recover the returns implied by the market.3 This relationship gives rise to the equation for reverse optimization: μ = λ Σ ωmarket Where μ is the return vector, λ is the risk aversion parameter, Σ is the covariance matrix, and ωmarket is the weights of the assets in the global market portfolio.5 By using CAPM, the expected return is essentially determined to be proportional to the asset’s contribution to the overall portfolio risk. It’s called a reverse optimization because the weights are taken as a given and this implies the returns that investors are expecting. While CAPM is an elegant theory, it does rely on a number of limiting assumptions: e.g., a one period model, a frictionless and efficient market, and the assumption that all investors are rational mean-variance optimizers.4 In order to complete the equation above and compute the expected returns using reverse optimization, we need the covariance matrix as an input. This matrix mathematically describes the relationships of every asset with each other as well as the volatility risk of the assets themselves. In another more recent evolution of our investment process, we also attempt to increase the robustness of our CMAs by averaging in the estimates of expected returns and volatilities published by large asset managers such as BlackRock, Vanguard, and State Street Global Advisors. We weight the contribution of their figures to our final estimates based on our judgment of the external provider’s methodology. Constrained optimization for stock-heavy portfolios After formulating our CMAs for each of the asset classes we favor for inclusion in the Betterment Core portfolio strategy, we then solve for target portfolio allocation weights (the specific set of asset classes and the relative distribution among those asset classes in which a portfolio will be invested), with the range of possible solutions constrained by limiting the deviation from the composition of the custom benchmark. To robustly estimate the weights that best balance risk and return, we first generate several thousand random samples of 15 years of expected returns for the selected asset classes based on our latest CMAs, assuming a multivariate normal distribution. For each sample of 15 years of simulated expected return data, we find a set of allocation weights subject to constraints that provide the best risk-return trade-off, expressed as the portfolio’s Sharpe ratio, i.e., the ratio of its return to its volatility. Averaging the allocation weights across the thousands of return samples gives a single set of allocation weights optimized to perform in the face of a wide range of market scenarios (a “target allocation”). The constraints are imposed to make the portfolio weights more benchmark-aware by setting maximum and minimum limits to some asset class weights. These constraints reflect our judgment of how far the composition of geographic regions within the portfolio’s stock and bond allocations should differ from the breakdown of the indices used in the benchmark before the risk of significantly varied performance between the portfolio strategy and the benchmark becomes untenable. For example, the share of the portfolio’s stock allocation assigned to international developed stocks should not be profoundly different from the share of international developed stocks within the MSCI ACWI. We implement caps on the weights of emerging market stocks and bonds, which are often projected to have high returns in our CMAs, and set minimum thresholds for U.S. stocks and bonds. This approach not only ensures our portfolio aligns more closely with the benchmark, but it also mitigates the risk of disproportionately allocating to certain high expected return asset classes. Constrained optimization for bond-heavy portfolios For versions of the Core portfolio strategy that have more than or equal to 60% allocation to bonds, the optimization approach differs in that expected returns are maximized for target volatilities assigned to each risk level. These volatility targets are determined by considering the volatility of the equivalent benchmark. Manually established constraints are designed to manage risk relative to the benchmark, instituting a declining trend in emerging market stock and bond exposures as stock allocations (i.e., the risk level) decreases. Meaning that investors with more conservative risk tolerances have reduced exposures to emerging market stocks and bonds because emerging markets tend to have more volatility and downside-risk relative to more established markets. Additionally, as the stock allocation percentage decreases, we taper the share of international and U.S. aggregate bonds within the overall bond allocation, and increase the share of short-term Treasury, short-term investment grade, and inflation-protected bonds. This reflects our view that investors with more conservative risk tolerances should have increased exposure to short-term Treasury, short-term investment grade, and inflation-protected bonds relative to riskier areas of fixed income. The lower available risk levels of the Core portfolio strategy demonstrate capital preservation objectives, as the shorter-term fixed income exposures likely possess less credit and duration risk. Clients invested in the Core portfolio at conservative allocation levels will likely therefore not experience as significant drawdowns in the event of waves of defaults or upward swings in interest rates. Inflation-protected securities also help buffer the lower risk levels from upward drafts in inflation. IV. Tax Management Using Municipal Bonds For investors with taxable accounts, portfolio returns may be further improved on an after-tax basis by utilizing municipal bonds. This is because the interest from municipal bonds is exempt from federal income tax. To take advantage of this, the Betterment Core portfolio strategy in taxable accounts is also tilted toward municipal bonds because interest from municipal bonds is exempt from federal income tax, which can further optimize portfolio returns. Other types of bonds remain for diversification reasons, but the overall bond tax profile is improved by tilting towards municipal bonds. For investors in states with some of the highest tax rates—New York and California—Betterment can optionally replace the municipal bond allocation with a more narrow set of bonds for that specific state, further saving the investor on state taxes. Betterment customers who live in NY or CA can contact customer support to take advantage of state specific municipal bonds. V. The Value Tilt Portfolio Strategy Existing Betterment customers may recall that historically the Core portfolio strategy held a tilt to value companies, or businesses that appear to be potentially undervalued based on metrics such as price to earnings ratios. The latest iteration of the Core portfolio strategy, however, has deprecated this explicit tilt that was expressed via large-, mid-, and small-capitalization U.S. value stock ETFs, while maintaining some exposure to value companies through broad market U.S. stock funds. We no longer favor allocating to value stock ETFs within the Core portfolio strategy in large part as a result of our adoption of a broad market benchmark, which highlights the idiosyncratic nature of such tilts, sometimes referred to as “off benchmark bets.” We believe our chosen benchmark that represents stocks through the MSCI ACWI, which holds a more neutral weighting to value stocks, more closely aligns with the risk and return expectations of Betterment’s diverse range of client types across individuals, financial advisors, and 401(k) plan sponsors. Additionally, as markets have grown more efficient and value factor investing more popularized, potentially compressing the value premium, we have a marginally less favorable view of the forward-looking, risk-adjusted return profile of the exposure. That being said, we have not entirely lost conviction in the research supporting the prudence of value investing. The value factor’s deep academic roots drove decisions to incorporate the value tilt into Betterment’s portfolios from the company’s earliest days. For investors who wish to remain invested in a value strategy, we have added the Value Tilt portfolio strategy, a separate option from the Core portfolio strategy to our investing offering. The Value Tilt portfolio strategy maintains the Core portfolio strategy’s global diversification across stocks and bonds while including a sleeve within the stock allocation of large-, mid-, and small-capitalization U.S. value funds. We calibrated the size of the value fund exposure based on a certain target historical tracking error to the backtested performance of the latest version of the Core portfolio strategy. Based on this approach, investors should expect the Value Tilt portfolio strategy to generally perform similarly to Core, with the potential to under- or outperform based on the return of U.S. value stocks. With the option to select between the Value Tilt portfolio strategy or a Core now without an explicit allocation to value, the investment flexibility of the Betterment platform has improved. VI. Innovative Technology Portfolio Strategy In 2021, Betterment launched the Innovative Technology portfolio strategy to provide access to the thematic trend of technological innovation. The premise of investing in this theme is that your investments incorporate exposure to the companies that are seeking to shape the next industrial revolution. Similar to the Value Tilt portfolio, the Core portfolio strategy is used as the foundation of construction for the Innovative Technology portfolio. With this portfolio strategy, we calibrated the size of the innovative technology fund exposure based on a certain target historical tracking error to the backtested performance of the latest version of the Core portfolio strategy. Through this process, the Innovative Technology portfolio maintains the same globally diversified, low-cost approach that is found in Betterment’s investment philosophy. The portfolio however has increased exposure to risk given that innovation requires a long-term view, and may face uncertainties along the way. It may outperform or underperform depending on the return experience of the innovative technology fund exposure and the thematic landscape. VII. Conclusion After setting the strategic weight of assets in the Betterment Core portfolio strategy, the next step in implementing the portfolio construction process is Betterment’s investment selection, which selects the appropriate ETFs for the respective asset exposure in a generally low-cost, tax-efficient way. In keeping with our philosophy, that process, like the portfolio construction process, is executed in a systematic, rules-based way, taking into account the cost of the fund and the liquidity of the fund. Beyond ticker selection is our established process for allocation management—how we advise downgrading risk over time—and our methodology for automatic asset location, which we call Tax Coordination. Finally, our overlay features of automated rebalancing and tax-loss harvesting are designed to be used to help further maximize individualized, after-tax returns. Together these processes put our principles into action, to help each and every Betterment customer maximize value while invested at Betterment and when they take their money home. VIII. Citations 1 Markowitz, H., "Portfolio Selection".The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91. 2 Black F. and Litterman R., Asset Allocation Combining Investor Views with Market Equilibrium, Journal of Fixed Income, Vol. 1, No. 2. (Sep., 1991), pp. 7-18. Black F. and Litterman R., Global Portfolio Optimization, Financial Analysts Journal, Vol. 48, No. 5 (Sep. - Oct., 1992), pp. 28-43. 3 Litterman, B. (2004) Modern Investment Management: An Equilibrium Approach. 4 Note that the risk aversion parameter is essentially a free parameter. 5 Ilmnen, A., Expected Returns. -
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How to course correct when you simply can't stay the course
De-risking during market volatility can be costly. Here’s how to do it without breaking the ...
