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What is Dollar-Cost Averaging?
Although it’s not always the most optimal investment strategy, choosing to dollar-cost average into the market has behavioral and psychological ...What is Dollar-Cost Averaging? Although it’s not always the most optimal investment strategy, choosing to dollar-cost average into the market has behavioral and psychological benefits that may help you over the long run. Dollar-cost averaging (DCA) is the practice of regularly investing a fixed amount of money over a period of time, regardless of market activity. For example, if you choose to invest $100 on the 15th of the month, every month for 1 year, you would be implementing the investment strategy of dollar-cost averaging. You don’t vary the dollar amount you choose to invest ($100), or the timing of the investment (on the 15th of each month), based on market activity. Types of Dollar-Cost Averaging There are two types of dollar-cost averaging: voluntary and involuntary. Voluntary DCA is when you have a specific amount of cash to invest, but are choosing to parcel it out over a period of time, rather than investing it all at once. Involuntary DCA is when your ability to invest depends on when you have the money to do so. Perhaps you set up auto-deposits, so that you can invest as you earn more money over time with each paycheck. The major difference between these two types of DCA is that involuntary DCA implies that you could not have invested sooner, while voluntary DCA is an investment strategy where you could have, but chose not to. Real Life Example Let’s pretend you have $1,200 sitting in cash that you can invest right now. You choose to invest that $1,200 by investing $100 per month for a period of one year. This would be an example of voluntary DCA. Now, let’s pretend you don’t have any money to invest right now, but through your paychecks you earn $100 per month that you could invest. You invest $100 per month for a period of one year. This is an example of involuntary DCA. Should You Dollar-Cost Average? This question really only applies to voluntary DCA and not involuntary DCA. If you don’t have any money sitting around to invest, then you’ll need to wait until you have the money to invest. For involuntary DCA, the choice becomes whether to invest that money as soon as you earn it, or to let that money build up over time so that you can invest the entire balance. An optimal strategy for involuntary DCA is to schedule auto-deposits as soon as you get paid. If you do have money sitting around to invest, the question then becomes, should you invest it all right away, or should you DCA it into the market over time? There are a couple of answers to this question. The Head vs The Heart The expected total return of markets is positive over time. Therefore, from a purely unemotional investment strategy perspective, it makes sense to invest your cash immediately and not DCA into the market. Studies show that a lump-sum investment will outperform DCA roughly two-thirds of the time and will consistently outperform DCA across global markets. Yet, we all know that leading with the head is easier said than done. Luckily, following one's heart can come with its own set of benefits. Since DCA is a fixed rule, independent of market performance, it is unemotional, diversifies your purchase price, and makes you less susceptible to the counterproductive behaviors people often have when investing. More specifically, DCA can make you less susceptible to the disposition effect, which is the tendency to sell assets that have increased in value, while keeping assets that have dropped in value. People significantly dislike losing more than they like winning, which is more formally known as loss aversion. This goes hand in hand with helping to reduce your susceptibility to anchoring bias, which is when you attach yourself to an irrelevant stock price and begin making investment decisions based on that irrelevant stock price at a later date. Additionally, DCA can prevent you from trying to time the market—which is generally a losing investment strategy over the long run. It also minimizes your chances of feeling regret and may reduce any potential anxiety that you “bought in at the top.” Maybe most important of all, DCA can help you establish good investment habits. After all, choosing to DCA into the market is better than never investing your cash at all. Make A Decision To recap, if you have a pile of cash sitting around to invest, studies show that investing it all right away is the optimal decision the majority of the time. However, choosing to voluntarily DCA into the market has many behavioral and psychological benefits that can have a positive impact on your investing behavior. The most important thing is picking your approach and getting started. It’s better than doing nothing and leaving your cash out of the market completely.
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How to Save with BettermentHow to Save with Betterment Believe it or not, there is an art to saving money. Here are Betterment’s tips on how you can save effectively for your financial goals. Believe it or not, there’s an art to saving money. It’s not a static process with rigid guidelines. How much you need to save and how you do it changes with your circumstances. You react and adjust to life. But with the right techniques and tools, you can be equipped to make the choices that are best for you, whatever your situation. Here are some tips on how to effectively save for your financial goals with Betterment. In this guide, we’ll: Help you determine how much to save Walk you through the strategy behind making deposits Explain how Betterment is built to optimize your account Talk about how you can adapt to market conditions How Betterment determines how much you need to save Tell us the goal you want to reach, your target amount, and the date you want to reach it by (your time horizon), and we’ll show you how much we recommend saving each month to help get you there. That number acts as a starting point, but it’s flexible. We’ll provide you with a goal projection and forecaster to reflect the likelihood of hitting your goal, but we can’t predict the future. But that doesn’t mean you need to constantly change the amount you save. Instead, we recommend a simple strategy called a “savings ratchet.” A savings ratchet means you increase how much you save when you have to, but you don’t decrease it afterward. By ratcheting your savings rates, you may end up with greater final portfolio values. How to choose the right deposit strategy for your goals It may not seem like a big deal, but how and when you make deposits can affect your outcome and your experience. So it’s worth considering the options and their implications. Deposit types There’s more than one way to make a deposit in Betterment. Here’s what you can do: One-time deposits are exactly what they sound like. Choose the amount to transfer and where you want it to go, and the transfer happens once. This works well when you have extra cash to invest, but it isn’t ideal as a long-term strategy. Just imagine how much time you’d spend logging in and manually making transfers over the years! Recurring deposits eliminate the manual process. You set it up once, and we’ll automatically transfer the set amount from your bank account on the frequency of your choice: weekly, every other week, monthly, or on two set dates per month. Recurring deposits are a great option if you know how much you want to deposit on an ongoing basis. We’ll send a confirmation email before a scheduled recurring deposit, giving you a chance to skip the auto-deposit if needed. Deposit timing Setting up your deposits to occur the day after each paycheck is an effective auto-deposit strategy. The extra day gives your paycheck time to settle in your bank account before we start the transfer, but you’ll usually want that transfer to happen as quickly as possible. There are three main reasons for this: Paying yourself first. Scheduling your auto-deposits for right after you get paid lets you separate your paycheck into two categories: savings and spending. From a behavioral standpoint, this protects you from yourself. Your paycheck goes toward your financial goals first, and you’re free to use any remaining cash in your checking account for other spending needs. Avoiding idle cash. When your cash sits in a traditional bank account, it typically earns very little interest at best—often none at all. In times of inflation, which is most of the time, your cash is actually losing value. Letting it sit may also tempt you to try timing the market, holding on to it for even longer because of market activity. Idle cash could cause you to miss out on dividend payments or coupon income events too. Reducing your taxes. Regular and frequent deposits and dividends can help us rebalance your portfolio more tax-efficiently, keeping you at the appropriate risk level without realizing unnecessary capital gains taxes when possible. We use the incoming cash to buy investments in asset classes where you’re underweight, instead of selling investments in asset classes where you’re overweight. Even small amounts allow us to invest your money in fractional shares. To get started with auto-deposits on a web browser, first log in then head to New Transfers and choose the deposit option. Or on the mobile app, log in and choose the Deposit button that will appear at the bottom of the screen. How Betterment helps keep your goals on track Want to stay on track to reach your goals? Then your investments are going to need some maintenance. Betterment uses five strategies aimed to optimize your account and help you reach your goals. We can automatically adjust your allocations Generally speaking, the closer your goal is, the less risk you should take. There’s less time for the market to recover, so a sudden dip could set you back. This is why our auto-adjust feature is so valuable for some goals. Here’s how it works: When setting up a goal, you tell us your time horizon. We recommend an initial risk level. If auto-adjust is eligible and selected, we gradually decrease your risk level as your eligible goal approaches its end date. All investing includes some risk. Auto-adjust can’t entirely eliminate that, but it does help protect your portfolio by gradually shifting away from riskier investments (like stocks) into safer investments (like bonds). We recommended conservative savings amounts Once you’ve set up your goals and provided a target savings amount, we provide a recommended deposit amount and cadence, based on our projections for how the market may perform. To be on the safe side and give you a bit of a buffer, we base this contribution estimate on a below-average market outcome. More specifically, we aim for a 60% likelihood of reaching your goal by the end of the investment term. We help you plan for the worst-case scenario Sometimes you want extra certainty that you’ll reach your goal in time. This might be the case when: The goal’s time horizon is not flexible. The goal is very important to you. You prefer to be conservative with your finances. If any of these apply, you may want to look at our projection graphs to see how very poor markets might affect your goal. Hovering your cursor over the graph shows not just average expected performance, but also how your goal could fare depending on market performance. The very poor market outcome is indicated by the 90% chance of having at least that amount. Many investors want a 90% chance for reaching certain goals. In that case, you may want to consider increasing your savings amount. We send you reminders to update your goals Even when markets behave as expected, changing life circumstances may require you to update your goals. It’s best practice to periodically check in on your goals and see if you need to make adjustments. You should also review your financial profile to ensure your income level, tax bracket, marital status, and address are all correct. We tell you if your goals go off track Betterment makes it easy to see how your goals are doing and whether you should make changes. Based on your goal type, its time horizon and target amount, we can provide guidance on whether your goal is on track. If it’s not, we’ll show you what changes you can make to help fix it. How Betterment’s recommendations change with the market Even with the best strategies in place, sometimes the market just doesn’t perform the way we want it to. So what happens if you’re no longer on track to reach your goal? There’s no magic solution, but Betterment has some recommendations to help your goal get back on track: Delay your goal Some goals have timelines that are more flexible than others. Moving back your timeline can give your portfolio a chance to recover. It also gives you extra time to save more. You can use the Goal Forecaster within your goal to see how big of an impact the delay could have. Downsize your goal If a smaller target amount will still let you accomplish what you need to do, you may not need to change your timeline or take other actions. You can adjust the target amount to see what effect it will have on the timeline and recommended deposits for reaching your goal. This only works if you’re willing to accept a smaller target amount for your goal. Increase your savings amount Putting more toward your goal each month can help you catch up to your original target. You can increase your auto-deposit amount at any time. It’s easier said than done, but temporarily cutting back on discretionary spending may be the key to reaching your goal. For goals like emergency funds, where you don’t want to decrease your target amount and you want to reach it as soon as possible, the short-term sacrifice can be worth the long-term security. Divert money from other goals Transferring money from another account (like a goal that’s ahead of schedule) can help get you back on track. Just be careful you aren’t robbing your future self to fulfill your immediate needs. You can transfer money between non-IRA/non-401(k) investment goals from within your account by performing a goal-to-goal transfer. Just choose the goal you want to move money out of, click on “Transfer or Rollover,” and then click “Transfer to another goal.” You’ll sometimes need a combination of more than one—or even all—of these options. For example, if you can save an extra $100 per paycheck, delay your goal by three months, and also use some money from another goal, that may be your formula to get back on track.
Investing in Your 50s: 4 Practical Tips for Retirement PlanningInvesting in Your 50s: 4 Practical Tips for Retirement Planning In your 50s, assess your retirement plan, lifestyle, earnings, and support for family. Practice goal-based investing to help meet your objectives. As you enter your 50s, you may feel like your long-term goals are coming within reach, and it’s up to you to make sure those objectives are realized. Now is also a perfect time to see how your investments and retirement savings are shaping up. If you’ve cut back on savings to meet big expenses, such as home repairs and (if you have children) college tuition, you now have an opportunity to make up lost ground. You might also think about how you want to live after you retire. Will you relocate? Will you downsize or stay put? If you have children, how much are you willing to support them as they enter adulthood? These decisions all matter when deciding how to strategize your investments for this important decade of your life. Four Goals for Your 50s Your 50s can be a truly productive and efficient time for your investments. Focus on achieving these four key goals to make these years truly count in retirement. Goal 1: Assess Your Retirement Accounts If you’ve put retirement savings on the back burner, or just want to make a push for greater financial security—the good news is that you can make larger contributions toward employer retirement accounts (401(k), 403(b), etc.) at age 50 and over, thanks to the IRS rules on catch-up contributions. If you’re already contributing the maximum to your employer plans and still want to save more for retirement, consider opening a traditional or Roth IRA. These are individual retirement accounts that are subject to their own contribution limits, but also allow for a catch-up contribution at age 50 or older. You may also wish to simplify your investments by consolidating your retirement accounts with IRA rollovers. Doing so can help you get more organized, streamline recordkeeping and make it easier to implement an overall retirement strategy. Plus, by consolidating now, you can help avoid complications after age 72, when you’ll have to make Required Minimum Distributions from all the tax-deferred retirement accounts you own. Goal 2: Evaluate Your Lifestyle and Pre-Retirement Finances When you’re in your 50s, you may still be a ways from retirement, however you’ll want to consider how to support yourself when you do begin that stage of your life. If you’ve just begun calculating how much you’ll need to save for a comfortable retirement, consider the following tips and tools. Tips and Tools for Estimating Income Needs Make a rough estimate of how much you spend on housing, food, utilities, health care, clothing, and incidentals. Nowadays, tools such as Mint® and Prosper include budgeting features that can help you see these expenditures. Subtract what you can expect to receive from Social Security. You can estimate your benefit with this calculator. Subtract any defined pension plan benefits or other sources of income you expect to receive in retirement. Subtract what you can safely withdraw each year from your retirement savings. Consider robust retirement planning tools, which can help you understand how much you’ll need to save for a comfortable retirement based on current and future income from all sources, and even your location. If there’s a gap between your income needs and your anticipated retirement income, you may need to make adjustments in the form of cutting expenses, working more years before retiring, increasing the current amounts you’re investing for retirement, and re-evaluating your investment strategy. Think About Taxes Your income may peak in your 50s, which can also push you into higher tax brackets. This makes tax-saving strategies like these potentially more valuable than ever: Putting more into tax-advantaged investing vehicles like 401(k)s or traditional IRAs. Donating appreciated assets to charities. Implementing tax-efficient investment strategies within your investments, such as tax loss harvesting* and asset location. Betterment automates both of these strategies and offers features to customers with no additional management fee. Define Your Lifestyle Your 50s are a great time to think about your current and desired lifestyle. As you near retirement, you’ll want to continue doing the things you love to do, or perhaps be able to start doing more and build on those passions. Perhaps you know you’ll be traveling more frequently. If you are socially active and enjoy entertainment activities such as dining out and going to the theater, those interests likely won’t change. Instead, you’ll want to enjoy doing all the things you love to do, but with the peace of mind knowing that you won’t be infringing on your retirement reserves. Say you want to start a new business when you leave your job. You’re not alone; more than a third of new entrepreneurs starting businesses in 2021 were between the ages of 55 and 64 according to research by the Kauffman Foundation. To get ready, you’ll want to start building or leveraging your contacts, creating a business plan, and setting up a workspace. You may also wish to consider relocating during retirement. Living in a warmer part of the country or moving closer to family is certainly appealing. Downsizing to a smaller home or even an apartment could cut down on utilities, property taxes, and maintenance. You might need one car instead of two—or none at all—if you relocate to a neighborhood surrounded by amenities within walking distance. If you sell your primary home, you can take advantage of a break on capital gains —even if you don’t use the money to buy another one. If you’ve lived in the same house for at least two out of the last five years, you can exclude capital gains of up to $250,000 per individual and $500,000 per married couple from your income taxes, according to the IRS. Goal 3: Chart Your Pre-Retirement Investment Strategy After you’ve determined how much you’ll need for a comfortable retirement, now’s also a good time to begin thinking about how you’ll use the assets you’ve accumulated to generate income after you retire. If you have shorter-term financial objectives over the next two to five years—such as paying for your kids’ college tuition, or a major home repair—you’ll have to plan accordingly. For these milestones, consider goal-based investing, where each goal will have different exposure to market risk depending on the time allocated for reaching that goal. Goal-based investing matches your time horizon to your asset allocation, which means you take on an appropriate amount of risk for your respective goals. Investments for short-term goals may be better allocated to less volatile assets such as bonds, while longer-term goals have the ability to absorb greater risks but also achieve greater returns. When you misallocate, it can lead to saving too much or too little, missing out on returns with too conservative an allocation, or missing your goal if you take on too much risk. Setting long investment goals shouldn’t be taken lightly. This is a moment of self-evaluation. In order to invest for the future, you must cut back on spending your wealth now. That means tomorrow’s goals in retirement must outweigh the pleasures of today’s spending. If you’re a Betterment customer, it’s easy to get started with goal-based investing. Simply set up a goal with your desired time horizon and target balance and Betterment will recommend an investment approach tailored to this information. Goal 4: Set Clear Expectations with Children If you have children, there’s nothing more satisfying than watching your kids turn into motivated adults with passions to pursue. As a parent, you’ll naturally want to prepare them with everything you can to help them succeed in the world. You may be wrapping up paying for their college tuition, which is no easy feat given that these costs – even at public in-state universities – now average in the tens of thousands of dollars per year. As your kids move through college, take the time to have a serious discussion with them about what they plan to do after graduation. If graduate school is on the horizon, talk to them about how they’ll pay for it and how much help from you, if any, they can expect. Unlike undergraduate programs, graduate programs assess financial aid requirements by looking at only the student’s assets and incomes, not the parents’, so your finances won't be considered. You’ll also want to set expectations about other kinds of support—such as any help in paying for their health insurance premiums up to a certain age, or their mobile phone plan, or even whether toward major purchases like a home or car. It’s great to help out your children, but you’ll want to make sure you’re not jeopardizing your own security. Your 50s may demand a lot from you, but taking the time to properly assess your investments, personal financial situation, lifestyle, and, if applicable, your support for children, can be truly rewarding in your retirement years. By tackling these four goals now, you can help set yourself up to meet your current responsibilities and increase your chances of a more financially secure and comfortable life in the decades to come.
An Investor’s Guide To DiversificationAn Investor’s Guide To Diversification Diversification is an investing strategy that helps reduce risk by allocating investments across various financial assets. Here’s everything you need to know. In 1 minute When you invest too heavily in a single asset, type of asset, or market, your portfolio is more exposed to the risks that come with it. That’s why investors diversify. Diversification means spreading your investments across multiple assets, asset classes, or markets. This aims to do two things: Limit your exposure to specific risks Make your performance more consistent As the market fluctuates, a diverse portfolio generally remains stable. Extreme losses from one asset have less impact—because that asset doesn’t represent your entire portfolio. Maintaining a diversified portfolio forces you to see each asset in relation to the others. Is this asset increasing your exposure to a particular risk? Are you leaning too heavily on one company, industry, asset class, or market? In 5 minutes In this guide, we’ll: Define diversification Explain the benefits of diversification Discuss the potential disadvantages of diversification What is diversification? Financial assets gain or lose value based on different factors. Stocks depend on companies’ performance. Bonds depend on the borrower’s (companies, governments, etc.) ability to pay back loans. Commodities depend on public goods. Real estate depends on property. Entire industries can rise or fall based on government activity. What’s good or bad for one asset may have no effect on another. If you only invest in stocks, your portfolio’s value completely depends on the performance of the companies you invest in. With bonds, changing interest rates or loan defaults could hurt you. And commodities are directly tied to supply and demand. Diversification works to spread your investments across a variety of assets and asset classes, so no single weakness becomes your fatal flaw. The more unrelated your assets, the more diverse your portfolio. So you might invest in some stocks. Some bonds. Some fund commodities. And then if one company has a bad quarterly report, gets negative press, or even goes bankrupt, it won’t tank your entire portfolio. You can make your portfolio more diverse by investing in different assets of the same type—like buying stocks from separate companies. Better yet: companies in separate industries. You can even invest internationally, since foreign markets can potentially be less affected by local downturns. What are the benefits of diversification? There are two main reasons to diversify your portfolio: It can help reduce risk It can provide more consistent performance Here’s how it works. Lower risk Each type of financial asset comes with its own risks. The more you invest in a particular asset, the more vulnerable you are to its risks. Put everything into bonds, for example? Better hope interest rates hold. Distributing your assets distributes your risk. With a diversified portfolio, there are more factors that can negatively affect your performance, but they affect a smaller percentage of your portfolio, so your overall risk is much lower. If 100% of your investments are in a single company and it goes under, your portfolio tanks. But if only 10% of your investments are in that company? The same problem just got a whole lot smaller. Consistent performance The more assets you invest in, the less impact each one has on your portfolio. If your assets are unrelated, their gains and losses depend on different factors, so their performance is unrelated, too. When one loses value, that loss is mitigated by the other assets. And since they’re unrelated, some of your other assets may even increase in value at the same time. Watch the value of a single stock or commodity over time, and you’ll see its value fluctuate significantly. But watch two unrelated stocks or commodities—or one of each—and their collective value fluctuates less. They can offset each other. Diversification can make your portfolio performance less volatile. The gains and losses are smaller, and more predictable. Potential disadvantages of diversification While the benefits are clear, diversification can have a couple drawbacks: It creates a ceiling on potential short-term gains Diverse portfolios may require more maintenance Limits short-term gains Diversification usually means saying goodbye to extremes. Reducing your risk also reduces your potential for extreme short-term gains. Investing heavily in a single asset can mean you’ll see bigger gains over a short period. For some, this is the thrill of investing. With the right research, the right stock, and the right timing, you can strike it rich. But that’s not how it usually goes. Diversification is about playing the long game. You’re trading the all-or-nothing outcomes you can get with a single asset for steady, moderate returns. May require more maintenance As you buy and sell financial assets, diversification requires you (or a broker) to consider how each change affects your portfolio’s diversity. If you sell all of one asset and re-invest in another you already have, you increase the overall risk of your portfolio. Maintaining a diversified portfolio adds another layer to the decision-making process. You have to think about each piece in relation to the whole. A robo advisor or broker can do this for you, but if you’re managing your own portfolio, diversification may take a little more work.
How to Choose the Right Investment Accounts for Your Financial GoalsHow to Choose the Right Investment Accounts for Your Financial Goals From 401(k)s to 529s, investment accounts vary in purpose. Learn the differences and which are better suited for your different long-term financial goals. Investment accounts are valuable tools for reaching your long-term financial goals. But they’re not all the same. Choosing the right investment account – or mix of multiple account types – could mean reaching your goal ahead of schedule, or having more finances to work with. But choosing the wrong account type could mean your money isn’t available when you need it. The right investment account depends on your plans for the future. Maybe you’re thinking about retirement or saving for your child’s college education. Perhaps you’re trying to pass on as much of your assets to your loved ones as possible. Or you might just be trying to earn more interest than you could expect from a traditional savings account or certificate of deposit (CD). Knowing your goal is the first step to choosing the right investment account. In general, you’ll end up with one of five basic types of investment account: IRAs, which are tax-advantaged accounts used by individuals and married couples to save for retirement. 401(k)s, which are accounts offered by employers that have a similar goal (retirement) and tax advantages as IRAs but relatively higher contribution limits. Health Savings Accounts (HSAs), which enjoy triple the tax advantages and can be used for retirement under the right circumstances. Individual (or Joint) Brokerage Accounts, which lack tax advantages but are available to virtually anyone for any investment purpose. 529 plans, which are tax-advantaged accounts that let individuals save for their own or a loved one’s education expenses. Each of these investment accounts is designed with different objectives in mind. Some are more liquid than others, giving you greater flexibility to withdraw money when you need it. Some come with tax advantages. Some have rules and restrictions for when (and how much) you can contribute to them. Or eligibility requirements that determine who can contribute to them. But you don’t have to have an MBA or work in finance to understand the different choices you have. In this guide, we’ll show you how identifying your goal helps narrow your options. Focus first on your investment goal Investment accounts come in many different forms, but you don’t have to learn the intricacies of them all. Before you choose where to put your money, you should have a clear understanding of what you’re trying to do with it. Starting with a financial goal in mind immediately narrows your options and keeps your decision rooted in your desired outcome. Here are some of the most common goals people have when opening an investment account. Planning for retirement When it comes to retirement planning, there are two main types of specialized retirement accounts to consider: IRAs and 401(k)s. HSAs can also be repurposed for retirement with some special considerations, which we’ll preview later. Retirement accounts offer unique tax advantages that can put you in a better position when you retire. However, you’ll usually incur penalties if you withdraw from these accounts before you reach retirement age. With either account type, you can control the ratio of securities (stocks, bonds, etc.) in the account, investment strategy, and more. Within each of these account types, there are also two main kinds to consider: Roth or traditional. First let’s talk about the difference between a 401(k) and an IRA, then we’ll look at Roth vs. traditional options. 401(k) A 401(k) is a retirement plan offered by your employer, also known as an employer-sponsored retirement account. If you invest in a 401(k), your contributions will be automatically deducted from your paycheck. One of the biggest advantages of a 401(k) is that employers will sometimes match a percentage of your contribution as an added benefit of employment, giving you money you wouldn’t otherwise have. If your employer offers to match 401(k) contributions and you don’t take advantage of that, you’re leaving money on the table and choosing to receive fewer benefits than some of your coworkers. 401(k)s also have higher contribution limits than IRAs. Every year, you can legally contribute more than three times as much to a 401(k) as you can into an IRA—up to $20,500 in 2022 if you’re under 50—helping you reach retirement goals sooner. When you leave your employer, you have to decide whether to leave your 401(k) funds with their provider, or roll them over to an IRA or a 401(k) offered by your new employer. Individual Retirement Account (IRA) An IRA works similarly to a 401(k), but your contributions don’t automatically come from your paycheck, and the annual contribution limits are lower ($6,000 if you’re under 50). Since an IRA isn’t offered through your employer, your employer won’t match your contributions to it. If your employer doesn’t offer a 401(k) or doesn’t match your contributions, an IRA can be an excellent choice to start retirement saving. Some investors choose to have both a 401(k) and an IRA to contribute as much as possible toward retirement through tax-advantaged means. The contribution limits are separate, so you can max out a 401(k) and an IRA if you can and are comfortable setting that much money aside every year. Roth vs. traditional The tax advantages of 401(k)s and IRAs come in two flavors: Roth and traditional. Contributions to Roth accounts are made with post-tax dollars, meaning Uncle Sam has already taken a cut. Contributions to traditional accounts, on the other hand, are usually made with pre-tax dollars. These two options effectively determine whether you pay taxes on this money now or later. Here’s another way of looking at it: Say you make $50,000 a year and contribute $5,000 to a Traditional retirement account, your taxable income is $45,000. You’re reaping the tax benefits of your retirement account now—and investing more than you may have been able to otherwise— in exchange for paying taxes on that money later. When you start withdrawing from your account, you’ll generally pay taxes on everything you withdraw, not just your original income. As a side note for high earners, the IRS limits deductions for Traditional IRAs based on income With a Roth account, you pay taxes on your contributions up front– meaning you potentially have less money to invest with–but enjoy the tax advantages later. If you make $50,000 a year and contribute $5,000, your taxable income is still $50,000. The earnings you accrue through a Roth 401(k) or Roth IRA are generally tax-free, so when you reach retirement age and start making withdrawals, you don’t have to pay taxes. As a side note for high earners, the IRS limits eligibility for Roth IRAs based on income. So, which is better, Roth or Traditional? The answer depends on how much money you expect to live on during retirement. If you think you’ll be in a higher tax bracket when you retire (because you’ll be withdrawing more than you currently make each month), then paying taxes now with a Roth account can keep more in your pocket. But if you expect to be in the same or lower tax bracket when you retire, then pushing your tax bill down the road via a Traditional retirement account may actually be the better route. Regardless, you should always consult a licensed tax advisor for the best information on your unique circumstances. HSA Designed primarily to help individuals pay for health care costs, HSAs can be an overlooked and underrated investing vehicle. That’s because your HSA contributions, potential earnings, and withdrawals (with a few key stipulations) are tax-free. This is what we mean when we say HSAs enjoy “triple” the tax advantages of IRAs and 401(k)s. In the case of those other two popular investment vehicles, you can catch a tax break on money coming in or going out, but not both. Learn more about how to use your HSA for retirement. Earning more from your savings Some people use investment accounts to simply help maximize the value of their unused income, or to save for major purchases down the road, like a home purchase or car. While a Cash Reserve account can work well for short-term financial goals, a general brokerage account lets you purchase stocks, bonds, exchange-traded funds (ETFs), mutual funds, and other financial assets that come with greater risk and the potential for greater returns. With a brokerage account, you need to decide if you want an individual or joint account. This choice basically comes down to who you want to have control over this account and what you’d like to happen with it when you pass away. It’s common for married couples to use a joint account to consolidate their resources and avoid the hassle of managing multiple accounts. But if you select a joint account, it’s important that you completely trust the other person, as their decisions and even their credit can significantly alter your financial assets. Creditors can sometimes claim funds from a joint investment account, even if the other person hasn’t contributed a dime. While general brokerage accounts offer a lot more flexibility than other investment accounts, they don’t provide tax advantages. If there are account types specialized toward your goal (like how IRAs are built for saving for retirement), they will likely have advantages over a general brokerage account. Saving for your own or a loved one’s education There are a lot of ways to save for education. But if you’re trying to make the most of your money, a 529 plan is an ideal choice because its earnings are tax-free, as long as you use them for qualified education costs. Your 529 plan doesn’t have to sit for a fixed period for you to start using it. As long as it’s applied to education-related expenses (tuition, room and board, books, student loan payments, etc.) for the beneficiary, you can withdraw from the plan as needed. The tax advantages and usage flexibility usually make 529 plans far more suitable for education planning than a simple savings account or a general brokerage account.
How To Avoid Common Investor MistakesHow To Avoid Common Investor Mistakes People often make financial decisions based on impulses and market shifts—here’s another way to do it. Investing mistakes are often rooted in our natural reactions. Let’s face it: We don’t always react the right way to information. And when enough investors have poor reactions, it can affect the entire market. Behavioral finance is a field of study that looks at how psychology affects financial decisions. It helps us understand why investors make common mistakes, so it’s easier to avoid them. But don’t worry—it doesn’t have to be complicated. Some of the most important lessons from this field are surprisingly simple. Try to invest with a goal in mind Investing can be one of the smartest financial decisions you can make. But a lot of investors start without knowing what they’re working toward—and that’s, well, less smart. When you don’t know why you’re building a financial portfolio, it’s a lot harder to know how to structure your investments. Instead, start with why. What do you want to be able to spend money on in the future? When are you going to use that money? These aren’t just stocks and bonds. Your investment is a future downpayment on a house. Your dream car. Retirement. College. Real things and experiences you want to be able to afford. Having a goal can help take the guesswork out of investing. You can calculate exactly how much you need to invest based on the range of potential outcomes. It’s also easier to decide where to put your investments. Retiring in 40 years? You might consider taking on more risk and allocating more in stocks. Hitting your goal next year? Play it safe. When you know how much you need to invest, break it into monthly chunks and automate your deposits. With recurring deposits, you're basically “paying yourself first” before worrying about other expenses. That way, you won’t talk yourself into skipping a month. (Which turns into two months, then three, and—oops, it’s been a year.) Focus on the long-term When you invest, you’ll likely have short-term losses here and there. It’s inevitable. And most times, it can be a mistake to make adjustments when your portfolio loses value. You can’t predict tomorrow’s performance based on yesterday’s. Even during the last ten years of steady growth, investors had to endure short-term losses at some point every year. Given enough time, the market trends upwards. And investments that perform poorly one day can easily make up for it the next. But that’s not what people tend to think about when they see their portfolio lose 15% of its value. They can panic. They make sweeping changes, reinvesting in funds and stocks that had short-term gains. And those big emotional decisions can do more harm than good. Investing is about long-term gains. Short-term losses are simply part of the process, so don’t panic every time there’s a loss. Watch out for “lifestyle creep” You don’t have to live frugally to be a successful investor. It helps, but the bigger issue is making sure that as your income increases, you stay in control of your lifestyle and spending. Most people see small pay increases over the course of their lives. 3% here. 8% there. When your regular spending increases with your income, it’s known as “lifestyle creep.” It can easily get in the way of saving enough to achieve your goals. If you have a lower income, it makes sense that more of your money goes toward basic necessities. But lifestyle creep happens when you gradually spend more on things you don’t need. Entertainment. Hobbies. Take out. Every time you increase your regular spending, your lifestyle costs more to maintain. You’ll likely need to save more for retirement. Your emergency fund may need to grow, too. Lifestyle creep is an even bigger problem if you started investing with the expectation that you’d invest more later. Some people feel intimidated by their goals, so they plan to increase the amount they invest when they start making more money. That’s fine—as long as you actually do it. Temporary increases in spending are OK. But as you make more money, don’t let a more extravagant lifestyle sabotage your goals. Five ways Betterment helps improve your investing behavior We help you see the big picture Our non-traditional portfolio presentation helps discourage investors from focusing on daily market movements. We show the constituents of your portfolio as the parts of a whole, but never the return of each individual component. This helps reduce the temptation to constantly adjust your allocation and make your portfolio less diverse. We encourage optimized deposit settings Setting up recurring deposits for the day after you get paid can set you up for success in a number of ways. First, it removes the constant temptation to pocket the cash instead. Second, it gives your paycheck just enough time to settle without letting that cash idle for long. And third, it can help rebalance your portfolio more tax-efficiently. We keep the focus on the future Our design helps you focus on decisions that matter—the ones about the future. Our minds assign a disproportionate significance to daily volatility, but it rarely impacts our long-term outlook. So instead of emphasizing daily market movements, we simply keep you updated on whether you’re on-track to reach your goals. We give you the information you need Conventional wisdom says advisors should proactively contact their customers when the market drops. This can create undue anxiety, and it can even prompt negative behaviors, such as making large unnecessary withdrawals. Instead, we carefully target our emails and in-app notifications, using active engagement as a filter. We show you the potential tax impact of transactions We display the estimated tax impact of an allocation change or withdrawal before you finalize the transaction. This estimate is not only useful information in its own right, but it’s also intended to help drive better investing behavior by reducing the number of unnecessary changes.