How to course correct when you simply can't stay the course De-risking during market volatility can be costly. Here’s how to do it without breaking the bank. The best course of action during market volatility is often inaction. That’s because selling riskier assets at a loss locks in those losses. It foregoes their potential for future growth, and it might also trigger capital gains taxes in the process. But if taking some sort of action feels necessary, then modestly reducing your overall risk exposure can be a reasonable alternative. Consider dialing down your existing stock allocation by a few percentage points, or lower the costs of recalibrating by using your future deposits instead. Either way, the solution may be the same: sprinkling in more bonds. Consider bonds to calm your investing nerves When people talk about diversification, equities like international stocks get most of the attention. But no less important in the role of managing risk are bonds. These are the loans given to governments and companies by investors, and while they're not completely risk-free (no asset is), the relatively-modest interest they tend to pay out can feel like a windfall when stock values are plunging. They won’t negate all of the volatility of stocks, but they can help smooth things out and preserve capital. This is why all of our recommended allocations include holding at least some bonds. One way to de-risk some of your future investing is with one of our portfolios made up of both stocks and bonds (Core, Value Tilt, etc.). We’ll recommend a risk level based on your goal, but we make it easy to dial up the bond allocation to your preference. Over time, you can slowly finetune things until your collective risk feels right. Or you can let us automatically adjust it based on your target date. We also offer two portfolios comprised entirely of bonds, each one designed for a different use: The BlackRock Target Income portfolio, designed to help you limit market volatility, preserve wealth, and generate income. The Goldman Sachs Tax-Smart Bonds portfolio, designed for high-income individuals seeking a higher after-tax yield compared to a cash account. Don’t forget about the role of cash One of the best ways to mitigate your overall financial risk is by shoring up your emergency fund, which may include a high-yield cash account like our Cash Reserve. Imagine losing your income stream, and how much time you'd want to get back on your feet. A good place to start is 3-6 months' worth of your essential expenses, but your right amount is whatever helps you sleep more soundly at night. Steadying the ship during unsteady times As we mentioned up front, right-sizing your risk during downturns isn’t always cheap. But there are ways to minimize the costs. Lowering your risk profile incrementally is one of them, and stretching out your safety net is another. Either way, it’s okay to recalibrate your risk tolerance from time-to-time, and you can do it wisely with Betterment.
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Inside the investing kitchen, part 1
Inside the investing kitchen, part 1 Jun 24, 2025 11:30:00 AM The recipe for a better portfolio, and the science behind a safer nest egg. Jamie Lee isn’t a Top Chef, but he knows his way around the kitchen. He dabbles in sous vide with the help of a sous chef (his 6-year-old daughter). He loves smoking salmon low and slow on a pair of pellet grills. And in some ways, his day job on the Betterment Investing team resembles the culinary world as well. He and his teammates work in a test kitchen of sorts, defining and refining the recipes for our low-cost, high-performing, and globally-diversified portfolios. They size up ingredients, pair flavors, and thoughtfully assemble the courses of each “meal.” All in service of customers with varying appetites for risk. It's highly-technical work, but we wouldn't be Betterment if we didn't make our methodologies as accessible as possible. So whether you're kicking the tires on our services, or you're already a customer and simply curious about the mechanics of your money machine, come along for a three-part, behind-the-scenes look at how we cook up a better portfolio. Here in part 1, we'll explore how we allocate your investing at a high level. In part 2, we'll zoom in to our process for selecting specific funds. And in part 3, we'll show you how we handle thousands of trades each day to keep our customers’ portfolios in tip-top shape. The science behind a safer nest egg Betterment customers rely on Jamie and team to do the heavy lifting of portfolio construction. They distill handfuls of asset classes, a hundred-plus risk levels, and thousands of funds into a simple yet eclectic menu of investment options. And underpinning much of this process is something called Modern Portfolio Theory, a framework developed by the late American economist Harry Markowitz. The theory revolutionized how investors think about risk, and led to Markowitz winning the Nobel Prize in 1990. Diversification lies at the heart of Modern Portfolio Theory. The more of it your investing has, the theory goes, the less risk you're exposed to. But that barely scratches the surface. One of the meatiest parts of building a portfolio (and by extension, diversifying your investing) is how much weight to give each asset class, also known as asset allocation. Broadly speaking, you have stocks and bonds. But you can slice up the pie in several other ways. There’s large cap companies or less established ones. Government debt or the corporate variety. And even more relevant as of late: American markets or international. Jamie came of age in South Korea during the late 90s. Back here in the States, the dot-com bubble was still years away from popping. But in South Korea and Asia more broadly, a financial crisis was well underway. And it changed the trajectory of Jamie’s career. His interest in and application of math shifted from computer science to the study of markets, and ultimately led to a PhD in statistics. Jamie Lee (right) helps optimize the weights of asset classes in Betterment portfolios. For Jamie, the interplay of markets at a global level is fascinating. So it’s only fitting that when optimizing asset allocations for customers, Jamie and team start with the hypothetical "global market portfolio," an imaginary snapshot of all the investable assets in the world. The current value of U.S. stocks, for example, represents about two-thirds the value of all stocks, so it's weighted accordingly in the global market portfolio. These weights are the jumping off point for a key part of the portfolio construction process: projecting future returns. Reverse engineering expected returns “Past performance does not guarantee future results.” We include this type of language in all of our communications at Betterment, but for quantitative researchers, or “quants,” like Jamie, it’s more than a boilerplate. It’s why our forecasts for the expected returns of various asset classes largely aren't based on historical performance. They're forward-looking. "Past data is simply too unreliable," says Jamie. "Look at the biggest companies of the 90s; that list is completely different from today.” So to build our forecasts, commonly referred to in the investing world as Capital Market Assumptions, we pretend for a moment that the global market portfolio is the optimal one. Since we know roughly how each of those asset classes performs relative to one another, we can reverse engineer their expected returns. This robust math is represented by a deceivingly short equation—μ = λ Σ ωmarket—which you can read more about in our full portfolio construction methodology. From there, we simulate thousands of paths for the market, factoring in both our forecasts and those of large asset managers like BlackRock to find the optimal allocation for each path. Then we average those weights to land on a single recommendation. This “Monte Carlo" style of simulations is commonly used in environments filled with variables. Environments like, say, capital markets. The outputs are the asset allocation percentages (refreshed each year) that you see in the holdings portion of your portfolio details Hypothetical portfolio; for illustration only At this point in the journey, however, our Investing team's work is hardly finished. They still need to seek out some of the most cost-effective, and just plain effective, funds that give you the intended exposure to each relevant asset class. For this, we need to head out of the test kitchen and into the market. So don’t forget your tote bag. -
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How we make market downturns less scary
How we make market downturns less scary Apr 7, 2025 12:12:58 PM And how it can benefit your investing’s bottom line. The recent round of tariffs and trade wars have roiled markets, offering the latest example of investing’s inherent volatility. The fact that market drops do happen, and happen with some regularity, means that managing them is not only possible but paramount. "It's not about whether you're right or wrong," the investor George Soros once quipped. "But how much money you make when you're right, and how much you lose when you're wrong." Mitigating losses, in other words, matters just as much as maximizing gains. And this is true for two important reasons: The bigger the loss, the more tempted you may be to sell assets and lock in those losses. The bigger the loss, the less fuel for growth you have when the market does rebound. Point A is psychological, while Point B is mathematical, so let’s take each one separately. In the process, we’ll explain how we build our portfolios to not only weather the storm, but soak up as many rays as possible when the sun shines again. Smoothing out your investing journey Imagine you’re given a choice of rides: one’s a hair-raising roller coaster, the other a bike ride through a series of rolling hills. Sure, thrill seekers may choose the first option, but we think most investors would prefer the latter, especially if the ride in question lasts for decades. So to smooth things out, we diversify. Owning a mix of asset types can help soften the blow on your portfolio when any one particular type underperforms. Our Core portfolio, for example, features a blend of asset types like U.S. stocks and global bonds. The chart below shows how those asset types have performed individually since 2018, compared with the blended approach of a 90% stocks, 10% bonds allocation of Core. As you can see, Core avoids the big losses that individual asset classes experience on the regular. That’s one reason why through all the ups and downs of the past 15 years, it’s delivered 9% composite annual time-weighted returns1, and that’s after fees are accounted for. 1As of 12/31/2024, and inception date 9/7/2011. Composite annual time-weighted returns: 12.7% over 1 year, 7.9% over 5 years, and 7.8% over 10 years. Composite performance calculated based on the dollar-weighted average of actual client time-weighted returns for the Core portfolio at 90/10 allocation, net of fees, includes dividend reinvestment, and excludes the impact of cash flows. Past performance not guaranteed, investing involves risk. Core’s exposure to global bonds and international stocks has also helped its cause, given their outperformance relative to U.S. stocks year-to-date amidst the current market volatility of 2025. A smoother ride can take your money farther Downside protection is all the more important when considering the “math of losses.” We’ll be the first to admit it’s hard math to follow, but it boils down to this: as a portfolio’s losses rack up, the gains required to break even grow exponentially. The chart below illustrates this with losses in blue, and the gains required to be made whole in orange. Notice how their relationship is anything but 1-to-1. This speaks to the previously-mentioned Point B: The bigger your losses, the less fuel for growth you have in the future. Investors call this “volatility drag,” and it’s why we carefully weigh the risk of an investment against its expected returns. By sizing them up together, expressed as the Sharpe ratio, we can help assess whether the reward of any particular asset justifies its risk. This matters because building long-term wealth is a marathon, not a race. It pays to pace yourself. And yet, there will still be bumps in the road Because no amount of downside protection will get rid of market volatility altogether. It’s okay to feel worried during drops. But hopefully, with more information on our portfolio construction and automated tools like tax loss harvesting, you can ride out the storm with a little more peace-of-mind. And if you’re looking for even more reassurance, consider upgrading to Betterment Premium and talking with our team of advisors. -
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How socially responsible investing connects your holdings to your heart
How socially responsible investing connects your holdings to your heart Mar 31, 2025 7:00:00 AM Learn more about this increasingly-popular category of investing. Socially responsible investing (SRI), also known as environmental, social, and governance (ESG) investing, screens for companies that consider both their returns and their responsibility to the wider world. It’s a growing market for investors, with assets totaling $30 trillion as of 2022. We launched our first SRI portfolio back in 2017, and have since expanded to a lineup of three options: Broad Impact Social Impact Climate Impact All three are globally-diversified, low-cost, and built to help align your investing with your values. So let’s explore a few ways they do that, before tackling a common question about the SRI category in general: performance. How our Social Impact portfolio lifts up underserved groups Social Impact uses the Broad Impact portfolio’s foundation while adding a trio of funds focused on helping underserved groups get on equal footing. There’s $SHE and $JUST, which screen for U.S. companies demonstrating a commitment toward gender and social equality, respectively. Then there’s $VETZ, our latest addition to the portfolio. $VETZ is the first of its kind: a publicly-traded ETF that mainly invests in loans to active and retired U.S. service members, and the survivors of fallen veterans. These types of home and small-business loans have historically helped diversify portfolios, and they also help lower borrowing costs for veterans and their families. And unlike $SHE and $JUST, which are comprised of stocks, $VETZ is an all-bond fund. So even if you have a lower appetite for risk when investing, your SRI portfolio can maintain an exposure to socially responsible ETFs. How the $VOTE fund is shaking up shareholder activism Remember the “G” in ESG? It stands for governance, or how companies go about their business. Do they open up their books when necessary? Is their leadership diverse? Are they accountable to shareholders? On that last front, there’s the $VOTE ETF found in each one of our SRI portfolios. On the surface, it seems like a garden variety index fund tracking the S&P 500. Behind the scenes, however, it’s working to push companies toward positive environmental and social practices. It does this by way of “proxy” voting, or voting on behalf of the people who buy into the fund. Engine No. 1, the investment firm that manages $VOTE, puts these proxy votes to use during companies’ annual shareholder meetings, where individual shareholders, or the funds that represent them, vote on decisions like board members and corporate goals. In 2021, Engine No. 1 stunned the corporate world by persuading a majority of ExxonMobile shareholders to vote for three new board members in the name of lowering the company’s carbon footprint. And it did all this in spite of holding just .02% of the company’s shares itself. Not a bad return on investment, huh? Does SRI sacrifice gains in the name of good? We now stand eye-to-eye with the elephant in the room: performance. Worrying about returns is common regardless of your portfolio, so it’s only natural to question how socially responsible investing in general stacks up against the alternatives. Well, the evidence points to SRI comparing quite well. According to a survey of 1,141 peer-reviewed papers and other similar meta-reviews: The performance of SRI funds has “on average been indistinguishable from conventional investing.” And while the researchers note that it’s “likely that these propositions will evolve,” they also found evidence that SRI funds may offer “downside” protection in times of social or economic crisis such as pandemics. Your socially responsible investing, in other words, is anything but a charity case. Simplifying the socially responsible space Not long ago, SRI was barely a blip on the radar of everyday investors. If you were hip to it, you likely had just two options: DIY the research and purchase of individual SRI stocks Pay a premium to buy into one of the few funds out there at the time Those days are thankfully in the past, because our portfolios make it easy to express your values through your investing. And our team of investing experts regularly seeks out new funds like $VETZ and updated SRI standards that strive to deliver more impact while helping you reach your goals. Check out our full methodology if you’re hungry for more details. And if you’re ready to invest for a better world, we’ve got you covered. -
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Our Socially Responsible Investing portfolios methodology
Our Socially Responsible Investing portfolios methodology Mar 31, 2025 7:00:00 AM Learn how we construct our Socially Responsible Investing (SRI) portfolios. Table of Contents Introduction How do we define SRI? The Challenges of SRI Portfolio Construction How is Betterment’s Broad Impact portfolio constructed? How is Betterment’s Climate Impact portfolio constructed? How is Betterment’s Social Impact portfolio constructed? Conclusion Introduction Betterment launched its first Socially Responsible Investing (SRI) portfolio in 2017, and has widened the investment options under that umbrella since then. Within Betterment’s SRI options, we currently offer a Broad Impact portfolio and two additional, more focused SRI portfolio options: a Social Impact SRI portfolio (focused on social empowerment) and a Climate Impact SRI portfolio (focused on climate-conscious investments). These portfolios represent a diversified, relatively low-cost solution constructed using exchange traded funds (ETFs), which will be continually improved upon as costs decline, more data emerges, and as a result, the availability of SRI funds broadens. How do we define SRI? Our approach to SRI has three fundamental dimensions that shape our portfolio construction mandates: Reducing exposure to investments involved in unsustainable activities and environmental, social, or governmental controversies. Increasing exposure to investments that work to address solutions for core environmental and social challenges in measurable ways. Allocating to investments that use shareholder engagement tools, such as shareholder proposals and proxy voting, to incentivize socially responsible corporate behavior. SRI