An Investor's Guide To Market VolatilityAn Investor's Guide To Market Volatility Knowing what to do during a market downturn can be especially difficult in the moment. Here’s how to plan ahead. In 1 minute When the prices in financial markets change, that’s market volatility. More volatility means greater potential for both gains or losses. In investing, market volatility comes with the territory. Some days the market is up, and other days it’s down. It’s OK to be anxious during a dip, but preparing for market volatility can help you avoid making decisions out of fear. Two of the biggest ways you can prepare for volatility: Diversify your portfolio Build an emergency fund Diversification helps protect your portfolio by spreading out your risk. A diversified portfolio may not gain as much as some individual assets, but it likely won’t lose as much as others. An emergency fund is a financial safety net. If market volatility negatively impacts your investments, your emergency fund can help cover your expenses until the economy recovers. During a downturn, we recommend resisting the urge to change your investments. Give your portfolio time to recover. But if you can’t do that, try to keep changes small, like lowering your stock allocation so that it’s more consistent with a more conservative risk tolerance level. In general, you should invest for the long-term, but at the same time you’ll likely want a diversified portfolio that you’re comfortable holding on to even when things in the market get bad. This can increase the odds you remain in the market when it ultimately recovers and continues on its path of expected long-term growth. Still not satisfying the itch to act? High management fees or capital gains distributions (from a mutual fund) could make that market volatility more uncomfortable. Or perhaps your financial advisor isn’t sticking to your target allocation as your portfolio experiences gains and losses. In these situations, a lower-fee robo-advisor like Betterment can help alleviate that discomfort. In 5 minutes In this guide, we’ll cover: What market volatility is How to prepare for it What to do about it Nobody likes to see their finances take a nosedive. But in a volatile market, dips happen often. Market volatility refers to fluctuations in the price of investments. Some markets—like the stock market—fluctuate more than others. And in times of economic stress, markets tend to be even more volatile, so you might see some big ups and downs. It’s tempting to sell everything and bail out during dips, but that often does more harm than good. Selling your assets could lock-in losses before they have a chance to rebound from the dip, and it’s nearly impossible to predict the market’s high points and low points. Reacting to market drawdowns by moving to cash is like selling your clothes because you gained a few pounds. Sure, they may feel a little snug, but you could find yourself with a bare closet if and when your weight fluctuates the other way. Historically, the stock market has had plenty of bad days. In any given decade, you’re bound to see many drawdowns, where investment values dip frightfully low. But when you step back and look at the big picture, the market has trended upward over time. So far, the global stock market, and by extension the U.S. stock market, has always recovered from economic downturns. And while nothing in life is guaranteed, those are some pretty good odds. History shows us that experiencing short-term losses is part of the path to long-term gains. The key for investors is to expect market volatility. It’s inevitable. And that means you need to prepare for it—not simply react to it. How to prepare for market volatility Market volatility can occur at any time. So you want to be ready for it now and in the future. The main thing you can do to prepare is diversify your portfolio. Having a balance of different assets decreases your overall level of risk. While some of your assets momentarily struggle, for example, others may hold steady or even thrive. The goal is your portfolio will hopefully feel less like a rollercoaster and more like a fun hike up wealth mountain. Beyond that, you’ll want to strongly consider building an emergency fund. A good starting point is having enough to cover three to six months of expenses. This is money you want on hand if market volatility takes a turn for the worse. Even if you don’t depend on your investments for income, major economic downturns can affect your life in other ways. The poor economy could lead to layoffs, bankruptcies, and other situations that impact your job stability. Or if you have rental properties, the real estate market could be adversely affected as well. All the more reason to have an emergency fund and ride out that turbulence if the need arises. What investors should do during downturns Caught in a downturn? Don’t panic. Seriously, when the market looks grim, the best reaction is usually to do nothing. Selling off your portfolio to prevent further losses is a common investor mistake that does two things: It locks-in those losses It takes away your chance to rebound with the market Scratching an itch usually won’t prevent it from recurring. The same goes for reacting to short-term losses in your portfolio. As much as you can, you want to resist the urge to react. Still, sometimes you may feel like you have to make a change. If that’s you, the first thing to do is make sure you’re comfortable with the level of risk you’re taking. Some asset classes, like stocks, are more volatile than others. The more weighted your portfolio is toward these assets, the more vulnerable it is to changes in the market. You’ll also want to confirm that your time horizon (when you need the money) is still correct. Think of this like checking your pulse, or taking a few deep breaths. You’re making sure your investments look right—that everything is working like it’s supposed to. If you’re still feeling tempted to do something drastic like withdraw all your investments, you probably should reduce your level of risk. Even if everything looks right for your goals, making a small adjustment now could prevent you from making a bigger mistake out of panic later. Your pulse is too high. Your breaths are too rapid. Sitting at 90% stocks and 10% bonds? You might try dialing it down to 75% stocks and 25% bonds. The time may be ripe to consider a Roth conversion Our investing advice of doing nothing and staying the course is generally the direction we try to nudge you toward when markets are down. While drops in global markets can be stressful, they also provide opportunities that can be beneficial for future you. One of those strategies is implementing a Roth conversion. A Roth conversion allows you to transfer, or convert, funds from a traditional IRA to a Roth IRA. You will typically owe income taxes on the amount you convert in the year of conversion, but the tradeoff is that once inside the Roth IRA future growth and withdrawals are generally tax-free. You can take a look at other pros and cons of Roth conversions in our Help Center. Here are a couple of reasons why you may want to consider converting your IRA when the market is down: The balance of your Traditional IRA has dropped significantly. When the balance of your Traditional IRA drops, you’re able to convert the same number of shares at lower market prices. This means you may pay less in taxes than if you converted those same number of shares at higher market prices. Growth from a global market recovery can be better in a Roth IRA than a Traditional IRA. As global markets recover over time, the value of your converted holdings may increase. This increase in value will now take place in your Roth IRA. Down the line, when you start taking withdrawals out of your Roth IRA in retirement, you’ll be able to do so without incurring any taxes. To understand how a Roth conversion may impact your personal financial situation, we strongly recommend consulting a tax advisor and IRS Publication 590. Betterment is not a licensed tax advisor and cannot provide tax advice. Reassess where you invest Depending on your situation, another option might be to shift your investments to a financial institution like Betterment. This could save you money in other ways, which might make your current risk level feel more comfortable. Some signs this might be the right move for you: 1. Your accounts have higher management fees You can’t control how the market performs, but you don’t have to be stuck with higher fees. Switching to a lower-fee institution like Betterment could lead to less of a drag on your long-term returns. 2. Your allocation is incorrect The sooner you need to use your money, the less risk you should take. Not sure what level of risk is right for you? When you set up a financial goal with Betterment, we’ll recommend a risk level based on your time horizon and target amount. 3. You own mutual funds that pay capital gains distributions When a mutual fund manager sells underlying investments in the fund, they may make a profit (capital gains), which are then passed on to individual shareholders like you. These distributions are taxable. Even worse: mutual funds can pay out capital gain distributions even if the fund’s overall performance is down for a year. So in a volatile market, your portfolio could lose value and you may still pay taxes on gains within the fund. In contrast, most exchange traded funds (ETFs) are more tax efficient.
Setting and Prioritizing Your Financial GoalsSetting and Prioritizing Your Financial Goals When you have more than one, think in terms of importance, timeline, and the amount you need In 1 minute Saving for big financial goals like retirement doesn’t have to mean letting go of your other goals. But prioritizing them is tough. How are you supposed to weigh something like a distant retirement versus a more immediate financial goal, like a honeymoon? Or a down payment on a home? Start by identifying all of the things you’d like to achieve. They might be big-ticket items you want to buy, experiences you want to have, or expenses you want to be prepared for. Once you’ve named them, estimate how much you’d need to reach each goal, and how soon you’d like to reach them. After you’ve clearly defined the goals you could save for, it’s time to choose which ones matter most to you. You might rank every goal or just narrow the list down to your top five to ten. Then you can calculate how much you’d have to save each month to reach these goals based on your timeline. From there, turn to your budget. Decide how much you can afford to save each month and apply it to your biggest goals first. We highly recommend turning on auto-deposit so you won’t be tempted to stop working toward your goals. Your financial goals don’t have to be set in stone, and neither does your plan. Over time, you may find that you can save more—or that you can’t save as much as you thought. Maybe it’ll take more or less to reach your goal. Or your priorities might change. That’s OK. With Betterment, it’s easy to set, automate, and adjust your goals. In 5 minutes In this guide, we’ll cover: Defining your financial goals Prioritizing your goals Deciding how to allocate your money Adjusting goals as needed Financial goals help you plan for the things you’d like to do with your money, but can’t afford to do right now. Like retiring. Buying a house. Sending your kids to college. Getting that dream car. Remodeling your kitchen. When you know what you want to do, you can estimate how much you need and when you need it. Knowing your goals also helps you choose the right financial accounts, so you can reach them sooner. But what happens when you have multiple financial goals? All of a sudden, it’s harder to know how much to put toward each goal. Thankfully, working toward one goal doesn’t mean you can’t reach another. Here’s how to set and prioritize your financial goals. Define your financial goals If you sit down and think about all of the things you’d like to do with your money, you can probably create a much longer list than you’d expect. Do it. It’s worth taking the time to write down every goal—because you might be forgetting something important! Some of your goals could be as simple as saving up for holiday gifts, as important as building a safety net, or as big as planning for retirement or long-term care. If it’s on your mind, put it on the list. Part of this process should involve estimating how much you’d need to save to reach each goal and when you’d like to reach it. Is it months away? Years? Decades? Will it take hundreds of dollars or hundreds of thousands? Each goal should have a timeline and amount. At Betterment, it’s easy to add this information every time you set up a goal. (And you can change it at any time.) Prioritize what matters to you Your financial goals are yours. This isn’t about what your parents want or what your friends expect from you. Whatever your goals are, prioritize them based on how important they are to you. Remember that ranking your goals doesn’t mean you won’t reach the ones on the bottom. For example, you shouldn’t be afraid to pay down debt and invest at the same time. This is just to help you think about which goals you care about the most. Once you’ve ranked your goals, your list might look like this: Pay off medical debt Build emergency fund Save for retirement Put a down payment on a house Remodel the bathroom You can include as many goals as you want. And in Betterment, you can add each goal to your account, whether you put anything toward it or not. Apply your budget to your list Now that you know how much you need to save, when you need to save it by, and which goals are most important to you, it’s time to see what you can actually accomplish. Using your estimated amount and your timeline (in investing, this is called your “time horizon”), calculate how much you need to save each month to reach each goal. It’s OK if this is more than you can afford to save right now. Putting the numbers in front of you with an ordered list helps you ask questions like, “Can I reach all of these goals on these timelines?” and “Which goal(s) am I willing to delay in order to make progress on the others? If you plan on investing to reach your goal, you should also consider how much you can expect to earn toward these goals with an investment account. Every time you set up a goal in Betterment, we’ll handle this part for you. You can see how achievable your goal is based on how much you put toward it. Automate your financial goals The best way to make sure you reach your goals? Automate them. Don’t make the mistake of putting your goals on pause. Set up recurring deposits for each goal with the amount you’ve set aside for them, and the right amount automatically goes to the right goal. This makes it easy to budget around your goals, and you won’t accidentally miss a month. The strategy is often called “paying yourself first” because you’re putting money toward your highest priorities before spending it on anything else. Want to start working toward your financial goals? Set up a goal with Betterment, and see what you can achieve.
What’s an IRA and How Does It Work?What’s an IRA and How Does It Work? Learn more about this investment account with tax advantages that help you prepare for retirement. An Individual Retirement Account (IRA) is a type of investment account with tax advantages that helps you prepare for retirement. Depending on the type of IRA you invest in, you can make tax-free withdrawals when you retire, earn tax-free interest, or put off paying taxes until retirement. The sooner you start investing in an IRA, the more time you have to accrue interest before you reach retirement age. But an IRA isn’t the only kind of investment account for retirement planning. And there are multiple types of IRAs available. If you’re planning for retirement, it’s important to understand your options and learn how to maximize your tax benefits. If your employer offers a 401(k), it may be a better option than investing in an IRA. While anyone can open an IRA, employers typically match a portion of your contribution to a 401(k) account, helping your investment grow faster. In this article, we’ll walk you through: What makes an IRA different from a 401(k) The types of IRAs How to choose between a Roth IRA and a Traditional IRA Timing your IRA contributions IRA recharacterizations Roth IRA conversions Let’s start by looking at what makes an Individual Retirement Account different from a 401(k). How is an IRA different from a 401(k)? When it comes to retirement planning, the two most common investment accounts people talk about are IRAs and 401(k)s. 401(k)s offer similar tax advantages to IRAs, but not everyone has this option. Anyone can start an IRA, but a 401(k) is what’s known as an employer-sponsored retirement plan. It’s only available through an employer. Other differences between these two types of accounts are that: Employers often match a percentage of your contributions to a 401(k) 401(k) contributions come right out of your paycheck 401(k) contribution limits are significantly higher If your employer matches contributions to a 401(k), they’re basically giving you free money you wouldn’t otherwise receive. It’s typically wise to take advantage of this match before looking to an IRA. With an Individual Retirement Account, you determine exactly when to make contributions. You can put money into an IRA at any time over the course of the year, whereas a 401(k) has to come from every paycheck. Note that annual IRA contributions can be made up until that year’s tax filing deadline, whereas the contribution deadline for 401(k)s is at the end of each calendar year. Learning how to time your IRA contributions can significantly increase your earnings over time. Every year, you’re only allowed to put a fixed amount of money into a retirement account, and the exact amount often changes year-to-year. For an IRA, the contribution limit for 2022 is $6,000 if you’re under 50, or $7,000 if you’re 50 or older. For a 401(k), the contribution limit for 2022 is $20,500 if you’re under 50, or $27,000. These contribution limits are separate, so it’s not uncommon for investors to have both a 401(k) and an IRA. What are the types of IRAs? The challenge for most people looking into IRAs is understanding which kind of IRA is most advantageous for them. For many, this boils down to Roth and/or Traditional. The advantages of each can shift over time as tax laws and your income level changes, so this is a common periodic question for even advanced investors. As a side note, there are other IRA options suited for the self-employed or small business owner, such as the SEP IRA, but we won’t go into those here. As mentioned in the section above, IRA contributions are not made directly from your paycheck. That means that the money you are contributing to an IRA has already been taxed. When you contribute to a Traditional IRA, your contribution may be tax-deductible. Whether you are eligible to take a full, partial, or any deduction at all depends on if you or your spouse is covered by an employer retirement plan (i.e. a 401(k)) and your income level (more on these limitations later). Once funds are in your Traditional IRA, you will not pay any income taxes on investment earnings until you begin to withdraw from the account. This means that you benefit from “tax-deferred” growth. If you were able to deduct your contributions, you will pay income tax on the contributions as well as earnings at the time of withdrawal. If you were not eligible to take a deduction on your contributions, then you generally will only pay taxes on the earnings at the time of withdrawal. This is done on a “pro-rata” basis. Comparatively, contributions to a Roth IRA are not tax deductible. When it comes time to withdraw from your Roth IRA, your withdrawals will generally be tax free—even the interest you’ve accumulated. How to choose between a Roth IRA and a Traditional IRA For most people, choosing an Individual Retirement Account is a matter of deciding between a Roth IRA and a Traditional IRA. Neither option is inherently better: it depends on your income and your tax bracket now and in retirement. Your income determines whether you can contribute to a Roth IRA, and also whether you are eligible to deduct contributions made to a Traditional IRA. However, the IRS doesn’t use your gross income; they look at your modified adjusted gross income, which can be different from taxable income. With Roth IRAs, your ability to contribute is phased out when your modified adjusted gross income (MAGI) reaches a certain level. If you’re eligible for both types of IRAs, the choice often comes down to what tax bracket you’re in now, and what tax bracket you think you’ll be in when you retire. If you think you’ll be in a lower tax bracket when you retire, postponing taxes with a Traditional IRA will likely result in you keeping more of your money. If you expect to be in a higher tax bracket when you retire, using a Roth IRA to pay taxes now may be the better choice. The best type of account for you may change over time, but making a choice now doesn’t lock you into one option forever. So as you start retirement planning, focus on where you are now and where you’d like to be then. It’s healthy to re-evaluate your position periodically, especially when you go through major financial transitions such as getting a new job, losing a job, receiving a promotion, or creating an additional revenue stream. Timing IRA contributions: why earlier is better Regardless of which type of IRA you select, it helps to understand how the timing of your contributions impacts your investment returns. It’s your choice to either make a maximum contribution early in the year, contribute over time, or wait until the deadline. By timing your contribution to be as early as possible, you can maximize your time in the market, which could help you gain more returns over time. Consider the difference between making a maximum contribution on January 1 and making it on December 1 each year. Then suppose, hypothetically, that your annual growth rate is 10%. Here’s what the difference could look like between an IRA with early contributions and an IRA with late contributions: This figure represents the scenarios mentioned above.‘Deposit Early’ indicates depositing $6,000 on January 1 of each calendar year, whereas ‘Deposit Late’ indicates depositing $6,000 on December 1 of the same calendar year, both every year for a ten-year period. Calculations assume a hypothetical growth rate of 10% annually. The hypothetical growth rate is not based on, and should not be interpreted to reflect, any Betterment portfolio, or any other investment or portfolio, and is purely an arbitrary number. Further, the results are solely based on the calculations mentioned in the preceding sentences. These figures do not take into account any dividend reinvestment, taxes, market changes, or any fees charged. The illustration does not reflect the chance for loss or gain, and actual returns can vary from those above. Hypothetical examples are for illustrative purposes only, and market conditions can and will impact performance. What’s an IRA recharacterization? You might contribute to an IRA before you have started filing your taxes and may not know exactly what your Modified Adjusted Gross Income will be for that year. Therefore, you may not know whether you will be eligible to contribute to a Roth IRA, or if you will be able to deduct your contributions to a Traditional IRA. In some cases, the IRS allows you to reclassify your IRA contributions. A recharacterization changes your contributions (plus the gains or minus the losses attributed to them) from a Traditional IRA to a Roth IRA, or, from a Roth IRA to a Traditional IRA. It’s most common to recharacterize a Roth IRA to a Traditional IRA. Generally, there are no taxes associated with a recharacterization if the amount you recharacterize includes gains or excludes dollars lost. Here are three instances where a recharacterization may be right for you: If you made a Roth contribution during the year but discovered later that your income was high enough to reduce the amount you were allowed to contribute—or prohibit you from contributing at all. If you contributed to a Traditional IRA because you thought your income would be above the allowed limits for a Roth IRA contribution, but your income ended up lower than you’d expected. If you contributed to a Roth IRA, but while preparing your tax return, you realize that you’d benefit more from the immediate tax deduction a Traditional IRA contribution would potentially provide. Additionally, we have listed a few methods that can be used to correct an over-contribution to an IRA in this FAQ resource. You cannot recharacterize an amount that’s more than your allowable maximum annual contribution. You have until each year’s tax filing deadline to recharacterize—unless you file for an extension or you file an amended tax return. What’s a Roth conversion? A Roth conversion is a one-way street. It’s a potentially taxable event where funds are transferred from a Traditional IRA to a Roth IRA. There is no such thing as a Roth to Traditional conversion. It is different from a recharacterization because you are not changing the type of IRA that you contributed to for that particular year. There is no cap on the amount that’s eligible to be converted, so the sky’s the limit for those that choose to convert. We go into Roth conversions in more detail in our Help Center.