is the traditional name for the broad concept of values-driven investing (many experts now favor “sustainable investing” as the name for the entire category). Our SRI approach uses SRI mandates based on a set of industry criteria known as “ESG,” which stands for Environmental, Social and Governance. ESG refers specifically to the quantifiable dimensions of a company’s standing along each of its three components. Betterment’s approach expands upon the ESG-investing framework with exposure to investments that use complementary shareholder engagement tools. Betterment does not directly select companies to include in, or exclude from, the SRI portfolios. Rather, Betterment identifies ETFs that have been classified as ESG or similar by third-parties and considers internally developed “SRI mandates” alongside other qualitative and quantitative factors to select ETFs to include in its SRI portfolios. Using SRI Mandates One aspect of improving a portfolio’s ESG exposure is reducing exposure to companies that engage in certain activities that may be considered undesirable because they do not align with specific values. These activities may include selling tobacco, military weapons, civilian firearms, as well as involvement in recent and ongoing ESG controversies. However, SRI is about more than just adjusting your portfolio to minimize companies with a poor social impact. For each Betterment SRI portfolio, the portfolio construction process considers one or more internally developed “SRI mandates.” Betterment’s SRI mandates are sustainable investing objectives that we include in our portfolios’ exposures. SRI Mandate Description Betterment SRI Portfolio Mapping ESG Mandate ETFs tracking indices which are constructed with reference to some form of ESG optimization, which promotes exposure to Environmental, Social, and Governance pillars. Broad, Climate, Social Impact Portfolios Fossil Fuel Divestment Mandate ETFs tracking indices which are constructed with the aim of excluding stocks in companies with major fossil fuels holdings (divestment). Climate Impact Portfolio Carbon Footprint Mandate ETFs tracking indices which are constructed with the aim of minimizing exposure to carbon emissions across the entire economy (rather than focus on screening out exposure to stocks primarily in the energy sector). Climate Impact Portfolio Green Financing Mandates ETFs tracking indices focused on financing environmentally beneficial activities directly. Climate Impact Portfolio Gender Equity Mandate ETFs tracking indices which are constructed with the aim of representing the performance of companies that seek to advance gender equality. Social Impact Portfolio Social Equity Mandate ETFs managed with the aim of obtaining exposures in investments that seek to advance vulnerable, disadvantaged, or underserved social groups. The Gender Equity Mandate also contributes to fulfilling this broader mandate. Social Impact Portfolio Shareholder Engagement Mandate In addition to the mandates listed above, Betterment’s SRI portfolios are constructed using a shareholder engagement mandate. One of the most direct ways a shareholder can influence a company’s decision making is through shareholder proposals and proxy voting. Publicly traded companies have annual meetings where they report on the business’s activities to shareholders. As a part of these meetings, shareholders can vote on a number of topics such as share ownership, the composition of the board of directors, and executive level compensation. Shareholders receive information on the topics to be voted on prior to the meeting in the form of a proxy statement, and can vote on these topics through a proxy card. A shareholder can also make an explicit recommendation for the company to take a specific course of action through a shareholder proposal. ETF shareholders themselves do not vote in the proxy voting process of underlying companies, but rather the ETF fund issuer participates in the proxy voting process on behalf of their shareholders. As investors signal increasing interest in ESG engagement, more ETF fund issuers have emerged that play a more active role engaging with underlying companies through proxy voting to advocate for more socially responsible corporate practices. These issuers use engagement-based strategies, such as shareholder proposals and director nominees, to engage with companies to bring about ESG change and allow investors in the ETF to express a socially responsible preference. For this reason, Betterment includes a Shareholder Engagement Mandate in its SRI portfolios. Mandate Description Betterment SRI Portfolio Mapping Shareholder Engagement Mandate ETFs which aim to fulfill one or more of the above mandates, not via allocation decisions, but rather through the shareholder engagement process, such as proxy voting. Broad, Climate, Social Impact Portfolios The Challenges of SRI Portfolio Construction For Betterment, three limitations have a large influence on our overall approach to building an SRI portfolio: 1. Many existing SRI offerings in the market have serious shortcomings. Many SRI offerings today sacrifice sufficient diversification appropriate for investors who seek market returns, and/or do not provide investors an avenue to use collective action to bring about ESG change. Betterment’s SRI portfolios do not sacrifice global diversification. Consistent with our core principle of global diversification and to ensure both domestic and international bond exposure, we’re still allocating to some funds without an ESG mandate, until satisfactory solutions are available within those asset classes. Additionally, all three of Betterment’s SRI portfolios include a partial allocation to an engagement-based socially responsible ETF using shareholder advocacy as a means to bring about ESG-change in corporate behavior. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly, even if particular shareholder campaigns are unsuccessful. 2. Integrating values into an ETF portfolio may not always meet every investor’s expectations. For investors who prioritize an absolute exclusion of specific types of companies above all else, certain approaches to ESG will inevitably fall short of expectations. For example, many of the largest ESG funds focused on US Large Cap stocks include some energy companies that engage in oil and natural gas exploration, like Hess. While Hess might not meet the criteria of the “E” pillar of ESG, it could still meet the criteria in terms of the “S” and the “G.” Understanding that investors may prefer to focus specifically on a certain pillar of ESG, Betterment has made three SRI portfolios available. The Broad Impact portfolio seeks to balance each of the three dimensions of ESG without diluting different dimensions of social responsibility. With our Social Impact portfolio, we sharpen the focus on social equity with partial allocations to gender diversity and veteran impact focused funds. With our Climate Impact portfolio, we sharpen the focus on controlling carbon emissions and fostering green solutions. 3. Most available SRI-oriented ETFs present liquidity limitations. While SRI-oriented ETFs have relatively low expense ratios compared to SRI mutual funds, our analysis revealed insufficient liquidity in many ETFs currently on the market. Without sufficient liquidity, every execution becomes more expensive, creating a drag on returns. Median daily dollar volume is one way of estimating liquidity. Higher volume on a given asset means that you can quickly buy (or sell) more of that asset in the market without driving the price up (or down). The degree to which you can drive the price up or down with your buying or selling must be treated as a cost that can drag down on your returns. To that end, Betterment reassesses the funds available for inclusion in these portfolios regularly. In balancing cost and value for the portfolios, the options are limited to funds of certain asset classes such as US stocks, Developed Market stocks, Emerging Market stocks, US Investment Grade Corporate Bonds, US High Quality bonds, and US Mortgage-Backed Securities. How is Betterment’s Broad Impact portfolio constructed? Betterment’s Broad Impact portfolio invests assets in socially responsible ETFs to obtain exposure to both the ESG and Shareholder Engagement mandates, as highlighted in the table above. It focuses on ETFs that consider all three ESG pillars, and includes an allocation to an engagement-based SRI ETF. Broad ESG investing solutions are currently the most liquid, highlighting their popularity amongst investors. In order to maintain geographic and asset class diversification and to meet our requirements for lower cost and higher liquidity in all SRI portfolios, we continue to allocate to some funds that do not reflect SRI mandates, particularly in bond asset classes. How is Betterment’s Climate Impact portfolio constructed? Betterment offers a Climate Impact portfolio for investors that want to invest in an SRI strategy more focused on the environmental pillar of “ESG” rather than focusing on all ESG dimensions equally. Betterment’s Climate Impact portfolio invests assets in socially responsible ETFs and is constructed using the following mandates that seek to achieve divestment and engagement: ESG, carbon footprint reduction, fossil fuel divestment, shareholder engagement, and green financing. The Climate Impact portfolio was designed to give investors exposure to climate-conscious investments, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio, as we seek to incorporate broad based climate-focused ETFs with sufficient liquidity relative to their size in the portfolio. How can the Climate Impact portfolio help to positively affect climate change? The Climate Impact portfolio is allocated to iShares MSCI ACWI Low Carbon Target ETF (CRBN), an ETF which seeks to track the global stock market, but with a bias towards companies with a lower carbon footprint. By investing in CRBN, investors are actively supporting companies with a lower carbon footprint, because CRBN overweights these stocks relative to their high-carbon emitting peers. One way we can measure the carbon impact a fund has is by looking at its weighted average carbon intensity, which measures the weighted average of tons of CO2 emissions per million dollars in sales, based on the fund's underlying holdings. Based on weighted average carbon intensity data from MSCI, Betterment’s 100% stock Climate Impact portfolio has carbon emissions per unit sales that are more than 47% lower than Betterment’s 100% stock Core portfolio as of March 12, 2025. Additionally, a portion of the Climate Impact portfolio is allocated to fossil fuel reserve funds. Rather than ranking and weighting funds based on a certain climate metric like CRBN, fossil fuel reserve free funds instead exclude companies that own fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in fossil fuel reserve free funds, investors are actively divesting from companies with some of the most negative impact on climate change, including oil producers, refineries, and coal miners such as Chevron, ExxonMobile, BP, and Peabody Energy. Another way that the Climate Impact portfolio promotes a positive environmental impact is by investing in bonds that fund green projects. The Climate Impact portfolio invests in iShares Global Green Bond ETF (BGRN), which tracks the global market of investment-grade bonds linked to environmentally beneficial projects, as determined by MSCI. These bonds are called “green bonds.” The green bonds held by BGRN fund projects in a number of environmental categories defined by MSCI including alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation. How is Betterment’s Social Impact portfolio constructed? Betterment offers a Social Impact portfolio for investors that want to invest in a strategy more focused on the social pillar of ESG investing (the S in ESG). Betterment’s Social Impact portfolio invests assets in socially responsible ETFs and is constructed using the following mandates: ESG, gender equity, social equity, and shareholder engagement. The Social Impact portfolio was designed to give investors exposure to investments which promote social empowerment without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio discussed above, as we seek to incorporate broad based ETFs that focus on social empowerment with sufficient liquidity relative to their size in the portfolio. How does the Social Impact portfolio help promote social empowerment? The Social Impact portfolio shares many of the same holdings as Betterment’s Broad Impact portfolio. The Social Impact portfolio additionally looks to further promote the “social” pillar of ESG investing by allocating to the following ETFs: SPDR SSGA Gender Diversity Index ETF (SHE) Academy Veteran Impact ETF(VETZ) Goldman Sachs JUST U.S. Large Cap Equity ETF (JUST) SHE is a US Stock ETF that allows investors to invest in more female-led companies compared to the broader market. In order to achieve this objective, companies are ranked within each sector according to their ratio of women in senior leadership positions. Only companies that rank highly within each sector are eligible for inclusion in the fund. By investing in SHE, investors are allocating more of their money to companies that have demonstrated greater gender diversity within senior leadership than other firms in their sector. VETZ, the Academy Veteran Impact ETF, is a US Bond ETF and is the first publicly traded ETF to primarily invest in loans to U.S. service members, military veterans, their survivors, and veteran-owned businesses. A majority of the underlying assets consist of loans to veterans or their families. The fund primarily invests in Mortgage-Backed Securities that are guaranteed by government-sponsored enterprises, such as Ginnie Mae, Fannie Mae, and Freddie Mac. The fund also invests in pools of small business loans backed by the Small Business Administration (SBA). JUST, Goldman Sachs JUST U.S. Large Cap Equity ETF, invests in U.S. companies promoting positive change on key social issues, such as worker wellbeing, customer privacy, environmental impact, and community strength, based on the values of the American public as identified by JUST Capital’s polling. Investment in socially responsible ETFs varies by portfolio allocation; not all allocations include the specific ETFs listed above. For more information about these social impact ETFs, including any associated risks, please see our disclosures. Should we expect any difference in an SRI portfolio’s performance? One might expect that a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio. The notion behind this reasoning is that somehow there is a premium to be paid for investing based on your social ideals and values. A white paper written in partnership between Rockefeller Asset Management and NYU Stern Center for Sustainable Business studied 1,000+ research papers published from 2015 to 2020 analyzing the relationship between ESG investing and performance. The primary takeaway from this research was that they found “positive correlations between ESG performance and operational efficiencies, stock performance, and lower cost of capital.” When ESG factors were considered in the study, there seemed to be improved performance potential over longer time periods and potential to also provide downside protection during periods of crisis. It’s important to note that performance in the SRI portfolios can be impacted by several variables, and is not guaranteed to align with the results of this study. Dividend Yields Could Be Lower Using the SRI Broad Impact portfolio for reference, dividend yields over a one-year period ending March 31, 2025 indicate that SRI income returns at certain risk levels have been lower than those of the Core portfolio. Oil and gas companies like BP, Chevron, and Exxon, for example, currently have relatively high dividend yields, and excluding them from a given portfolio can cause its income return to be lower. Of course, future dividend yields are uncertain variables and past data may not provide accurate forecasts. Nevertheless, lower dividend yields can be a factor in driving total returns for SRI portfolios to be lower than those of Core portfolios. Comparison of Dividend Yields Source: Bloomberg, Calculations by Betterment for one year period ending March 31, 2025. Dividend yields for each portfolio are calculated using the dividend yields of the primary ETFs used for taxable allocations of Betterment’s portfolios as of March 2025. Conclusion Despite the various limitations that all SRI implementations face today, Betterment will continue to support its customers in further aligning their values to their investments. Betterment may add additional socially responsible funds to the SRI portfolios and replace other ETFs as the investing landscape continues to evolve. -
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ETF selection methodology
ETF selection methodology Mar 20, 2025 8:00:00 AM When constructing a portfolio, Betterment focuses on exchange-traded funds (“ETFs”) with generally low costs and high liquidity. In the following piece, we detail Betterment’s investment selection methodology, including: Why ETFs Cost of Ownership (CO) Mitigating market impact Actively-managed investments Conclusion 1. Why ETFs? When constructing a portfolio, Betterment focuses on exchange-traded funds (“ETFs”) with generally low costs and high liquidity. An ETF is essentially a basket which contains underlying securities, such as stocks and bonds, and generally come in two different flavors: passive (or index tracking) and active. By design, passive index ETFs closely track their benchmarks—such as the S&P 500. On the other hand, active ETFs represent a group of hand-selected securities decided upon by a portfolio manager with the intention of beating a benchmark. Additionally, ETFs have certain structural advantages when compared to mutual funds. These include: A. Clear goals and mandates Betterment generally selects ETFs that have mandates to passively track broad-market benchmark indexes. A passive mandate explicitly restricts the fund administrator to the singular goal of replicating a benchmark rather than making active investment decisions in an effort to beat the fund’s underlying benchmark. We largely favor such transparency and lower idiosyncratic market risk, yet some asset classes may benefit from fundamental research-driven security selection, and in some instances, Betterment employs the use of active ETFs managed by experienced external portfolio management teams (more on that below). B. Intraday availability ETFs are transactable during all open market hours just like any other stock. As such, they are heavily traded by the full spectrum of equity market participants including market makers, short-term traders, buy-and-hold investors, and fund administrators themselves creating and redeeming units as needed (or increasing or decreasing the supply of ETFs based on market demand). This diverse trading activity leads to most ETFs carrying low liquidity premiums (or lower costs to transact due to competition from readily available market participants pushing prices downward) and equity-like