How To Keep Your Financial Data SafeHow To Keep Your Financial Data Safe Cybersecurity threats are now the norm. Here's how we work with customers to protect their financial data. In 10 seconds Your financial information is incredibly valuable. And if you’re like most people, it’s also vulnerable. But by following best practices and using secure apps and services, you can protect your money from digital threats. In 1 minute Cybersecurity threats are bigger and more common than ever. Every investor needs to be on guard. Thankfully, there are plenty of tips and tech to keep your financial data secure. It all starts with you. Trust your instincts Scammers have plenty of tools to steal information. But their most effective tool is often manipulation. Don’t fall for impersonators. If it feels like someone is phishing for your personal information, they probably are. Use encryption Where and how you access your financial accounts is important. Public networks and unsecure apps or sites can easily compromise your information. Encryption adds a level of security. It’s like using a secret code to communicate with a server. Only the server knows the code, and your online activity is unreadable to outside parties. Hide your data with hashing Hashing is similar to encryption, except even the server doesn’t know the secret code. We use hashing to secure your data at Betterment. If there’s information we don’t need to know—like your password—hashing uses an algorithm to turn it into random characters. At Betterment, we only see the random characters. To ensure your password is correct, we just confirm that the random characters are the same as what we have on file. Sync your accounts securely It’s nice to have all your financial information in one place. Usually, that means giving one account access to the others. This makes those other accounts more vulnerable. Thankfully, there’s a better way. At Betterment, we use app-specific passwords to prevent one account from giving access to others. In 5 minutes In this guide, we’ll: Discuss the threats to your financial data Explore your best digital defenses Explain the safest way to sync your financial accounts When it comes to protecting your financial information, the biggest threats are the most obvious: spam calls, phishing emails, and questionable messages. Scammers are constantly developing new, more devious ways to steal your personal information. With software, they guess millions of passwords per second. They scrape your social media accounts for personal information to manipulate you or your friends. But most of all, they’re counting on you to let your guard down. Here are four ways we can work together to protect your financial data. 1. Caution is your first line of defense If a phone call, email, or message seems fishy, it probably is. Would your bank really ask for your account number over the phone? What comes up when you Google the number? The IRS says they don’t email or text message people, and they’ll never ask for your personal information—so is that really them in your inbox? Why does that link have random characters instead of a URL you recognize? Is that the correct spelling of that company’s name? Don’t ever share personal information unless you’re sure who you’re sharing it with. And make sure that other people don’t have access to your passwords or login information, and you’re not reusing passwords on multiple sites. Two-factor authentication helps secure your account using a passcode that rotates over time, or one that you receive via text or a phone call. 2. Encryption is essential Any time you access a website or use an app, your device communicates with a server. With the right expertise, someone could hijack these communications and steal your information. Encryption prevents this. Encryption takes these sensitive communications and jumbles them up. The only way to un-jumble them? A key that only your device and the server share. It works like this: When you access Betterment, your connection is encrypted. But if you’re ever visiting a third-party site and don’t see the padlock in the browser bar, your connection is not secure. Don’t share any information on those sites! Bottom line: even if someone snoops on your encrypted activity, they won’t learn anything. 3. Hashing hides your information—even from us! We don’t need to know your password. That’s a secret only you should know. So, we use a technique called “hashing” to let you use it without telling us what it is. Like encryption, hashing uses an algorithm to turn information (like your password) into an unreadable sequence. But unlike encryption, hashing is irreversible. There’s no key to decipher it. We can’t translate the hashing to read your password. However, every time you enter your password, the hashing algorithm produces the same sequence. So we don’t know your password; we just know if it was entered correctly. 4. App-specific passwords let you securely sync accounts Odds are, between all your investments, savings, payment cards, budgeting apps, and financial assets, you use more than one financial institution. That’s OK. But if you’re trying to get a more complete picture of your financial portfolio and see what you have to work with, it helps to have a single, central account that can see the others. Today’s technology makes it easier than ever to sync external accounts. But if you’re not careful, connecting them can make your financial data more vulnerable. To provide a middle ground between complete access and maximum security, Betterment uses app-specific passwords to sync your external accounts. Let’s say you want to sync your Mint account with Betterment, for example. Mint can generate a separate password that gives Betterment read-only access to your Mint account. You’re not sharing your login credentials, and it won’t give you or anyone else the ability to change your Mint account from within Betterment. But you can still see the information you need to make informed decisions about your money. Keep your finances secure At Betterment, we want you to reach your financial goals. It’s a lot easier to do that when you use financial services you can trust. We help secure your financial data through layers of encryption, hashing information we don’t need, and app-specific passwords that reduce your risk.
How To Plan For RetirementHow To Plan For Retirement It depends on the lifestyle you want, the investment accounts available, and the income you expect to receive. In 1 minute Retirement planning is personal. It all depends on what you want and what you can do. No matter how far away retirement is, it’s worth thinking through what you want and how you’ll get there. Your retirement account needs to cover your cost of living—whatever that entails. Three of the biggest factors are: How much you want to spend each year Where you want to live When you want to retire Understanding these factors will help you decide how much you need to save. You will also need to decide where to put your money. For many people, retirement savings will live in some combination of these five accounts: Traditional 401(k) Roth 401(k) Traditional IRA Roth IRA Health Savings Account (HSA) 401(k)s are only available through an employer. IRAs are available to anyone. With 401(k)s and IRAs, a Traditional account usually gives you pre-tax benefits, and a Roth account gives you after-tax benefits. The right choice for you depends on whether you think you’ll be in a higher tax bracket now or when you retire. If you’re self-employed, there are some additional retirement accounts to consider, namely: Solo 401(k) SEP IRA SIMPLE IRA These are each suited toward companies of a particular size. A Solo 401(k) has high contribution limits, making it appealing, but it’s only available if you’re the only employee. For businesses with fewer than 100 employees, a SIMPLE IRA may be best, as it allows employees and employers to contribute. You’ll also want to think about supplemental income. If you can expect income beyond what you withdraw from a retirement account, such as social security benefits or a pension, you may not need to save as much. In 5 minutes In this guide, we’ll cover: How much you should save for retirement Choosing retirement accounts Supplemental income to consider Self-employed retirement options Most people want to retire some day. But retirement planning looks a little different for everyone. There’s more than one way to get there. And some people want to live more extravagantly—or frugally—than others. Your retirement plan should be based on the life you want to live and the financial options you have available. And the sooner you sort out the details, the better. Even if retirement seems far away, working out the details now will set you up to retire when and how you want to. First things first: figure out how much you need to save. How much should you save for retirement? How much you need to save ultimately depends on what you want retirement to look like. Some people see themselves traveling the world when they retire. Or living closer to their families. Maybe there’s a hobby you’ve wished you could spend more time and money on. Perhaps for you, retirement looks like the life you have now—just without the job. For many people, that’s a good place to start. Take the amount you spend right now and ask yourself: do you want to spend more or less than that each year of retirement? How long do you want your money to last? Answering these questions will give you a target amount you’ll need to reach and help you think about managing your income in retirement. Don’t forget to think about where you’ll want to live, too. Cost of living varies widely, and it has a big effect on how long your money will last. Move somewhere with a lower cost of living, and you need less to retire. Want to live it up in New York City, Seattle, or San Francisco? Plan to save significantly more. And finally: when do you want to retire? This will give you a target date to save it by (in investing, that’s called a time horizon). It’ll also inform how much you need to retire. Retiring early reduces your time horizon, and increases the number of expected years you need to save for. Still not sure how much to save? Betterment can help you plan for retirement. Choosing retirement accounts Once you know how much you need to save, it’s time to think about where that money will go. Earning interest and taking advantage of tax benefits can help you reach your goal faster, and that’s why choosing the right investment accounts is a key part of retirement planning. While there are many kinds of investment accounts, people usually use five main types to save for retirement. 1. Traditional 401(k) A Traditional 401(k) is an employer-sponsored retirement plan. These have two valuable advantages: Your employer may match a percentage of your contributions Your contributions are tax deductible You can only invest in a 401(k) if your employer offers one. If they do, and they match a percentage of your contributions, this is almost always an account you’ll want to take advantage of. The contribution match is free money. You don’t want to leave that on the table. And since your contributions are tax deductible, you’ll pay less income tax while you’re saving for retirement. 2. Roth 401(k) A Roth 401(k) works just like a Traditional one, but with one key difference: the tax advantages come later. You make contributions, your employer (sometimes) matches a percentage of them, and you pay taxes like normal. But when you withdraw your funds during retirement, you don’t pay taxes. This means any interest you earned on your account is tax-free. With both Roth and Traditional 401(k)s, you can contribute a maximum of $20,500 in 2022, or $27,000 if you’re age 50 or over. 3. Traditional Individual Retirement Account (IRA) As with a 401(k), an IRA gives you tax advantages. Depending on your income, contributions may lower your pre-tax income, so you pay less income tax leading up to retirement. The biggest difference? Your employer doesn’t match your contributions. The annual contribution limits are also significantly lower: just $6,000 for 2022, or $7,000 if you’re age 50 or over. 4. Roth Individual Retirement Account (IRA) A Roth IRA works similarly, but as with a Roth 401(k), the tax benefits come when you retire. Your contributions still count toward your taxable income right now, but when you withdraw in retirement, all your interest is tax-free. So, should you use a Roth or Traditional account? One option is to use both Traditional and Roth accounts for tax diversification during retirement. Another strategy is to compare your current tax bracket to your expected tax bracket during retirement, and try to optimize around that. Also keep in mind that your income may fluctuate throughout your career. So you may choose to do Roth now, but after a significant promotion you might switch to Traditional. 5. Health Savings Account (HSA) An HSA is another solid choice. Contributions to an HSA are tax deductible, and if you use the funds on medical expenses, your distributions are tax-free. After age 65, you can withdraw your funds just like a traditional 401(k) or IRA, even for non-medical expenses. You can only contribute to a Health Savings Accounts if you’re enrolled in a high-deductible health plan (HDHP). In 2022, you can contribute up to $3,650 to an HSA if your HDHP covers only you, and up to $7,200if your HDHP covers your family. What other income can you expect? Put enough into a retirement account, and your distributions will likely cover your expenses during retirement. But if you can count on other sources of income, you may not need to save as much. For many people, a common source of income during retirement is social security. As long as you or your spouse have made enough social security contributions throughout your career, you should receive social security benefits. Retire a little early, and you’ll still get some benefits (but it may be less). This can amount to thousands of dollars per month. You can estimate the benefits you’ll receive using the Social Security Administration’s Retirement Estimator. Retirement accounts for the self-employed Self-employed people have a few additional options to consider. One Participant 401(k) Plan or Solo 401(k) A Solo 401(k) is similar to a regular 401(k). However, with a Solo 401(k), you’re both the employer and the employee. You can combine the employee contribution limit and the employer contribution limit. As long as you don’t have any employees and you’re your own company, this is a pretty solid option. However, a Solo 401(k) typically requires more advance planning and ongoing paperwork than other account types. If your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account. Simplified Employee Pension (SEP IRA) With a SEP IRA, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee. Savings Incentive Match Plan for Employees (SIMPLE IRA) A SIMPLE IRA is ideal for small business owners who have 100 employees or less. Both the employer and the employee can contribute. You can also contribute to a Traditional IRA or Roth IRA—although how much you can contribute depends on how much you’ve put into other retirement accounts.
What To Do With An Inheritance Or Major WindfallWhat To Do With An Inheritance Or Major Windfall You may feel the urge to splurge, but don’t waste this opportunity to move closer to your financial goals. In 10 seconds When an inheritance or major windfall leaves you with more money than usual, you may feel the urge to splurge. But don’t waste this opportunity. Use your extra money on the financial goals you’re already working toward. In 1 minute It’s natural to start thinking about what you could buy when you’re suddenly flush with cash. But before you spend your financial windfall on a big purchase or blow through your inheritance, stop and take a moment to reflect. Think about what else you could do with that money. What is likely to have the most significant impact years down the road? Oh, and don’t forget: you may have some extra taxes coming your way, too. Depending on how big your windfall is and how you got it, you may need to set some of it aside to cover taxes. It’s worth talking to a CPA or tax advisor before you use this money. After that, look at your short- and long-term goals to find the best ways to put your windfall to work. This is an opportunity to accelerate progress on your financial goals. You might be working toward financial security, chipping away at debt, and planning for retirement. Maybe you’re saving for college—for yourself or someone else. Perhaps you want to pay off your mortgage someday. A financial windfall like an inheritance gives you a chance to make major progress toward long-term goals like these. But you’ll also want to think about your emergency fund. How much have you saved? How long will it last with your current expenses? Is it enough? It might be time to start estate planning, too. This helps ensure that if something terrible happens to you, more of your wealth goes toward the people and purposes you want it to. Bottom line: create a financial plan, or stick to the one you have. In 5 minutes In this guide, we’ll cover: Why it’s so easy to waste a windfall Why taxes should always come first What to do with the rest of your windfall It’s hard to be rational when thousands of dollars appear in your bank account, or you’re staring at a massive check. You might be excitedly thinking about what to buy with a tax refund. Or mourning the loss of a loved one who left you an inheritance. Whether you were expecting this windfall or not, it’s important to slow down and think about the best way to use it. Many people let their impulses get the better of them. But used wisely, every windfall is a chance to give your financial plan a boost. Why it’s so easy to waste a windfall We tend to treat windfalls like inheritances differently than we treat other money. Many of us naturally think of it like a “bonus,” so saving may not even cross our mind. And even if you’ve worked hard to develop healthy spending habits, a sudden windfall can undo your effort. Here’s how it can happen: An inheritance makes your cash balance spike. You spend a little on early splurges, and start to slack on saving habits. This behavior snowballs, and a few months or years later, you face two consequences: you’ve completely spent the inheritance, and you’ve lost the good fiscal habits you had before. You can also fall into the trap of overextending your finances after using an inheritance for a big purchase. Say you use the inheritance for a down payment on a bigger house. Along with a bigger house comes higher property taxes, home maintenance costs, homeowner’s insurance, and monthly utilities. New furniture, too. Your monthly expenses can expand quickly while your income stays the same. The moment you find yourself with a lot of extra money, think about taxes. Why taxes should always come first You don’t want to spend money you don’t have. If you burn through your windfall without setting aside money for taxes, that’s exactly what you could be doing. You’re not going to pay taxes on a tax refund, but if you receive an inheritance, win the lottery, sell a property, or find yourself in another unique situation, you could owe some hefty taxes. The best thing to do is consult a certified public accountant (CPA) or tax advisor to determine if you owe taxes on your windfall. What to do with the rest of your windfall Once taxes are taken care of, look at your windfall as an opportunity to accelerate your financial goals. Remember, if you created a financial plan, you already thought about the purchases and milestones that will be most meaningful to you. Sure, plans can change, but many of your responsibilities and long-term goals will stay the same. Still stuck? Here are some high-impact financial goals you can make serious progress on in the event of a windfall. Pay down your debt Left unchecked, high-interest debt can often outpace your financial gains. Credit card debt is especially dangerous. And while your student loan debt may have low interest rates, paying it off early could save you thousands of dollars. Paying off debt doesn’t have to mean you can’t work toward other financial goals—the important thing is to consider how fast your debt will accrue interest, and make paying it off one of your top priorities. Depending on the size of your windfall, you could snap your fingers and make your debt disappear. Boost your retirement fund It’s not always fun to plan years into the future, but putting some of your windfall to work in your retirement fund could make life a lot easier down the road. Put enough into retirement savings, and you may even be able to adjust your retirement plan. Maybe you could think about retiring earlier, or giving yourself more money to spend each year of retirement. Here’s more on planning your retirement. Refinance your mortgage Paying off your primary mortgage isn’t usually a top priority . . . but refinancing can be a smart move. If you’re paying mortgage insurance and your equity has gone up enough, refinancing might mean you can stop. And locking in a lower interest rate can save tens of thousands of dollars over the life of your mortgage. Taking this step means your goal of home ownership may interfere less with your other financial goals. Revisit your safety net Any time your cost of living or responsibilities change, your emergency fund needs to keep up. Whatever stage of life you’re in, you want to be confident you have the finances to stay afloat in a crisis. If you suddenly lost your job or couldn’t work, do you have enough set aside to maintain your current lifestyle for at least a few months? Start estate planning Wherever you’re at in life, it’s important to consider what would happen if you suddenly died or became incapacitated. What would happen to you, your loved ones, and your assets? Would your finances make it into the right hands? Would they be used in the right ways? When you find yourself with a major windfall, it’s a good time to create or reevaluate your estate plan. Take time to double-check that you’ve set beneficiaries for all of your investment accounts. If you haven’t already, create a will and appoint a power of attorney. If you have children, you may want to set up a trust. Estate planning isn’t fun, but it can start paying immediate dividends in the form of peace of mind. Give your financial goals a boost It’s normal to want to spend your inheritance. It feels like extra cash, just waiting to be spent on a big purchase. But if you resist the temptation, your financial windfall could be an incredible opportunity to reach new milestones and achieve goals that matter to you. Not sure where to start? Tell us about your financial goals. Please note that Betterment is not a licensed tax advisor or estate planning professional.
Putting Together An Estate Plan For Your InvestmentsPutting Together An Estate Plan For Your Investments Help make sure the right people make decisions on your behalf and receive the inheritance you want. In 10 seconds Your estate plan provides a roadmap for what happens when you die. It can cover everything from funeral plans to who will take care of your kids and how your assets will be distributed. In 1 minute If you suddenly found yourself on life support or developed a serious mental illness, what would happen to you? If you died tomorrow, what would happen to your children, and your things? State laws can answer these questions, or you can decide for yourself with an estate plan. By preparing in advance, you can help ensure that the right people make decisions on your behalf and that your loved ones receive the inheritance you want them to. (And if there’s anyone who shouldn’t receive an inheritance, your estate plan can keep them from cutting in.) Designating a financial power of attorney and creating an advanced medical directive will help ensure that important decisions are made by people you trust if you’re ever incapacitated. For financial accounts, you can set up joint ownership or name beneficiaries so that these assets make it to the right hands. Sometimes you may want to divide these responsibilities between trustworthy people. But this can also make even simple decisions more complicated—because two or more people have to sign off on every choice. Creating a last will and testament can lay out your final arrangements, distribute your personal possessions, and name a new guardian for your children. You’ll also choose an executor to carry out your desires. A trust is another key estate planning arrangement that can give you control over who receives financial assets, when they receive them, and how they can use them. Together, these roles and documents allow your financial plan to live on when you’re unable to manage it. A well thought-out estate plan can give your loved ones a little piece of mind and remove some of the uncertainty they’ll face in your absence. In 5 minutes In this guide, we’ll cover: What your estate plan needs to do Who should be part of your estate plan What documents to include in your estate plan An estate plan can define what will happen with the people and things you’re responsible for if you die or become incapacitated. Who will make medical or financial decisions on your behalf? Who will be your child’s new guardian? How will your finances be divided? Who gets the house? Those aren’t decisions you want a stranger to make for you. But without an estate plan, that could be what happens. Unless you say otherwise, state laws will govern your estate. And those generic laws may not align with your values and goals. That’s why whatever your age and whatever your financial situation, an estate plan is crucial. Before you start creating an estate plan, it helps to consider your unique situation. What does your estate plan need to do? Your estate plan can answer questions about what happens with your assets and how your loved ones will be taken care of when you’re gone. So you need to consider how you’d answer those questions now, anticipating choices that could come up in the future. For example, if you’re expecting to receive an inheritance, be sure to think through how your estate plan would distribute it or who would manage it. And if there’s anyone you need or want to financially support, that should guide your estate plan as well. Who should be part of your estate plan? An estate plan doesn’t just decide who gets what. It can also determine who’s in charge of what. There are several key roles to consider in your estate plan. You may want to divide these roles between multiple people, or let one call the shots. For example, if all of your children have the authority to make medical decisions on your behalf, that may lead to more thoughtful decisions. But it’s a trade off. Each of the people you give power to has to sign off on decisions, which can slow things down and make it much more difficult to coordinate. Financial Power Of Attorney (POA) Giving someone financial power of attorney can make it easier for them to pay bills, file taxes, or cash checks on your behalf. You can decide how broad or limited their control is. Even with broad authority, a financial power of attorney can’t change your will. The idea is that if you’re physically or mentally unable to take care of your day-to-day finances, you’ve designated someone to take care of that for you. Make sure the person you designate has a copy of this paperwork or knows where to find it. You can also give a copy to your financial institutions. Advanced Healthcare Directive An advanced healthcare directive helps decide how to handle medical decisions when you can’t make them yourself. It can lay out specific care instructions like, “Do not resuscitate,” but it can also give someone medical power of attorney to make decisions on your behalf. When you can’t think through important decisions anymore, who do you want to make the call? Your spouse? Your children? A parent? A sibling? As with financial power of attorney, you can define the scope of this power. Joint Owner If you name someone the joint owner of your accounts, then when you die, they become the sole owner. This is a common way for married couples to handle their estates, and it usually keeps the state from getting involved in distributing your assets when you die. Just keep in mind: anyone you name as a joint owner gains equal control of your assets while you’re alive, too. Also, retirement accounts such as 401(k)s and IRAs can’t be put into joint ownership. Beneficiaries You may also want individual assets to go to specific people. In that case, you may want to name beneficiaries for your bank accounts, investment accounts, life insurance policy, real estate, and other major assets. Name beneficiaries in your will, and these assets will have to go through probate first, where a court process proves that your will is authentic. This typically increases the time before your beneficiaries receive the inheritance and reduces the amount that ultimately makes it to them. For your accounts, adding beneficiaries can be as simple as filling out a form through your bank or investment firm. In some states, you may be able to use a Transfer on Death (TOD) Deed to ensure that your real estate goes directly to the beneficiary. Here’s how easy it is to set up beneficiaries in Betterment. What documents should your estate plan include? While there are many legal documents that make up an estate plan, two of the more important ones are a will and a trust. Here’s what those entail. Last will and testament A will serves several purposes. It can clearly lay out your final wishes, state who will take care of your non-adult children, and say who receives your belongings. If you do a good job naming beneficiaries for your assets, this mostly affects personal belongings. A will should usually start with a declaration. This identifies who you are and says that the document is your will. You’ll generally have to sign it in front of witnesses (and possibly a notary). You’ll need to choose an executor who will ensure your wishes are carried out, including any final arrangements for your death and funeral services. Your will can define the scope and limitations of their power as well as any compensation you want them to receive. If you have non-adult children, your will should name their new guardians. Wills also define bequests: individual gifts you give someone. Think family heirlooms. Clothing. Vehicles. Money. You can change your will at any time. And as your valuables and relationships change, you’ll want to keep it up to date. Trust A trust is a legal entity that gives someone (usually you) the right to hold your assets for the benefit of someone else. It provides several advantages that help your financial plan live on when you’re gone. Some types of trusts can shield your assets from estate taxes. They can also protect your assets from creditors, litigation, and even public records. As part of your trust, these assets also avoid probate. By using a trust, you keep greater control over your assets, too. You can define who gets your assets and when, as well as what they can do with them. With Betterment, you can open an account in the name of a trust–revocable or irrevocable–that you have already established. Plan your estate State laws can vary and every personal situation is different. Betterment is not a licensed estate planning professional, so we highly recommend speaking with an estate planning professional or an attorney to help you navigate this journey.
How To Manage Debt And Invest At The Same TimeHow To Manage Debt And Invest At The Same Time With the right strategy, it's possible to make progress on both goals. In 1 minute Managing debt and investing is a tricky balancing act, but they're both vital to your financial future. At Betterment, we recommend you focus on your high-interest debt first. Anything over 6% should be prioritized, starting from the highest-interest debt and working your way down the list. You shouldn’t let this grow, or it might get out of hand. For your other debts, you may be able to get by with minimum payments. If your employer offers to match your contributions to a retirement plan, get on that! An employer match is one of the fastest ways to maximize the value of your investments. You don’t want to waste the opportunity for free money. And a 401(k) comes with tax advantages to boot! You’ll also want to protect yourself from unexpected expenses by saving up a safety net. When a surprise bill shows up, you want cash on hand to prevent you from going further into debt. Other than that, treat your debt payments and investments as part of your fixed monthly expenses. Don’t let working toward your goals feel optional. Managing debt and investing can feel overwhelming. But our step-by-step guide below will walk you through it. In 5 minutes In this guide, we’ll explain how to manage debt and invest in six steps: Account for your spending Make minimum debt payments Contribute to an employer-matched retirement plan (if you can) Build a Safety Net Fund Focus on high-interest debt Invest for the long-term First, let’s talk about your debt, your goals, and your repayment strategy. Planning around your debt. Debt can completely derail your financial goals. It eats through your savings and can offset the gains you make through investing. Repaying major debt like student loans can feel like climbing a mountain. For Black and Latino folks, that mountain tends to be higher as the need for student loans is often greater and the interest rates often higher than non-Black or Latino students. But not all debt is the same. High-interest credit card debt will quickly outpace your investment earnings. Ignore it, and it will consume your finances. Debt with lower interest rates, like some student loans or your mortgage, can be much less of a priority. If you put off investing in favor of attacking this debt, you may not have time to reach your goals. It is possible to pay debt and invest at the same time—the key is to create a strategy based on your debt and your financial goals. At Betterment, we recommend focusing on the debt with the highest interest first. The more time you give this debt to grow, the harder it becomes to pay off. Now let's walk through Betterment’s six steps to manage your debt and invest. Step 1: Account for your spending. Your finances are finite. You have a limited amount of money to pay down debt, invest, and cover your expenses. The first step is to learn what comes in and goes out each month. How much do you have to work with after rent, food, utilities, and other fixed expenses? Are there expensive habits you can eliminate to free up more money? Don’t plan to make changes you can’t stick to. The goal here is to establish a monthly budget, so you have enough to cover your bills and know how much you can save or put towards debt. We also recommend keeping enough in your checking account to act as a small buffer—three to five weeks of living expenses is generally a good rule of thumb—as even the best laid plans (or budgets) are derailed at times. Step 2: Make minimum payments. You really don’t want to miss your minimum payments. Fees and penalties make your debt hit harder, and they’re usually avoidable. Think of your minimum debt payments as fixed expenses. After your regular living expenses, minimum debt payments should be a top priority. Step 3: Contribute to an employer-matched retirement plan. If your employer offers to match contributions to a 401(k), that’s free money! Don’t leave it on the table. A 401(k) also comes with valuable tax benefits. Even if it under performs, the match program allows your contributions to grow faster. It’s like your employer is giving your financial goals a boost. And that’s why this is almost always one of the smartest investment moves you can make. Step 4: Focus on high-interest debt. When it comes down to it, high-interest debt is your biggest enemy. It’s a festering financial wound that grows faster than any interest you’re likely to earn. Left unchecked, credit card debt can easily cost you thousands of dollars in interest or more. And that’s money you could’ve invested, applied to other debt, or saved. Step 5: Build a Safety Net Fund. Without a financial safety net, you’re one unexpected medical bill, car accident, or surprise expense away from even more debt. Generally we encourage you to pay off your high interest debt before fully funding a three to six month emergency fund. However, some people, particularly those who are worried about income loss, prefer building a large cushion of cash for emergencies first over paying down extra debt Step 6: Invest for the long-term. Once you’ve paid down your high-interest debt, you can begin investing for the long-term. With a diversified portfolio, your investments can outpace your lower-interest debt. So you can work toward financial goals while making minimum payments. Using automatic deposits, you can create an investment plan and stick to it over time, treating your investments as part of your fixed budget. Your safety net will give you some financial breathing room, and before you know it, you’ll be making progress toward retirement, a downpayment on a house, college for your kids, or whatever your goal is.
Financing An Education: A Guide For Students And ParentsFinancing An Education: A Guide For Students And Parents Learn more about two common vehicles: 529 plans and student loans In 1 minute There’s more than one way to finance your education. A 529 plan is like a retirement account—but for education. It comes with tax benefits and can grow over time. Just keep in mind that each state has its own 529 plan, and the investment choices, rules and benefits vary. Some states match whatever you put into the account, or let you pay for tuition credits now (with today’s prices). Performance, contribution limits, and usage rules can also vary from plan to plan. You’re not limited to the 529 plan offered by your state. So don’t assume your state’s plan is right for you. As you compare plans, focus on tax benefits, fees, and investment choices. You can also pay for school with student loans. Most students have to take out at least some loans to fund their education. As long as you choose your loans wisely and have a strategy for paying them off, borrowing can make sense. You may not even have to repay all of your loans if you qualify for loan forgiveness after you graduate. And if you need to, you can usually consolidate or refinance your loans to make repayment simpler or lower your interest rate. Whether by borrowing, saving, or some combination of the two, an early emphasis on how to fund your studies helps set you up for academic success once class is in session. In 5 minutes In this guide, we’ll cover: Investing in a 529 plan Financing responsibly with student loans Whether you’re looking at university or trade school, education is expensive. And if you’re like most people, you probably don’t have that kind of cash on hand. Some manage to work their way through college, but depending on the school, even a full-time job will barely put a dent in your expenses. So how should you pay for school? The answer depends on how much time you have, where you live, and where you want to go. If you have money to set aside for school, a 529 plan might be your best bet. Student loans are always an option, too—you just have to be careful. What’s a 529 plan? How do you choose one? A 529 plan is a specialized investment account with tax benefits. It works similarly to a Roth IRA or Roth 401(k). You put money into the account and pay taxes up front, and if you withdraw for education expenses, you usually don’t have to pay taxes on anything you earned. While IRAs and 401(k)s help you plan for retirement, 529 plans help you plan for education expenses. Oh, and every state has its own plan. There are two types of 529 plans: Prepaid tuition plans Education savings plans Prepaid tuition plans With a prepaid tuition plan, you pay for tuition credits upfront, using today’s tuition rates. These plans are not very popular, and most states don’t offer these plans anymore, but since tuition costs are always increasing, this can be a good option. Who knows how much tuition will cost in the coming years! The downside is that this money can only be used for tuition, and there are plenty of other education expenses. Education savings plans An education savings plan is more like a traditional investment account. You invest in funds, stocks, bonds, and other financial assets, and your account has the potential to grow through compound interest. You can also use this money on more than just tuition. Depending on your state, you could use your account for education fees, living expenses, technology, school supplies, or even student loan payments. Use it on anything else, and there’s a 10% penalty. 529 plan limitations Every 529 plan needs a specific beneficiary. It could be yourself, your child, a grandkid, a friend—whoever. Their age doesn’t matter. The only limitations are what the funds can be used for and how much you can contribute. Everything you put into a 529 plan is considered “a gift” to the beneficiary. And there are limits to how much you can gift to a person each year before being subject to gift tax rules. But you also have a lifetime limit in the millions of dollars. After that, there’s a gift tax. Gift tax rules are complex, so we recommend consulting a tax professional. Every state is different 529 plans can vary widely from state-to-state. And since you can choose plans from other states, it’s worth shopping around. While some plans let you apply your account to in-state or out-of-state education, others don’t. If you’re looking at a plan you can only use in-state, make sure you’re comfortable with the available schools. Some states offer a match program, where they’ll match a percentage of 529 plan contributions from low- and middle-income families. This could substantially boost your savings. Your state might also offer a full or partial tax break on your contributions—but that usually only applies if you live in state. And of course, each 529 plan is an investment account, so you’ll also want to review the investment choices and consider the cost of fees. For every plan, the account’s total worth can only be equal to the “expected amount” of future education expenses for each beneficiary. But that’s going to vary widely from state to state. The exact limit depends on which 529 plan you choose, but it’s typically a few hundred thousand dollars for each beneficiary. If you’re wanting to save for a private college or grad program, that may not be enough. And if your state’s limit is lower than what you think you’ll need, that may offset the benefit of a state tax break or match program. And according to Federal law, you can use up to $10,000 from a 529 plan to pay for “enrollment or attendance at an eligible elementary or secondary school.” It also lets you apply $10,000 toward student loans. But some states don’t follow these federal laws. If they don’t, and you use your funds like this anyway, you’ll have to pay a 10% penalty. Bottom line: do your research, and make sure you’re familiar with the specifics of your 529 plan. How to choose a 529 plan The best 529 plan for you depends on: Where you live Where you or your beneficiary will go to school How much you want to save What you want to spend this money on But if you’re wondering how to tell which plan is likely to make the most of your money, it really comes down to just three things: tax benefits, fees, and investment choices. Be sure to look at all plan details and compare these factors before choosing one. Student loan basics Student loans have a bad reputation. And it’s understandable. About 43 million Americans owe an average of $39,000 in student loans. The average student needs to borrow about $30,000 to earn their bachelor’s degree. But when it comes down to it, if you don’t have money to contribute to a 529 plan or investment account (or your account doesn’t have enough money), your options are: Work your way through college Take out student loans Even with a job, you may need to take student loans. Used wisely (and sparingly), student loans don’t have to consume your finances or derail your other goals. But as with 529 plans, you can’t assume every loan is the same. Types of student loans There are two main types of student loans to consider: Federal Private Federal student loans often (but not always) have the lowest interest rates, don’t require credit checks, and come with benefits like pathways to loan forgiveness. You don’t need a cosigner to get most federal loans, and nearly all students with a high school diploma or GED are eligible for them. However, there’s a cap on how much money you can take out in federal loans, and some types of federal loans require you to demonstrate financial need. Financial institutions like banks can also provide private student loans. These typically require a good credit score, and you can take out as much as you need (as long as you’re approved for it). Another big difference: with private loans, you typically start making payments immediately and have a fixed repayment schedule set by your lender. With federal loans, you may not have to pay while you’re in school, you get a six-month grace period after you graduate, and you can choose from four repayment plans. Federal loan repayment options Federal loans give you flexibility with repayment. If you’re struggling to make monthly payments, you can choose one of four Income-Driven Repayment (IDR) plans that may work better for your situation. Each of these plans allows for payments based on your income, usually 10-20% of it with a few exceptions, which makes individual payments more manageable. Unfortunately, this usually also means you’ll be making payments for longer. Check out the Federal Student Loan website for more detailed information on each plan. If you want to pay off your loans faster, you can also select a Graduated Repayment Plan, which increases your payments periodically, ensuring you pay off your loans in 10 years. There’s also another way to ditch your federal loan payments ahead of schedule: loan forgiveness. Student loan forgiveness With federal loans, there are two pathways to loan forgiveness: Public service Income-Driven Repayment Go into the right line of work after college, and you could be eligible for Public Student Loan Forgiveness (PSLF). This is available to students who pursue careers with nonprofits, government agencies, and some public sectors. If you make monthly qualifying payments for 10 years, then you can apply for forgiveness. If you don’t qualify for PSLF, but you’re on an IDR plan, you have another potential pathway to forgiveness. After 20-25 years of monthly payments, you may qualify for forgiveness, too. Unfortunately, on this path, you have to pay income taxes on the amount that was forgiven. (This is referred to as a “tax bomb.”) Consolidating and refinancing student loans Sometimes it’s tough to juggle multiple repayment schedules, interest rates, and payment amounts. If you’re having a hard time keeping track of your student loans, you may want to consider consolidating them so you have one monthly payment. Consolidating through a private institution could also give you a new interest rate (the average of your old ones) and let you adjust your payment time horizon. The federal consolidation program won’t change your interest rate, but it will still group your loans into a single payment for you. Whatever loans you wind up with and whatever your repayment plan, make sure you stay on top of your minimum payments. Fees and penalties can significantly increase your debt over time.