transaction times irrespective of the underlying holdings of each fund. This generally makes ETFs fairly liquid, which makes them cheaper and easier to trade on-demand for activities like creating a new portfolio or rebalancing an existing one. C. Low-fee structures Because most benchmarks update constituents (i.e., the specific stocks and related weights that make up a broad-market index) fairly infrequently, passive index-tracking ETFs also register lower annual turnover (or the rate a fund tends to transact its holdings) and thus fewer associated costs are passed through to investors. In addition, ETFs are generally managed by their administrators as a single share class that holds all assets as a single entity. This structure naturally lends itself as a defense against administrators practicing fee discrimination across the spectrum of available investors. With only one share class, ETFs are investor-type agnostic. The result is that ETF administrators provide the same exposures and low fees to the entire spectrum of potential buyers. Where actively-managed ETFs are utilized in Betterment portfolios, fees and expenses remain a critical aspect of our decision making.Our selection process will favor active over passive when we strongly believe the value added by an active manager outweighs its likely higher expense ratio.. D. Tax efficiency In the case when a fund (irrespective of its specific structure) sells holdings that have experienced capital appreciation, the capital gains generated from those sales must, by law, be accrued and distributed to shareholders by year-end in the form of distributions. These distributions increase tax liabilities for all of the fund’s shareholders. With respect to these distributions, ETFs offer a significant tax advantage for shareholders over mutual funds. Because mutual funds are not exchange traded, the only available counterparty available for a buyer or seller is the fund administrator. When a shareholder in a mutual fund wishes to liquidate their holdings in the fund, the fund’s administrator must sell securities in order to generate the cash required to satisfy the redemption request. These redemption-driven sales generate capital gains that lead to distributions for not just the redeeming investor, but all shareholders in the fund. Mutual funds thus effectively socialize the fund’s tax liability to all shareholders, leading to passive, long-term investors having to help pay a tax bill for all intermediate (and potentially short-term) shareholder transactions. Because ETFs are exchange-traded, the entire market serves as potential counterparties to a buyer or seller. When a shareholder in an ETF wishes to liquidate their holdings in the fund, they simply sell their shares to another investor just like that of a single company’s equity shares. The resulting transaction would only generate a capital gain or loss for the seller and not all investors in the fund. In addition, ETFs enjoy a slight advantage when it comes to taxation on dividends paid out to investors. After the passing of the Jobs and Growth Tax Relief Reconciliation Act of 2003, certain qualified dividend payments from corporations to investors are only subject to the lower long-term capital gains tax rather than standard income tax (which is still in force for ordinary, non-qualified dividends). Qualified dividends have to be paid by a domestic corporation (or foreign corporation listed on a domestic stock exchange) and must be held by both the investor and the fund for 61 of the 120 days surrounding the dividend payout date. As a result of active mutual funds’ higher turnover, a higher percentage of dividends paid out to their investors violate the holding period requirement and increase investor tax profiles. E. Investment flexibility The maturation and growth of the global ETF market over the past few decades has led to the development of an immense spectrum of products covering different asset classes, markets, styles, and geographies. The result is a robust market of potential portfolio components which are versatile, extremely liquid, and easily substitutable. Despite all the advantages of ETFs, it is still important to note that not all ETFs are exactly alike or equally beneficial to an investor. Betterment’s investment selection process seeks to select ETFs that provide exposure to the desired asset classes. For certain asset classes where markets are more efficient, we seek to achieve these asset class exposures through passively managed ETFs due to its cost-effectiveness. Alternatively, where Betterment utilizes active management, we conduct rigorous analysis and due diligence to best understand the trade-off of benchmark deviation for potential performance benefit. The cornerstone of Betterment’s approach to investment selection is our “Cost of Ownership” or CO, allowing us to effectively rank and select ETFs based upon their fees to hold and cost to trade. 2. Cost of Ownership (CO) The Cost of Ownership (“CO”) is Betterment’s fund scoring method, used to rate funds for inclusion in the Betterment portfolio. CO takes into account an ETF’s transactional costs as well as costs associated with holding funds. In addition to CO, Betterment also considers certain other qualitative factors of ETFs, particularly when Betterment considers the use of actively-managed funds. Qualitative factors may include, but are not limited to whether the ETF fulfills a desired portfolio mandate and/or exposure and due diligence interviews with portfolio management teams. CO is determined by two components, a fund’s cost-to-trade and cost-to-hold. The first, cost-to-trade, represents the cost associated with trading in and out of funds during the course of regular investing activities, such as rebalancing, cash inflows or withdrawals, and tax loss harvesting. Betterment defines the the cost-to-trade as the bid-ask spread, or the difference between the price at which you can buy a security and the price at which you can sell the same security at any given time. The second component, cost-to-hold, is represented by the ETF’s expense ratio, or the fund expenses imposed by an ETF administrator. Let’s review the specific inputs to each component in more detail: Cost-to-Trade: Bid-Ask spread Bid-Ask spread: Generally market transactions are associated with two prices: the price at which people are willing to sell a security, and the price others are willing to pay to buy it. The difference between these two numbers is known as the bid-ask spread, and can be expressed in currency or percentage terms. For example, a trader may be happy to sell a share at $100.02, but only wishes to buy it at $99.98. The bid-ask currency spread here is $.04, which coincidentally also represents a bid-ask percentage of 0.04%. In this example, if you were to buy a share, and immediately sell it, you’d end up with 0.04% less due to the spread. This is how traders and market makers make money—by providing liquid access to markets for small margins. Generally, heavily-traded securities with more competitive counterparties willing to transact will carry lower bid-ask spreads. Unlike the expense ratio, the degree to which you care about bid-ask spread likely depends on how actively you trade. Buy-and-hold investors typically care about it less compared to active traders, because they will accrue significantly fewer transactions over their intended investment horizons. Minimizing these costs is beneficial to building an efficient portfolio which is why Betterment attempts to select ETFs with narrower bid-ask spreads. Cost-to-Hold: Expense ratio Expense ratio: An expense ratio is the set percentage of the price of a single share paid by shareholders to the fund administrators every year. ETFs often collect these fees from the dividends passed through from the underlying assets to holders of the security, which result in lower total returns to shareholders. Finding cost of ownership We calculate CO as the sum of the above components: CO = "Cost-to-Trade" + "Cost-to-Hold" Where Cost-to-trade = 0.5 * bid-ask spread As mentioned above, cost-to-trade estimates the costs associated with buying and selling funds in the open market. This amount is weighted to appropriately represent the aggregate investing activities of the average Betterment client in terms of cash flows, rebalances, and tax loss harvests. Additionally, we utilize ½ of the bid-ask spread in our calculations as this mid-point is generally what customers realize in terms of trade costs. The cost-to-hold represents our expectations of the annual costs an investor will incur from owning a fund as defined by the fund’s expense ratio In many cases, cost-to-hold, which includes an ETF’s expense ratio, will be the dominant factor in the total cost calculations. Of course, one can’t hold a security without first purchasing it, so we must also account for transaction costs, which we accomplish with our cost-to-trade component. 3. Minimizing market impact Market impact, or the change in price caused by an investor buying or selling a fund, is incorporated into Betterment’s total cost number through the cost-to-trade component. This is specifically through the interaction of bid-ask spreads. However, we do review and monitor other trading-related metrics not represented specifically in the CO calculation when evaluating our universe of investable funds. Additional metrics include whether the ETF has relatively high levels of existing assets under management and average daily traded volumes. This helps to ensure that Betterment’s trading activity and holdings will not dominate the security’s natural market efficiency, which could either drive the price of the ETF up or down when trading. ETFs without an appropriate level of assets or daily trade volume might lead to a situation where Betterment’s activity on behalf of clients moves the existing market for the security. In an attempt to avoid potentially negative effects upon our investors, we generally do not consider ETFs with smaller asset bases and limited trading activity unless some other extenuating factor is present. 4. Actively-managed investments Compared to passive investments which track a broad-market index, actively-managed ones seek to outperform their benchmark index by selecting and weighting securities based on a fundamental company research or market outlook. Betterment believes that certain markets may favor active management, and therefore, are less efficient than others, resulting in an opportunity where value may be added through actively-managed investments Given this, Betterment believes that a rigorous due diligence process can help identify favorable active managers who have developed a time-tested research-driven investment process. Additionally, while active management may have the potential to add return potential, Betterment continues to hold true to its Core portfolio construction philosophy, prioritizing cost-efficiency. This results in the continued evaluation of any actively-managed investment strategies we utilize with their ability to beat the benchmark vs. their, typically, higher expense ratio. Conclusion As with any investment, ETFs are subject to market risk, including the possible loss of principal. The value of any portfolio will fluctuate with the value of the underlying securities. ETFs may trade for less than their net asset value (NAV). There is always a risk that an ETF will not meet its stated objective on any given trading day. Betterment reviews its investment selection analysis on a periodic basis to assess: the validity of existing selections, potential changes by fund administrators (raising or lowering expense ratios), and changes in specific ETF market factors,including tighter bid-ask spreads). Additionally, Betterment undertakes qualitative due diligence to enhance our selection process for actively-managed investments. Finally, at the core of our portfolio construction process, we are constantly considering the tax implications of portfolio selection changes and estimates the net benefit of transitioning between investment vehicles for our clients. -
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Meet the Innovative Technology Portfolio
Meet the Innovative Technology Portfolio Mar 10, 2025 8:00:00 AM If you believe in the power of tech to blaze new trails, you can now tailor your investing to track the companies leading the way. The most valuable companies of today aren’t the same bunch as 20 years ago. With each generation comes new challengers and new categories (Hello, Big Tech). And while we can’t really predict the next class of top performers, innovation will likely come from parts of the economy that use technology in new and exciting applications, industries like: artificial intelligence alternative finance clean energy manufacturing biotechnology This dynamic led us to create the Innovative Technology portfolio. What is the Innovative Technology portfolio? The portfolio increases your exposure to companies pioneering the technology mentioned above and more. These innovations carry the potential to reshape the way we work and play, and in the process shape the market’s next generation of high-performing companies. Using the Core portfolio as its foundation, the Innovative Technology portfolio is built to generate long-term returns with a diversified, low-cost approach, but with increased risk. It contains many of the same investments as Core, but also includes an allocation to the SPDR S&P Kensho New Economies Composite ETF (Ticker: KOMP) and AB Disruptors ETF (Ticker: FWD). The iShares Exponential Technologies ETF (Ticker: XT) and Invesco NASDAQ 100 ETF (Ticker: QQQM) are used as secondaries for the purposes of Tax Loss Harvesting+ (“TLH”). For a more in-depth look at the portfolio’s construction, skip over to its methodology. How are pioneering companies selected? The ETFs that Betterment utilizes to gain exposure to the innovation theme take their own unique approach to security selection. For KOMP, the Kensho index that it tracks uses a special branch of artificial intelligence called “natural language processing” to screen regulatory data and identify companies helping drive the Fourth Industrial Revolution. After picking companies across more than 20 categories, each is combined into the overall index and weighted according to their risk and return profiles. On the other hand, FWD is an actively-managed ETF by AllianceBernstein which also utilizes natural language processing but additionally incorporates both top-down thematic research and bottom-up fundamental equity research to create a portfolio of global companies that are aligned with the fund’s themes of cloud infrastructure & AI, digital transactions & media, energy transition, industrial innovation, and medical innovation. Why might you choose this portfolio over Betterment’s Core portfolio? We built the Innovative Technology portfolio to have similar foundations as then equivalent stock/bond allocation of the Core portfolio. It may, however, outperform or underperform depending on the return experience of the companies invested in by KOMP and FWD. So, if you believe the emerging tech of today will drive the returns of tomorrow—and are willing to take on some additional risk to take that long-term view— this is a portfolio made with you in mind. Risk and early adoption can tend to go hand-in-hand, after all. Why invest in innovation with Betterment? Innovative technology is in our DNA. We may be the largest independent digital financial advisor now, but the “robo advisor” category barely existed when we opened shop in 2008. If you choose to invest in the Innovative Technology portfolio with Betterment, you not only get our professional, tech-forward, portfolio management tools, you also get an investment manager with first-hand experience in the field of first movers. -
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See what's in store for our annual portfolio updates
See what's in store for our annual portfolio updates Jan 31, 2025 10:00:00 AM Tweaks to Core, Value Tilt, SRI, and Innovative Tech are coming soon. When you pay someone to manage your investing, it's good to know exactly what you're paying for. In one sense, you’re paying for how your shares are bought, sold, and held. Our sophisticated spins on strategies like asset location, for example, can help minimize your taxes and maximize your returns. Then there's the collections of investments themselves, and making sure these portfolios keep up with market conditions. We do this in part by regularly adjusting our portfolios' asset allocations, or the specific weights of asset classes (i.e., stocks and bonds) and subasset classes (large cap stocks, long-term bonds, etc.). Let's quickly walk through our approach to portfolio management, or feel free to skip ahead to preview the upcoming changes. How we evaluate and manage our portfolios It all starts with sizing up asset classes. We run a rigorous, data-driven process to form long-term expectations for both the returns and the risk levels of various classes. From there, we simulate thousands of paths for the market, and average the optimal asset allocations to build more robust portfolio weights. This “Monte Carlo” technique is ideal when random variables are everywhere, such as capital markets. Lastly, it’s important to reiterate that while things like interest rate shifts and federal fiscal policy can drive short-term market volatility, we manage our portfolios based on long-term outlooks. We keep an eye on the short-term, but we don’t chase trends. This year's updates, in a nutshell For starters, we're updating a handful of portfolios, ones we build and manage ourselves. We offer a few others managed by partners like Goldman Sachs and BlackRock—you can check out those allocations in the Betterment app or on our website. This year’s updates, which are much smaller in scope and scale than last year’s, will encompass these portfolios: Core Value Tilt All three Socially Responsible Investing portfolios Innovative Technology Select Betterment Premium-exclusive portfolios Here's what's changing. More U.S. exposure While we don't advise going all-in on American markets, the forecasted risk-adjusted return for the U.S. remains strong in the long run (think: decades) relative to international markets. So similar to last year’s portfolio updates, we’re dialing down the international exposure for most portfolios. Those portfolios will see: Small increases in U.S. stock and bond allocations Small decreases in international emerging market stocks and bonds Small decreases in international developed market bonds More short-term corporate bonds The biggest change this year will be felt by portfolios with larger bond allocations. We expect U.S. short-term, high-quality corporate bonds to offer higher yields without undue increases in long-term risk, so we’re increasing the exposure to them while decreasing the weight of short-term U.S. Treasuries. The yields on these types of treasury bonds, which mature in a year or less, tend to fall right along with interest rates, and a lower interest rate environment is still expected in the long run. New innovation ETF Separately, we’re diversifying the Innovative Technology portfolio by adding a new actively-managed fund. This new ETF builds on themes like AI and biotech while adding more exposure to large-cap stocks and the Information Technology sector (hardware, software, etc.) as a whole. Sit back and enjoy the switch The great thing about technology like ours is that it makes implementing updated portfolios simple. Our automated rebalancing will tax-efficiently transition customers’ portfolios to the new target weights over time. It’s yet another example of how we make it easy to be invested. -