Crypto Investing 101Crypto Investing 101 Three questions to ask yourself before you invest in crypto. If you’re taking your first steps into the world of cryptocurrency investing, we recommend asking three questions to gain your footing. Don’t worry, we have some answers to get you moving when you’re ready. And remember, to invest in crypto you don’t have to be an expert. We’re here to be your guide so you can make the best decision for you. Question 1: What is crypto? A simple question with a not so simple answer. To date, there are over 17,000 types of crypto in existence.1 Bitcoin and Ethereum may be household names but the world of crypto extends far beyond their influence. In order to understand crypto, it helps to understand its underlying technology: blockchain. Blockchain is a technology that, in the context of crypto, provides recordkeeping through five foundational features: Immutable: The data can’t be changed. Decentralized: Controlled by a large network of computers instead of a central authority. Distributed: Many parties hold public copies of the ledger. Cryptographically Secure: Makes tampering or changing the data basically impossible. Permissionless: Open to anyone to participate. If you don’t remember any of the five features above, here’s the big idea: The internet enabled the digital flow of information. Blockchain technology enables the digital flow of almost anything of value. What does that mean? It means we can create systems to record ownership without the need for third parties. And we can transfer ownership—using blockchain—between each other without a third party. This creates potential for new economic and business models, which is why there are more than 17,000 types of crypto. Crypto use cases span from art (for example, you can bid on a bored looking ape for only a few hundred thousand dollars) to banking (making financial services available to marginalized groups) to gaming (better grab that plot of land in the metaverse before Snoop Dogg does). All of this is made possible because crypto, built on blockchains, creates new ways to transact in a growing digital economy. Question 2: Why should I invest in crypto? If you want to invest in crypto, reflecting on why can help guide your investments. Crypto is an emerging asset class and is transforming the financial industry. However, you should be careful to understand the risks of cryptocurrency, which can be highly speculative and volatile and can experience sharp drawdowns. Like all investing, this is personal and not without risk, and we encourage you to invest in crypto only when you are comfortable bearing the risk of loss. One of the things that excites us about crypto is the diversity of the ecosystem that is being created. Crypto is far more than simply a digital currency used to buy NFT art or “digital gold” as we see in the headlines. The use cases are creating global investment opportunities available to anyone who chooses to participate. Keep in mind, across the thousands of crypto projects, you do have to look out for scams and fraud. For example, Squid Game may have been a TV show worth binge watching but ended up being a crypto worth almost nothing. But that’s not to say that crypto can’t be used for good. (Fun Fact: Did you know that you can donate crypto to charity? GiveWell, one of Betterment’s partner charities, accepts many different types of crypto!) Here are a few common reasons people invest in crypto: Make Money Crypto investing comes with risks. There can be extreme price fluctuations compared to traditional asset classes. With that said, there is the potential for crypto to rapidly increase in value both over short and long periods of time. Based on Betterment’s research, this is the #1 reason people invest in crypto. And that’s perfectly fine—we invest to create wealth for ourselves and loved ones. Decentralization Many of the projects that create crypto tokens are considered decentralized, which means they aim to remove the control banks and large institutions have on financial services and other business models such as advertising. When applied to traditional finance, this sector of crypto is called Decentralized Finance, or DeFi. Blockchain technology, including digital wallets and smart contracts, can be used to replace banks and other third parties. In theory, this can put users in control, reduce fees, and speed up transactions. (You can send crypto almost instantly to another digital wallet.) Oh, and did we mention that crypto transactions can occur 24/7/365? Another benefit of its decentralized nature. Invest in the Future As we’ve mentioned, crypto spans a broad spectrum of our lives, and it's changing the future, even if we don’t know how yet. By now, you’ve likely heard the term metaverse being casually used, whether by Facebook’s (sorry, we mean Meta’s) CEO Mark Zuckerberg or by a family member at a holiday dinner. It’s everywhere we look. And one way or another, many investors believe the metaverse will be part of our future. Similarly, the concept of Web 3.0, which is a broader evolution of the internet, offers investors many forward thinking investments to consider. The best part? It’s generally accessible to anyone, not just angel investors and venture capitalists. Stepping back, a more general reason for investing in crypto, especially if you are completely new to it, is diversifying your broader investment portfolio. If done correctly, including a small amount of crypto in your overall portfolio may help prevent you from being overly exposed to concentrated risks. Depending on what crypto investments you select, you’ll gain exposure to advancements in the metaverse, decentralized finance, and Web 3.0 technologies, among others. Question 3: How should I invest in crypto? There are many ways to invest in crypto but we’ll boil this down to two categories for you to choose from: Do-It-Yourself Crypto and Managed Crypto Portfolios. Do-It-Yourself Crypto DIY crypto investing involves navigating digital wallets, selecting crypto exchanges, and safekeeping keys (so important!). Before you do any of that, don’t forget you need to research which of the 17,000-plus cryptos you want to invest in while navigating the crypto ecosystem yourself 24/7/365. Particularly because cryptocurrency is so varied and prone to speculation, DIY crypto involves significant upfront research to understand which crypto is the right fit for you. Managed Crypto Portfolios Crypto managed portfolios function similarly to managed equity portfolios. The technology and investment experts that manage the crypto portfolio do much of the heavy lifting (the nitty gritty research of which cryptocurrencies may be appropriate for you based on your financial situation and preferences, the rebalancing and reallocation, and the managing of your account, including wallets/keys) while you can focus on the bigger picture like creating the life you want through your investments. There is still risk with this method of investing in that the underlying cryptocurrencies may experience losses, but it can help you invest in crypto based on your needs and interests, creating a personalized crypto investing experience. Plus, you’ll save time and not have to stress about remembering your digital wallet’s password for fear of losing your Bitcoin forever. Are you ready to invest in crypto? Before you step into crypto investing, make sure you know what you are investing in and why it’s important to you, and try to understand the risks involved. Remember, you don’t have to be an expert. If you reserve the term DIY for weekend trips to the Home Depot, not crypto investing, consider a managed crypto investing portfolio.
How To Use Your Health Savings Account (HSA) For RetirementHow To Use Your Health Savings Account (HSA) For Retirement Once you turn 65, you can use them for anything you want—without incurring penalties. In 1 minute Like IRAs and 401(k)s, health savings accounts provide tax benefits. Your contributions to an HSA are tax-free, and if you use this money to cover qualified medical costs, your withdrawals are tax-free, too. With the right HSA, you can even invest these funds and earn interest on your contributions. Unfortunately, there’s a couple of catches. You can read more detail here, but the key highlights are below. For starters, you’re only eligible to contribute to an HSA if you’re currently enrolled in a high deductible health plan (HDHP) and meet a few other conditions: You are not enrolled in Medicare You are not someone else’s dependent You do not have other health coverage And just as importantly, if you use HSA funds on unqualified expenses before you turn 65, there’s a steep 20% penalty. Many people should expect to have more medical costs during retirement, and since withdrawals for qualified medical expenses are tax-free, it’s usually best to delay using your HSA until retirement. And since the penalty disappears after 65, HSAs can be a great tool to save for general retirement, too. Especially if you’re already maxing out your contributions to other retirement accounts! If you’re thinking about switching health plans to open an HSA, make sure you consider whether an HDHP is right for you and your family. Your HSA won’t help you plan for retirement if you have to use it all on medical expenses each year. That’s why it’s usually smart to have a fully-funded emergency fund before or soon after signing up for an HDHP. You’ll also want to choose an HSA with investment options that fit your goals. Decades away from retirement? An HSA that only lets you invest in short-term money market funds probably isn’t ideal. As long as the health plan is a good fit and you find the right opportunity, an HSA can be a smart investment in your future. In 5 minutes In this guide, we’ll cover: HSA eligibility The benefits of HSAs HSA withdrawal rules Using an HSA for retirement Health Savings Accounts (HSAs) are designed to cover future medical expenses. But that’s not the only way to use them. Thanks to their tax benefits and withdrawal rules, HSAs can make a valuable addition to your retirement plan. As long as you’re eligible, you can make tax-deductible contributions to an HSA. The balance on this account rolls over every year, so there’s no pressure to “use it or lose it.” But you can’t just dump all your extra money into an HSA to avoid taxes, either. Your contribution limit depends on your age and who your health plan covers. If you’re 55 or over, you can make additional “catch-up” contributions. And if your family is covered by your health plan, it effectively doubles your limit. HSA Contribution Limits Contribution Limits Catch-up Contribution Limits (for individuals 55 and above) HSA 2021 2022 2021 2022 Self-only coverage $3,600 $3,650 $1,000 $1,000 Family coverage $7,200 $7,300 $1,000 $1,000 Want to take advantage of an HSA? First you need to find out if you’re eligible. Am I eligible for an HSA? To be eligible for an HSA, you have to: Be covered under a high deductible health plan (HDHP). Not be enrolled in Medicare. Not be claimed as a dependent on someone else’s tax return. Have no other health coverage except what the IRS covers under “Other Employee Health Plans”. Your employer may have information on HSA providers available to you. The expanded IRS rules can provide more detailed eligibility information. What are the benefits of an HSA? Health Savings Accounts have a couple tax benefits that help you make the most of your assets. Your contributions are pre-tax, meaning you can deduct them from your income taxes. You can use these funds at any time to pay for qualified medical expenses without paying taxes or penalties. And when you turn 65, you can use your HSA for anything without incurring a penalty. While you must have a high deductible health plan in order to contribute to your HSA, your HSA isn’t tied to a specific employer. It stays with you when you change jobs or retire. The money doesn’t leave the account until you use it. Also, your employer may contribute to your HSA—and since the contribution is pre-tax, it doesn’t count toward your gross income. Some HSAs are specialized savings accounts. But some are actually investment accounts. Any interest and earnings that come from these HSAs are tax-free provided you don’t use them on unqualified expenses before you turn 65. So HSAs can rank amongst the best ways to save for retirement, on par with some 401(k)s and IRAs depending on factors such as an employer match, fees, and/or investment choices. HSA withdrawal rules Need some money to cover unexpected medical costs? Make a tax-free withdrawal. Don’t need it? Save it for your retirement. Withdrawing from an HSA for non-medical expenses comes with a 20% penalty . . . unless you’re over 65. Once you turn 65, withdrawals from an HSA work a lot like withdrawals from a traditional IRA or 401(k). Your withdrawals count toward your annual income, so you’ll pay income taxes based on your tax bracket. However, if you use your withdrawal to pay for medical expenses, it’s still tax-free. Basically, there are three possible outcomes when you withdraw from an HSA—and it all comes down to your age and what you use the money for. Your age Qualified Medical Expenses Other Expenses Less than 65 years old No taxes, no penalty Taxes are applicable, 20% penalty 65 years old or older Taxes are applicable, no penalty How to use your Health Savings Account for retirement When you reach retirement age, medical bills can start to add up quickly. Use your HSA to cover these expenses, and you’re triple-dipping on the tax benefits! Your contributions are tax free, your interest and earnings are tax free, and so are your withdrawals. From a financial planning perspective, that’s hard to beat. And it can make expenses like long-term care a lot less frightening. But an HSA is also a great supplement to your IRA or 401(k). Since the 20% penalty disappears when you turn 65, you won’t have to worry about whether an expense is qualified—just use your money as you see fit. Before you choose an HSA ... An HSA is like a financial Swiss Army Knife. But while it’s highly versatile, it’s not the right choice for everyone. So, before you switch health plans and open an HSA, there are a few things to consider. Know the fees When it comes to fees and other costs, HSAs are often less transparent than accounts like 401(k)s. Look at the full fee schedule for your HSA before contributing. Also, sometimes your employer will cover all, or a portion, of your fees—so find out about that, too. Explore the investment options Ideally, you want an HSA with investment options that fit your goals. Some providers only allow investments with low risk and low returns, like money market funds. Other HSAs offer multiple mutual fund listings with higher returns and more risk exposure. Some HSAs have minimums before you can start investing. For example, you might only be able to invest your money once you’ve contributed $1,000 to the HSA. Stay current on withdrawal rules Withdrawal rules around taxes and penalties can change with new regulations, so it’s important to stay up-to-date with any new changes that take place. Don’t just switch to an HDHP A high-deductible health plan isn’t right for everyone. Before switching to an HDHP so you can use an HSA to save for retirement, make sure that works for you and your family. A high-deductible health plan brings with it the potential for higher out-of-pocket medical costs.
What Are The Most Common Asset Classes For Investors?What Are The Most Common Asset Classes For Investors? Every type of asset gains or loses value differently, so it helps to know what those types are and how they work. In 1 minute Asset classes are investments that share the same risk factors, influences, and regulations. The most common asset classes are stocks, bonds, and cash. Stocks: Stocks are shares of a company, and they gain or lose value based on the company’s performance and potential. Bonds: Bonds are like loans—usually loans to a company or government—which accrue interest over time. Cash: Think bank accounts. Cash investments are usually short-term loans with low risk and low returns. They’re also federally insured. Betterment helps you automatically select the mix of assets that can help you meet your goals, and bundles them into funds. Tell us about your financial goals, and we’ll show you a roadmap for how to reach them. Got more time? Keep learning about asset classes below. In 5 minutes In this guide, we’ll: Explain what an asset class is Explore the most common asset classes Look at mutual funds and ETFs What is an asset class? An asset class is a name for a group of assets that share common qualities and behave similarly in the market. They’re governed by the same rules and regulations, and gain or lose value based on the same factors and circumstances. Different asset classes have relatively little in common, and tend to have fluctuations in value that are imperfectly correlated. There are eight main asset classes: Equities (stocks) Fixed income (bonds) Cash Real Estate Commodities Cryptocurrencies Alternative investments Financial Derivatives Within these groups, there are several assets people commonly invest in. The most common types of assets for investors. The three financial assets you may hear about the most are stocks, bonds, and cash. A strong investment portfolio likely often includes a balance of these assets, or combines them with others. Let’s take a closer look at each of these. Stocks A stock is a type of equity. It’s basically a tiny piece of a company. When you invest in stocks, you become a partial “owner” of the companies that issued those stocks. You don’t own the building, and you can’t go bossing around the employees, but you’re a shareholder. Your stock’s value is directly tied to the company’s profits, assets, and liabilities. And that means you have a stake in the company’s success or failure. Stocks are volatile assets—their value changes often—but over time they tend to perform better than other assets (such as bonds and cash). Choosing stocks from a wide range of companies in different industries is one of the smartest ways to diversify your portfolio. Bonds A bond represents a share of a loan. Its value comes from the interest on the loan. Bonds are typically more stable than stocks. Lower risk, lower reward. Bonds belong to the “fixed income” asset class, and tend to depend on different risk variables than stocks. If a company has a bad quarter, that’s probably not going to affect the value of your bond. Unless they have a really bad quarter, and default on their loan. When stock markets have a bad month, investors tend to flock to safer asset classes and bonds therefore will likely outperform. Other than that, the main things to consider with bonds are interest rates and inflation. When interest rates increase or decrease, it directly affects how much interest you accrue. And since bonds generate lower returns than stocks, they leave you more vulnerable to inflation, too. Cash With cash investments, you’re basically loaning cash (often to a bank) in exchange for interest. This is usually a short-term investment, but some cash investments like certificates of deposit (CDs) can last for a few years. These investments are pretty low-risk because you can be confident they will generate a return, and they’re actually insured by the FDIC. Cash investments offer higher liquidity meaning you can more quickly sell these assets when you need the money. As such, the return you get is typically lower than what you’d achieve with other asset classes. Investors therefore tend to park the money they need to spend in the near-term in cash investments. Other common assets Those are the big three. But investors also invest in real estate, commodities, alternative asset classes, financial derivatives, and cryptocurrencies. Each of these asset classes come with their own set of risk factors and potential advantages. What about investment funds? An investment fund is a basket of assets that can include stocks, bonds, and other investments. The most common kinds of funds you can invest in are mutual funds and exchange-traded funds (ETFs). Mutual funds and ETFs are similar, but there’s a reason ETFs are gaining popularity: they’re usually cheaper. ETFs tend to be less expensive to manage and therefore typically have lower expense ratios. Additionally, mutual funds charge a fee to cover their marketing expenses. ETFs don’t. Mutual funds are also more likely to be actively managed, so they can have more administrative costs. Most ETFs are funds that simply track the performance of a specific benchmark index (e.g., the S&P 500), so there’s less overhead to manage ETFs. ETFs have another advantage: you can buy and sell them on the stock exchange, just like stocks. You can only sell a mutual fund once per day, at the end of the day. That’s not always the best time. Being able to sell at other times opens the door to other investment strategies, like tax-loss harvesting. Want to learn more about investment strategies? Check out the ones we use at Betterment. [Button] Go How to choose the right assets When you start investing, it’s hard to know what assets belong in your investment portfolio. And it’s easy to make costly mistakes. But if you start with a goal, choosing the right assets is actually pretty easy. Say you want $100,000 to make a down payment on a house in 10 years. You have a target amount and a deadline. Now all you have to do is decide how much risk you’re willing to take on and choose assets that fit that risk level. For most investors, it’s simply a matter of balancing the ratio of stocks and bonds in your portfolio.