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The Goldman Sachs Smart Beta portfolio methodology
The Goldman Sachs Smart Beta portfolio methodology Nov 7, 2024 6:00:00 AM The Goldman Sachs Smart Beta portfolio is meant for investors who seek to outperform a market-cap portfolio strategy in the long term, despite periods of underperformance. Our Smart Beta portfolio sourced from Goldman Sachs Asset Management helps meet the preference of our customers who are willing to take on additional risks to potentially outperform a market capitalization strategy. The Goldman Sachs Smart Beta portfolio strategy reflects the same underlying principles that have always guided the core Betterment portfolio strategy—investing in a globally diversified portfolio of stocks and bonds. The difference is that the Goldman Sachs Smart Beta portfolio strategy seeks higher returns by moving away from market capitalization weightings in and across equity asset classes. What is a smart beta portfolio strategy? Portfolio strategies are often described as either passive or active. Most index funds and exchange-traded funds (ETFs) are categorized as “passive” because they track the returns of the underlying market based on asset class. By contrast, many mutual funds or hedge fund strategies are considered “active” because an advisor or fund manager is actively buying and selling specific securities to attempt to beat their benchmark index. The result is a dichotomy in which a portfolio gets labeled as passive or active, and investors infer possible performance and risk based on that label. In reality, portfolio strategies reside within a plane where passive and active are just two cardinal directions. Smart beta funds, like the ones that were selected for this portfolio, seek to achieve their performance by falling somewhere in between extreme passive and active, using a set of characteristics, called “factors,” with an objective of outperformance while managing risk. The portfolio strategy also incorporates other passive funds to achieve appropriate diversification. This alternative approach is also the reason for the name “smart beta.” An analyst comparing conventional portfolio strategies usually operates by assessing beta, which measures the sensitivity of the security to the overall market. In developing a smart beta approach, the performance of the overall market is seen as just one of many factors that affects returns. By identifying a range of factors that may drive return potential, we seek the potential to outperform the market in the long term while managing reasonable risk. When we develop and select new portfolio strategies at Betterment, we operate using five core principles of investing: Personalized planning A balance of cost and value Diversification Tax optimization Behavioral discipline The Goldman Sachs Smart Beta portfolio strategy aligns with all five of these principles, but the strategy configures cost, value, and diversification in a different way than Betterment’s Core portfolio. In order to pursue higher overall return potential, the smart beta strategy adds additional systematic risk factors that are summarized in the next section. Additionally, the strategy seeks to achieve global diversification across stocks and bonds while overweighting specific exposures to securities which may not be included in Betterment’s Core portfolio. Meanwhile, with the smart beta portfolio, we’re able to continue delivering all of Betterment’s tax-efficiency features, such as tax loss harvesting and Tax Coordination. Investing in smart beta strategies has traditionally been more expensive than a pure market cap-weighted portfolio. While the Goldman Sachs Smart Beta portfolio strategy has a far lower cost than the industry average, it is slightly more expensive than the core Betterment portfolio strategy. Because a smart beta portfolio incorporates the use of additional systematic risk factors, we typically only recommend this portfolio for investors who have a high risk tolerance and plan to save for the long term. Which “factors” drive the Goldman Sachs Smart Beta portfolio strategy? Factors are the variables that drive performance and risk in a smart beta portfolio strategy. If you think of risk as the currency you spend to achieve potential returns, factors are what determine the underlying value of that currency. We can dissect a portfolio’s return into a linear combination of factors. In academic literature and practitioner research (Research Affiliates, AQR), factors have been shown to drive historical returns. These analyses form the backbone of our advice for using the smart beta portfolio strategy. Factors reflect economically intuitive reasons and behavioral biases of investors in aggregate, all of which have been well studied in academic literature. Most of the equity ETFs used in this portfolio are Goldman Sachs ActiveBetaTM, which are Goldman Sach’s factor-based smart beta equity funds. Stocks are scored according to four factors where the highest scoring companies have greater weighting. The weights are then constrained to be in-line with the market. These factors include: Good Value When a company has solid earnings (after-tax net income), but has a relatively low price (i.e., there’s a relatively low demand by the universe of investors), its stock is considered to have good value. Allocating to stocks based on this factor gives investors exposure to companies that have high growth potential but have been overlooked by other investors. High Quality High-quality companies demonstrate sustainable profitability over time. By investing based on this factor, the portfolio includes exposure to companies with strong fundamentals (e.g., strong and stable revenue and earnings) and potential for consistent returns. Low Volatility Stocks with low volatility tend to avoid extreme swings up or down in price. What may seem counterintuitive is that these stocks also tend to have higher returns than high volatility stocks. This is recognized as a persistent anomaly among academic researchers because the higher the volatility of the asset, the higher its return should be (according to standard financial theory). Low-volatility stocks are often overlooked by investors, as they usually don’t increase in value substantially when the overall market is trending higher. In contrast, investors seem to have a systematic preference for high-volatility stocks based on the data and, as a result, the demand increases these stocks’ prices and therefore reduces their future returns. Strong Momentum Stocks with strong momentum have recently been trending strongly upward in price. It is well documented that stocks tend to trend for some time, and investing in these types of stocks allows you to take advantage of these trends. It’s important to define the momentum factor with precision since securities can also exhibit reversion to the mean—meaning that “what goes up must come down.” How can these factors lead to future outperformance? In specific terms, the factors that drive the smart beta portfolio strategy—while having varying performance year-to-year relative to their market cap benchmark—have potential to outperform their respective benchmarks when combined. You can see an example of this in the chart of yearly factor returns for US large cap stocks below. You’ll see that the ranking of the four factor indexes varies over time, rotating outperformance over the S&P 500 Index in nearly all of the years. Performance Ranking of Smart Beta Indices vs. S&P 500 Why invest in a smart beta portfolio? As we’ve explained above, we generally only advise using Betterment’s choice smart beta strategy if you’re looking for a more tactical strategy that seeks to outperform a market-cap portfolio strategy in the long term despite potential periods of underperformance. For investors who fall into such a scenario, our analysis, supported by academic and practitioner literature, shows that the four factors above may provide higher return potential than a portfolio that uses market weighting as its only factor. While each factor weighted in the smart beta portfolio strategy has specific associated risks, some of these risks have low or negative correlation, which allow for the portfolio design to offset constituent risks and control the overall portfolio risk. Of course, these risks and correlations are based on historical analysis, and no advisor could guarantee their outlook for the future. An investor who elects the Goldman Sachs Smart Beta portfolio strategy should understand that the potential losses of this strategy can be greater than those of market benchmarks. In the year of the dot-com collapse of 2000, for example, when the S&P 500 dropped by 10%, the S&P 500 Momentum Index lost 21%. Given the systematic risks involved, we believe the evidence that shows that smart beta factors may lead to higher expected return potential relative to market cap benchmarks, and thus, we are proud to offer the portfolio for customers with long investing horizons.
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