What Is a Tax Advisor? Attributes to Look ForWhat Is a Tax Advisor? Attributes to Look For Since Betterment isn't a tax advisor, we often suggest that customers see a tax advisor regarding certain issues or decisions. Who exactly is a tax advisor and how should you think about picking one? Tax season is now upon us. Now that you’ve probably received all of your tax forms, you may be facing a choice for how to proceed with filing: do it yourself with tax software or hire a professional tax advisor? Although it certainly will be more expensive than using tax software, hiring a tax advisor makes sense for certain individuals, depending on their financial circumstances. Here are two important factors to consider when deciding if a tax advisor is right for you: Time: Even with tax software guiding you, filing your taxes yourself can be time consuming. You’ll need to make sure that you’ve entered or imported the data from your tax forms correctly, which often takes at least several hours, and your time is worth something. Complexity: The more complicated your financial situation, the more a tax advisor may be able to help you. Have partnership income, or income from an S corporation? Been subject to alternative minimum tax in past years? Received or exercised stock options this year? Tax software can handle these issues, but it will take time, and the risk of mistakes (and even an audit) increases. If you decide that your situation warrants professional assistance, some further questions are worth exploring: what exactly is a tax advisor and how should you think about picking one? Who counts as a tax advisor? Anyone with an IRS Prepare Tax Identification number (a “PTIN” for short) can be paid to file tax returns on behalf of others. But merely having a PTIN doesn’t tell you much about the tax preparer; tax preparers have different experience, skills, and expertise. What you really want is a tax advisor, a professional with a certification and experience level that qualifies her not only to prepare your return, but to use her knowledge of the tax code to provide advice on your financial situation. There are three different professional certifications to consider, each of which qualifies a tax advisor to practice with unlimited representation rights before the IRS. This means that in addition to preparing returns, they also are licensed to represent their clients on audits, payments and collection issues, and appeals. Certified Public Accountants (CPAs) CPAs have completed coursework in accounting, passed the Uniform CPA Examination, and are licensed by state boards of accountancy (which require that they meet experience and good character standards). Some, but not all, CPAs specialize in tax preparation and planning. You can find complaints about CPAs either by searching records with state boards of accountancy and at Better Business Bureaus. Enrolled Agents Enrolled agents are licensed by the Internal Revenue Service after they have passed a three-part examination and a background check. The IRS maintains complaints about enrolled agents on the website of its office for enrollment, and you can also find complaints on the National Association of Enrolled Agents website. Licensed Tax Attorneys Licensed attorneys have graduated from law school, passed a state bar exam, and are admitted to the bar in at least one state. Some, but not all, attorneys specialize in tax preparation and planning. Many tax attorneys have completed an additional year of law school study in a master’s program in tax (called a Tax LL.M. degree). Disciplinary actions against attorneys can be found by searching the state bar associations with which the attorney is registered. How to Select a Tax Advisor or Tax Consultant No tax advisor with one of the certifications described above is necessarily better than any of the others in all situations. Rather, what matters most is: How the advisor approaches the tax preparation process, including the specific experience the tax advisor has with issues relevant to your particular financial situation. Whether you feel comfortable with the tax advisor. How the advisor structures their fees. You may be able to screen potential advisors along several of these dimensions based on information you can find about them online; for others, an initial meeting will be critical to determine if the advisor is right for you. 1. Assess your confidence in the quality of a tax advisor's recommendations, as well as their experience. Here are a few specific factors to consider carefully when assessing the potential quality of a tax advisor's work. First, you should try to identify a tax advisor who will act ethically and with integrity. Before scheduling a meeting with a potential tax advisor, check to see if the advisor has been subject to any complaints, disciplinary actions, or other ethical infractions. When meeting with the advisor, be on the lookout for outlandish promises: if an advisor guarantees you a certain refund without having first looked at your returns, you should be wary (any promise that sounds too good to be true probably is). If the advisor suggests taking a position on a tax return that strikes you as overly aggressive (because it is not grounded in your actual financial situation) or if you simply do not understand something the advisor is saying, make sure to ask, and keep asking until you are satisfied with the answer. Having a tax advisor prepare your returns does not take away your responsibility for the accuracy of your tax return. Of course, an advisor who knowingly takes an improper position on a tax return will face consequences, but it is your return, and you can too. A good tax advisor also should provide more value than simply filling out your returns. She should help you to structure your finances in an optimal way from a tax perspective. Not every tax advisor has expertise with every nuance of the tax code, and so you’ll want to make sure that the advisor you select has significant experience with the particular issues for which you’re seeking expert advice. Of course, there are certain common issues that every good advisor should know: for example, how to maximize the value and efficacy of your charitable contributions, how to weigh the tax tradeoffs between renting and owning a home, or how to save money for or gift money to family members. For other less common situations, however, you’ll want an advisor with specific experience. If you own a business or are self-employed, if you work for a startup and own a significant number of stock options, or if some portion of your income is reported on a K-1 (because you are a partner in a business or own shares in an S corporation), you likely will be best served by finding an advisor who has worked with a significant number of clients with these tax issues. Finally, maintaining the security of your personal information is more important than ever these days, and the inputs for your taxes is some of the most sensitive information you have. There will always be some risk of data breaches, but a good tax advisor will take steps to safeguard your information. Make sure that you ask about how the tax advisor stores your personal information and what methods she uses to communicate with you regarding sensitive topics. You also should ask about whether the advisor has ever been subject to a data breach and what steps the advisor is taking to protect against future ones. 2. Assess your comfort level with the working relationship. You want to make sure you have a good rapport with your tax advisor, and that you feel like you understand each other. At your first meeting, make sure to bring three years’ worth of old tax returns for your advisor to review. Ask if you missed any deductions, and if your old returns raise any audit flags. Consider the advisor’s responses. Does the advisor seem willing to spend time with you to ask thorough questions to fully understand your situation? Or does she rush through in a way that makes you feel like she might be missing certain issues or nuances? Does the advisor explain herself in a way that is understandable to you, even though you don’t have a tax background? Or does the advisor leave you confused? A tax advisor may work by herself or be a member of a larger organization or practice. Each approach has its benefits and drawbacks. You can be sure that a solo practitioner will be the one who actually prepares your returns, but it may be harder to reach the advisor during the height of tax season, and the advisor may find it difficult to get a second opinion on tricky issues or issues outside her core areas of expertise. On the other hand, although the collective expertise of a larger practice may exceed that of even a very talented advisor practicing on her own, it may be more difficult to ensure that your return is prepared personally by your advisor. Finally, think about whether you want to work with a tax advisor who is already part of your social network, or who has been referred by a trusted family member or friend. On the one hand, having the seal of approval of someone you know and trust may help to assure you that the advisor is right for you. On the other hand, consider whether it will be harder to part ways with the advisor down the road if she fails to meet your standards. 3. Evaluate the cost of the tax advice. The final issue you’ll want to think about is cost. Tax preparation services are a low margin business (particularly with the competition that tax preparers face from low cost software), but you can expect to pay more for tax planning services or advice. The best cost structure is one where the tax advisor charges for her time or for the specific forms that the advisor completes and files. By paying for the advice itself and not a particular outcome, this cost arrangement properly aligns the incentives between your tax advisor and you. Be wary of compensation structures that create the potential for conflicts of interest between you and and your tax advisor. For example, some tax advisors may try to earn additional revenue from you by selling other services or financial products along with tax preparation. Ultimately, when it comes to cost, your goal should not be solely to minimize your combined out of pocket cost to the IRS and your advisor for this year’s tax return. Rather, you should take a longer term view, recognizing that good, personalized tax advice can help you to structure your financial life in a tax-efficient way that can pay dividends for years to come.
How Robo-Advisors Guide Your InvestingHow Robo-Advisors Guide Your Investing Here’s everything you need to know In 10 seconds A robo-advisor is a digital investment platform. Using algorithms, it automatically manages your investments according to your goals. In 1 minute Robo-advisors like Betterment use formulas to make smart investment decisions, lowering your cost and seeking to reduce human error in comparison to traditional financial advisors. This approach can give you some unique advantages. Here are the five principles that drive robo-advisors’ approach to investing. Personalization. You’re the most important part of the equation. We adjust our algorithms to fit your goals and circumstances. Automation and discipline. Avoid some common investor mistakes by automating your deposits and resisting the urge to meddle with your portfolio. Robo-advisors aim to make this easy, with the hope that you can reach your goals sooner and keep more in your pocket. Diversification. Robo-advisors set up your portfolio for long-term success by investing in a wide range of assets. Diversification prevents you from being overly exposed to concentrated risks. Lower fees and costs. Algorithms don’t have salaries. It takes a lot less overhead to automate portfolio management. Manage taxes. Taxes are often unavoidable. But with savvy investment moves, you may be able to offset them. Robo-advisors like Betterment can do this automatically if you choose, with features like Tax Loss Harvesting. If you have more time, we can unpack these principles in more detail. In 5 minutes In this article, we’ll: Explain what robo-advisors are Walk you through our five principles of investing What are robo-advisors? A robo-advisor is basically an automated financial advisor. Just like a human financial advisor, a robo-advisor gives recommendations based on your personal financial goals and circumstances. But instead of having a human manage your investment portfolio, a robo-advisor uses algorithms designed to find the optimal investment approach and maximize your returns. It’s technology that helps you manage your money. You can have as much or as little responsibility as you like. The robo-advisor gives you the data-driven insights you need to make wise choices or fully automate your investments. The biggest difference from a human financial advisor? A robo-advisor can cost you far less. Bottom line: Robo-advisors are able to give you similar performance to a financial advisor, but without the steep fees. So you can keep more of what your investments earn. So what guides a robo-advisor’s recommendations? There are five key principles. 1. Personalization We want you to reach your financial goals. So, we start by learning about you. What do you want to achieve? How soon do you want to achieve it? The right investment depends on how much you need to earn and how much time you have to earn it. Not sure how much you need to reach your goal? Or how much you can even invest? We can help with that, too. We explore how things like your income, where you live, and your tax bracket affect what your goal looks like and how fast you can reach it. The result is clear, achievable goals that fit your life and help you get the most from your accounts. 2. Automation and discipline With automatic deposits and decisions based on algorithms, it’s easy to make steady progress toward your goals. It’s also easier to avoid common investor mistakes. Your portfolio will likely experience short-term losses here and there. It’s part of investing. And your reactions to these losses can have a huge impact on your long-term success. You can’t let emotions get in the way of your goals. By automating your portfolio and staying disciplined about investing, you’re better equipped to ride out the short-term losses and enjoy long-term gains. 3. Diversification We’re not here to help you pick the perfect stock. Investing in a single financial asset leaves you vulnerable to that asset’s risks. With a single stock, you could lose everything if a company goes bankrupt, performs poorly, or gets some bad press. Instead, we help you build a well-diversified portfolio. Diversification spreads your investments across assets, asset classes, and even markets, lowering your overall risk. We automatically diversify your portfolio based on your goals and desires. Through socially responsible investing (SRI), you can even diversify your portfolio according to your values. Want to invest in environmentally-conscious companies? Done. How about businesses that demonstrate a commitment to social values? Check. Want to have the broadest positive impact you can? Easy. We have three SRI portfolios to choose from. Note that higher bond allocations in your SRI portfolio decrease the percentage attributable to socially responsible ETFs. However you diversify, this strategy helps you make steady progress toward your goal. 4. Lower fees and costs A robo-advisor can save you a lot of money in fees and ongoing costs. We remove human advisors from the equation—unless you want them. When you have Assets Under Management (AUM) with a robo-advisor, the fees are typically a fraction of what you’d pay for a financial advisor. Our fees are just 0.25% annually. With a financial advisor, you’re looking at more like 1% to 2%. And since everything is based on algorithms, you won’t pay extra for rebalancing and making other changes to your portfolio. 5. Manage taxes Taxes are one of the trickiest parts of investing. Sell for a profit at the wrong time, and you’ll be on the hook for short-term capital gains taxes. Sell the right asset for a loss at the right time, and you can offset taxes through tax-loss harvesting. Managing taxes wisely helps keep your gains consistent and maximize what you get to keep. With a robo-advisor like Betterment, this can happen automatically if you elect this feature. The algorithm optimizes your portfolio to try and keep you from being hit hard by taxes. A financial advisor can do this too, but will usually charge an additional fee. Put your financial goals on cruise control. Investing doesn’t have to be difficult. And reaching your financial goals doesn’t have to take all your time and attention. With a robo-advisor and a smart strategy, you can create your plan and let the algorithms do the rest.
Buying A Home: Down Payments, Mortgages, And Saving For Your FutureBuying A Home: Down Payments, Mortgages, And Saving For Your Future Your home may be the largest single purchase you make during your lifetime. That can make it both incredibly exciting and nerve wracking. Purchasing a primary residence often falls in the grey area between a pure investment (meant to increase one’s capital) and a consumer good (meant to increase one’s satisfaction). Your home has aspects of both, and we recognize that you may purchase a home for reasons that are not strictly monetary, such as being in a particular school district or proximity to one’s family. Those are perfectly valid inputs to your purchasing decision. However, as your financial advisor, this guide will focus primarily on the financial aspects of your potential home purchase: We’ll do this by walking through the five tasks that should be done before you purchase your home. 1. Build your emergency fund. Houses are built on top of foundations to help keep them stable. Just like houses, your finances also need a stable foundation. Part of that includes your emergency fund. We recommend that, before purchasing a home, you should have a fully-funded emergency fund. Your emergency fund should be a minimum of three months’ worth of expenses. How big your emergency fund should be is a common question. By definition, emergencies are difficult to plan for. We don’t know when they will occur or how much they will cost. But we do know that life doesn’t always go smoothly, and thus that we should plan ahead for unexpected emergencies. Emergency funds are important for everyone, but especially so if you are a homeowner. When you are a renter, your landlord is likely responsible for the majority of repairs and maintenance of your building. As a homeowner, that responsibility now falls on your shoulders. Yes, owning a home can be a good investment, but it can also be an expensive endeavor. That is exactly why you should not purchase a home before having a fully-funded emergency fund. And don’t forget that your monthly expenses may increase once you purchase your new home. To determine the appropriate size for your emergency fund, we recommend using what your monthly expenses will be after you own your new home, not just what they are today. Open your Safety Net Get Started 2. Choose a fixed-rate mortgage. According to 2020 survey data by the National Association of Realtors®, 86% of home buyers took out a mortgage. This means that most people have to choose which type of mortgage is appropriate for them, and one of the key factors is deciding between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage (FRM). Betterment generally recommends choosing a fixed-rate mortgage. Here’s why: As shown below, ARMs usually—but not always—offer a lower initial interest rate than FRMs. Source: Federal Reserve Bank of St. Louis. Visualization of data by Betterment. But this lower rate comes with additional risk. With an ARM, your monthly payment can increase over time, and it is difficult to predict what those payments will be. This may make it tough to stick to a budget and plan for your other financial goals. Fixed-rate mortgages, on the other hand, lock in the interest rate for the lifetime of the loan. This stability makes budgeting and planning for your financial future much easier. Locking in an interest rate for the duration of your mortgage helps you budget and minimizes risk. Luckily, most home buyers do choose a fixed-rate mortgage. According to 2020 survey data by the National Association of Realtors®, 89% of home buyers who financed their home purchase used a fixed-rate mortgage, and this was very consistent across all age groups. Research by the Urban Institute also shows FRMs have accounted for the vast majority of mortgages over the past 2 decades. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. 3. Save For The Upfront Costs: Down Payment And Closing You’ll need more than just your emergency fund to purchase your dream home. You’ll also need a down payment and money for closing costs. Betterment recommends making a down payment of at least 20%, and setting aside about 2% of the home purchase for closing costs. A 2020 National Association of Realtors® survey shows the median down payment amount for home purchases is 12%. As the chart below shows, younger buyers tend to make smaller down payments than older buyers. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. But is making an average down payment of only 12% a wise decision? It is true that you are often allowed to purchase a home with down payments far below 20%. For example: FHA loans allow down payments as small as 3.5%. Fannie Mae allows mortgages with down payments as small as 3%. VA loans allow you to purchase a home with no down payment. However, Betterment typically advises putting down at least 20% when purchasing your home. A down payment of 20% or more can help avoid Private Mortgage Insurance (PMI). Putting at least 20% down is also a good sign you are not overleveraging yourself. Lastly, a down payment of at least 20% may help lower your interest rate. This is acknowledged by the CFPB and seems to be true when we compare interest rates of mortgages with Loan-to-Values (LTVs) below and above 80%, as shown below. Source: Federal Reserve Bank of St. Louis. Visualization of data by Betterment. Depending on your situation, it may even make sense to go above a 20% down payment. Just remember, you shouldn’t put every spare dollar you have into your home, as that will likely mean you don’t have enough liquid assets elsewhere for things such as your emergency fund and other financial goals like retirement. Closing Costs In addition to a down payment, buying a home also has significant transaction costs. These transaction costs are commonly referred to as “closing costs” or “settlement costs.” Closing costs depend on many factors, such as where you live and the price of the home. ClosingCorp, a company that specializes in closing costs and services, conducted a study that analyzed 2.9 million home purchases throughout 2020. They found that closing costs for buyers averaged 1.69% of the home’s purchase price, and ranged between states from a low of 0.71% of the home price (Missouri) up to a high of 5.90% of the home price (Delaware). The chart below shows more detail. Source: ClosingCorp, 2020 Closing Cost Trends. Visualization of data by Betterment. As a starting point, we recommend saving up about 2% of the home price (about the national average) for closing costs. But of course, if your state tends to be much higher or lower than that, you should plan accordingly. In total, that means that you should generally save at least 20% of the home price to go towards a down payment, and around 2% for estimated closing costs. With Betterment, you can open a Major Purchase goal and save for your downpayment and closing costs using either a cash portfolio or investing portfolio, depending on your risk tolerance and when you think you’ll buy your home. 4. Think Long-Term We mentioned the closing costs for buyers above, but remember: There are also closing costs when you sell your home. These closing costs mean it may take you a while to break even on your purchase, and that selling your home soon after is more likely to result in a financial loss. That’s why Betterment doesn’t recommend buying a home unless you plan to own that home for at least 4 years, and ideally longer. Unfortunately, closing costs for selling your home tend to be even higher than when you buy a home. Zillow, Bankrate, NerdWallet, The Balance and Opendoor all estimate them at around 8% to 10% of the home price. Betterment’s research analyzed closing costs for both buying and selling, the opportunity costs of potentially investing that money, and more. It shows that the average expected breakeven time is about 4 years as shown below. Of course, this will depend on many factors, but is helpful as a general guide. Thus, if you do not plan to own your home for at least 4 years, you should think carefully on whether buying a home is a smart move at this point in your life. Source: Betterment, Is Buying A Home A Good Investment? Visualization of data by Betterment. Luckily, it appears that most home buyers stay in their homes beyond our 4-year rule of thumb. The chart below is built from 2020 survey data by the National Association of Realtors®. It shows how long individuals of various age groups stayed in their previous homes before selling them. Across all age groups, the median length of time was 10 years, which is more than double our 4-year rule of thumb. That’s excellent. However, we can see that younger buyers, on average, come in well below the 10-year median, which indicates they are more at risk of not breaking even on their home purchases. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. Some things you can do to help ensure you stay in your home long enough to at least break even include: If you’re buying a home in an area you don’t know very well, consider renting in the neighborhood first to make sure you actually enjoy living there. Think ahead and make sure the home makes sense for you 4 years from now, not just you today. Are you planning on having kids soon? Might your elderly parents move in with you? How stable is your job? All of these are good questions to consider. Don’t rush your home purchase. Take your time and think through this very large decision. The phrase “measure twice, cut once” is very applicable to home purchases. 5. Calculate Your Monthly Affordability The upfront costs are just one component of home affordability. The other is the ongoing monthly costs. Betterment recommends building a financial plan to determine how much home you can afford while still achieving your other financial goals. But if you don’t have a financial plan, we recommend not exceeding a debt-to-income (DTI) ratio of 36%. In other words, you take your monthly debt payments (including your housing costs), and divide them by your gross monthly income. Lenders often use this as one factor when it comes to approving you for a mortgage. Debt Income Ratios There are lots of rules in terms of what counts as income and what counts as debt. These rules are all outlined in parts of Fannie Mae’s Selling Guide and Freddie Mac’s Seller/Servicer Guide. While the above formula is just an estimate, it is helpful for planning purposes. In certain cases Fannie Mae and Freddie Mac will allow debt-to-income ratios as high as 45%-50%. But just because you can get approved for that, doesn’t mean it makes financial sense to do so. Keep in mind that the lender’s concern is your ability to repay the money they lent you. They are far less concerned with whether or not you can also afford to retire or send your kids to college. The debt to income ratio calculation also doesn’t factor in income taxes or home repairs, both of which can be significant. This is all to say that using DTI ratios to calculate home affordability may be an okay starting point, but they fail to capture many key inputs for calculating how much you personally can afford. We’ll outline our preferred alternative below, but if you do choose to use a DTI ratio, we recommend using a maximum of 36%. That means all of your debts—including your housing payment—should not exceed 36% of your gross income. In our opinion, the best way to determine how much home you can afford is to build a financial plan. That way, you can identify your various financial goals, and calculate how much you need to be saving on a regular basis to achieve those goals. With the confidence that your other goals are on-track, any excess cash flow can be used towards monthly housing costs. Think of this as starting with your financial goals, and then backing into home affordability, instead of the other way around. Wrapping Things Up If owning a home is important to you, you can use the five steps in this guide to help you make a wiser purchasing decision. Have an emergency fund of at least three months’ worth of expenses to help with unexpected maintenance and emergencies. Choose a fixed-rate mortgage to help keep your budget stable. Save for a minimum 20% down payment to avoid PMI, and plan for paying ~2% in closing costs. Don’t buy a home unless you plan to own it for at least 4 years. Otherwise, you are not likely to break even after you factor in the various costs of homeownership. Build a financial plan to determine your monthly affordability, but as a starting point, don’t exceed a debt-to-income ratio of 36%. If you’d like help saving towards a down payment or building a financial plan, sign up for Betterment today. Save for your home with Betterment Get Started
Investing in Your 40s: 4 Financial Goals You Should Prioritize at Mid-LifeInvesting in Your 40s: 4 Financial Goals You Should Prioritize at Mid-Life In your 40s, your priorities and investing goals become clearer than ever; it’s your mid-life opportunity to get your goals on track. It’s easy to put off planning for the future when the present is so demanding. Unlike in your 20s and 30s when your retirement seemed like a distant event, your 40s are when your financial responsibilities become palpable—now and for retirement. You may be earning more income than ever, so you can benefit far more from planning your taxes carefully. Perhaps you have increased expenses as a result of homeownership. If you have kids, now may also be the time that you’re thinking about or preparing to pay for college tuition. When all of these elements of your financial life converge, they require some thoughtful planning and strategic investing. Consider the following roadmap to planning your investments wisely during these rewarding years of your life. Here are four ways to think about goals you might prepare for. Preparing for Your Next Phase: Four Goals for Your 40s You may have already made a plan for the future. If so, now is a good time to review it and adjust course if necessary. If you haven’t yet made a plan, it’s not too late to get started. Set aside some time to think about your situation and long-term goals. If you’re married or in a relationship, it’s best to include your spouse or partner in identifying your goals. Consider the facts: How much are you making? How much do you spend? Will your spending needs be changing in the near future? (Perhaps you're paying for day carte right now but can plan to redirect that amount towards savings in a few years instead.) How much are you setting aside for savings, investments, and retirement? What will you need in the next five, 10, or 20 years? Work these factors into your short- and long-term financial goals. 1. Pay off high-interest debt. The average variable-rate credit card charges more than 16% a year in interest, so paying off any high-interest credit card debt can boost your financial security more than almost any other financial move you make related to savings or investing. Student loans may also be a high-cost form of debt, especially if you borrowed money when rates were higher. For instance, even federally subsidized loans taken out in the 1990s may carry interest rates as high as 8.25%. If you have a high-interest-rate student loan (say more than 5%), or if you have multiple loans that you’d like to consolidate, you may want to consider refinancing your student debt. These days, lenders offer many options to refinance higher-rate student loans. There’s one form of debt that you don’t necessarily need to repay early, however: your mortgage. This is because mortgage rates are lower than most credit cards and may offer you a tax break. If you itemize deductions, you may be able to subtract mortgage interest from your taxable income. Many people file using the standard deduction, however, so check with your tax professional about what deductions may apply to your situation come tax time. 2. Check that you’re saving enough for retirement. If you’ve had several jobs—which means you might have several retirement or 401(k) plans—now is a good time to organize and check how all of your investments have performed. Betterment can help you accomplish this by allowing you to connect and review your outside accounts. Connecting external accounts allows you to see your wealth in one place and align different accounts to your financial goals. Connecting your accounts in Betterment can also help you see higher investment management fees you might be paying, grab opportunities to invest idle cash, and determine how your portfolios are allocated when we are able to pull that data from other institutions. There could also be several potential benefits of consolidating your various retirement accounts into low-fee IRA accounts at Betterment. Because it’s much easier to get on track in your 40s than in your 50s since you have more time to invest, you should also check in on the advice personalized for you in a Betterment retirement goal. Creating a Retirement goal at Betterment allows you to build a customized retirement plan to help you understand how much you’ll need to save for retirement based on when and where you plan on retiring. The plan also considers current and future income—including Social Security income—as well as your 401(k) accounts and other savings. Your plan updates regularly, and when you connect all of your outside accounts, it provides even more personalized retirement guidance. 3. Optimize your taxes. In your 40s, you’re likely to be earning more than earlier in your career–which may put you in a higher tax bracket. Review your tax situation to help make sure you are keeping as much of your hard-earned income as you can. Determine if you should be investing in a Roth (after-tax contribution) or traditional (pre-tax contribution) employer plan option, or an IRA. These days, more than half of employer-sponsored plans like 401(k)s offer a Roth option, and unlike Roth IRAs, it’s not limited by a maximum income threshold. The optimal choice usually depends on your current income versus your expected income in retirement. If your income is higher now than you expect it to be in retirement, it’s generally better to use a traditional 401(k) and take the tax deduction. If your income is similar or less than what you expect in retirement, you should consider choosing a Roth if available. Those without employer plans can generally take traditional IRA deductions no matter what their taxable income is (as long as your spouse doesn’t have one, either). You can use Betterment’s 401(k) vs. IRA calculator to help decide which one you should be contributing to, or if you’re a Betterment customer, consult your Retirement Goal’s “How To Save” section, after ensuring that you have connected any external retirement accounts. You’ll also want to make sure you take advantage of all the tax credits and deductions that may be available to you. For instance, if you work and pay for childcare, you may be eligible for a dependent care tax credit. Depending on your income, this credit may be worth anywhere from 20% to 35% of what you spend on childcare, and the expenses are capped at $3,000 for one qualifying individual, and $6,000 for two qualifying individuals. Check also to see whether your company offers tax-free transportation benefits—including subway or bus passes or commuter parking. The value of these benefits isn’t included in your taxable income, so you can save money. You can also save money on a pre-tax basis by contributing to a Health Savings Account (HSA) or Flexible Spending Account (FSA). You might not think using these accounts is worth the time, but for a couple making $100k in taxable income per year, you should receive a 29.65% return on investment in the federal/social security/medicare income tax break.1 You may not have that much in expenses, but even if you only pay $200 a month for commuter parking and/or transportation passes and only contribute $500 annually to your FSA, paying those costs pre-tax is the equivalent to paying yourself over $850 in tax savings - it’s worth the time it takes to sign up! Health Saving Accounts (HSA) Health savings accounts (HSAs) are like personal savings accounts, but the money in them is used to pay for health care expenses. Only you—not your employer or insurance company—own and control the money in your HSA. The money you deposit into the account is not taxed. To be eligible to open an HSA, you must have a special type of health insurance called a high-deductible plan. Your 401(k) may be tied to your employer, however your HSA is not. As long as your health plan meets the deductible requirement and permits you to open an HSA, and you’re not receiving Medicare benefits or claimed as a dependent on someone else’s tax return, you can open one with various HSA “administrators” or “custodians” such as banks, credit unions, insurance companies, and other financial institutions. You can withdraw the funds tax-free at any time for qualified medical expenses. Flexible Spending Accounts (FSA) A Flexible Spending Account (FSA) is a special account that can be used to save for certain out-of-pocket health care costs. You don’t pay taxes on this money—this is a tax-favored program that some employers offer to their employees. If you have an FSA, remember that in most cases your spending allowance does not carry over from year-to-year. It’s important to find out whether your employer offers a grace period into the next year (typically through mid-March) to spend down your account. Before you waste your tax-free savings on eyeglasses, check what you can buy with FSA money—with and without a prescription. Any unused funds will be forfeited, so it’s a good idea to use up what you can. If you find yourself with more than you can spend, then you might want to adjust how much you’re allocating to your FSA. 4. If you have children, start saving for college—just don’t shortchange your retirement to do it. If you have children, you may already be paying for their college tuition, or at least preparing to pay for it. For 2020-2021, the average annual costs of college tuition and fees in the United States were $10,560 for in-state public colleges, $27,020 for out-of-state public colleges, and $37,650 for private education, according to the College Board. This doesn’t include the cost of room and board, so you can see why paying for college is something many people have to plan strategically for. Kids grow up fast, so if you haven’t started thinking about college costs, here’s some information to get started. According to the College Board’s College Cost Calculator, today’s fifth grader today will need approximately $268,8832 to graduate from an average four-year private college by the year 2033. Scholarships, grants and federal loans can help, but many parents feel it is up to them to make sure that their kids can get the education they deserve. It is a mistake to save for your kids’ college costs while neglecting your own financial security. Plenty of parents submit a final tuition payment only to realize that they’ve saved nothing for retirement—without any time left to save more. It is a mistake to save for your kids’ college costs while neglecting your own financial security. So, first things first, make sure you’re saving enough for your own retirement. Then if you have money left over, think about tax-deferred college savings plans, such as 529 plans. A 529—named for the section of the tax code that allows for them—can be a great way to save for college because earnings are tax-free if used for qualified education expenses. Some states even allow you to deduct contributions from your state income tax, if you use your state’s plan. (While each state has its own plan, you can use any state’s plan, no matter where your child will go to college.) An alternative is to put money away in your own taxable savings accounts. Some investors prefer this method since it gives them more control over the money if things change, and may be more beneficial for financial aid. Your 40s are all about taking stock of how far you’ve come, re-adjusting your priorities, and getting ready for the next phase of life. By working on your financial goals now, you can gain peace of mind that allows you to concentrate on important things like family, friends, work, and the way you want to spend this rewarding decade of your life. Get a better handle on your 40s with Betterment. Betterment handles your investments so you don’t have to. We make it easy to roll over your retirement accounts (or get new accounts set up), and much of what we do is designed to help you save money on taxes. Our customer support team is available to answer questions, and we have licensed experts available to help you plan. Get started today. 1 Assuming taxable income of 100k, married filing jointly, the tax bracket of 22% applying to the 2021 taxable income Bracket of 22% for $81,051 to $172,750, 1.45% medicare tax (2.9% split evenly by employees/employers), and 6.2% Social Security tax (12.4% split evenly by employees/employers). 2 Assuming 8 years remain until college, 4 years of attendance, 5% education inflation, average 4-year private college as of June 2021 ($42,224), full tuition covered by savings. The information in this article is provided solely for marketing and educational purposes. It does not address the details of your personal situation and is not intended to be an individualized recommendation that you take any particular action, including rolling over an existing account. When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. Specific factors that may be relevant to you include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account, consult tax and other advisors with any questions about your personal situation, and review our Form CRS relationship summary and other disclosures. If you currently participate in a 401(k) plan administered or advised by Betterment (or its affiliate), please understand that this article is part of a general educational offering and that neither Betterment nor any of its affiliates are acting as a fiduciary, or providing investment advice or recommendations, with respect to your decision to roll over assets in your 401(k) account or any other retirement account. Betterment’s Licensed Concierge Team offers support for individuals transferring assets to Betterment of $100,000 or more, and receives incentive compensation based on assets brought to or invested with Betterment. Betterment’s revenue varies for different offerings (e.g., Betterment Digital and Premium) and consequently Team members have an incentive to recommend the offering which results in the greatest revenue for Betterment. The marketing and solicitation activities of these individuals are supervised by Betterment to ensure that these individuals act in the client’s best interest. Disclosure: Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Betterment or its writers endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
How to Estimate Your Tax Bracket When InvestingHow to Estimate Your Tax Bracket When Investing Knowing your tax bracket opens up a huge number of planning opportunities that have the potential to save you taxes and increase your investment returns. If you’re an investor, knowing your tax bracket opens up a number of planning opportunities that can decrease your tax liability and increase your investment returns. Investing based on your tax bracket is something that good CPAs and financial advisors, including Betterment, do for customers. Because the IRS taxes different components of investment income (e.g., dividends, capital gains, retirement withdrawals) in different ways depending on your tax bracket, knowing your tax bracket is an important part of optimizing your investment strategy. In this article, I’ll show you how to estimate your tax bracket and begin making more strategic decisions about your investments with regards to your income taxes. First, what is a tax bracket? In the United States, federal income tax follows what policy experts call a progressive tax system. This means that people with higher incomes are generally subject to a higher tax rate than people with lower incomes. Currently there are seven different tax brackets, ranging from 10% up to 37%. Below are the 2021 federal tax brackets if you are single or married filing jointly. 2021 Federal Tax Brackets Taxable Income Bracket: Filing as Single Taxable Income Bracket: Filing as Married, Filing Jointly Tax Rate $0 to $9,950 $0 to $19,900 10% $9,951 to $40,525 $19,901 to $81,050 12% $40,526 to $86,375 $81,051 to $172,750 22% $86,376 to $164,925 $172,751 to $329,850 24% $164,926 to $209,425 $329,851 to $418,850 32% $209,426 to $523,600 $418,851 to $628,300 35% $523,601 or more $628,301 or more 37% For example, if you are single and have taxable income of $75,000 this year, you fall into the 22% tax bracket. However, that does not mean that all $75,000 of your income will be taxed at 22%. Instead, tax brackets apply to each portion of your income, building up like a staircase. Here’s a visual to help explain. U.S. Federal Tax Brackets for Single Filers If you are a single individual with a taxable income of $75,000, the first $9,950 of your income will be taxed at 10%, then dollars $9,951 - $40,525 will be taxed at 12%, and dollars $40,526 – $75,000 will be taxed at 22%. If your taxable income were to grow, then dollars $75,001 — $86,375 would still be taxed at 22%, but after that, the dollars would be taxed at higher tax rates. Filing status (single, married, head of household, etc.) also affects your tax bracket. See the tax brackets for each filing status. How difficult is it to estimate my tax bracket? Luckily, estimating your tax bracket is much easier than actually calculating your exact taxes, because U.S. tax brackets are fairly wide. Just look at the 22% tax bracket. If you are filing as single, any income between $40,526 and $86,375 falls within that same tax bracket. That’s a big margin of error for making an estimate. The wide tax brackets allow you to estimate your tax bracket fairly accurately even at the start of the year, before you know how big your bonus will be, or how much you will donate to charity. Of course, the more detailed you are in calculating your tax bracket, the more accurate your estimate will be. And if you are near the cutoff between one bracket and the next, you will want to be as precise as possible. How Do I Estimate My Tax Bracket? Estimating your tax bracket requires two main pieces of information: Your estimated annual income Tax deductions you expect to file These are the same pieces of information you or your accountant deals with every year when you file your taxes. Normally, if your personal situation has not changed very much from last year, the easiest way to estimate your tax bracket is to look at your last year’s tax return. However, with the passing of the Tax Cuts and Jobs Act in December 2017, a lot of the rules and brackets have changed. Thus, it is wise for most people to estimate their bracket by crunching new numbers. Estimating Your Tax Bracket with Last Year’s Tax Return If you expect your situation to be roughly similar to last year, then open up last year’s tax return. If you review Form 1040, you can see your taxable income on Page 2, Line 43, titled “Taxable Income.” As long as you don’t have any major changes in your income or personal situation this year, you can use that number as an estimate to find the appropriate tax bracket on the table above (or the full set of tables provided by the Tax Foundation). Estimating Your Tax Bracket by Predicting Income, Deductions, and Exemptions Estimating your bracket requires a bit more work if your personal situation has changed from last year. For example, if you got married, changed jobs, had a child or bought a house, those, and many more factors, can all affect your tax bracket. It’s important to point out that your taxable income, the number you need to estimate your tax bracket, is not the same as your gross income. The IRS generally allows you to reduce your gross income through various deductions, before arriving at your taxable income. When Betterment calculates your estimated tax bracket, we use the two factors above to arrive at your estimated taxable income. You can use the same process. 1. Add up your Income. Add up your income from all expected sources for the year. This includes salaries, bonuses, interest, business income, pensions, dividends and more. If you’re married, don’t forget to include your spouse’s income sources. 2. Subtract Your Deductions Tax deductions reduce your taxable income. Common examples include mortgage interest, property taxes and charity, but you can find a full list on Schedule A – Itemized Deductions. If you don’t know your deductions, or don’t expect to have very many, simply subtract the Standard Deduction instead. For 2020, the standard deduction is $12,400 if you are single, and $24,800 if you are married filing jointly. By default, Betterment assumes you take the standard deduction. If you know your actual deductions will be significantly higher than the standard deduction, you should not use this assumption when estimating your bracket, and our default estimation will likely be inaccurate. The number you arrive at after reducing your gross income by deductions and exemptions is called your taxable income. This is an estimate of the number that would go on line 11b of your 1040, and the number that determines your tax bracket. Look up this number on the appropriate tax bracket table and see where you land. Again, this is only an estimate. There are countless other factors that can affect your marginal tax bracket such as exclusions, phaseouts and the alternative minimum tax. But for planning purposes, this estimation is more than sufficient for most investors. If you have reason to think you need a more detailed calculation to help formulate your financial plan for the year, you can consult with a tax professional. How Can I Use My Tax Bracket to Optimize My Investment Options? Now that you have an estimate of your tax bracket, you can use that information in many aspects of your financial plan. Here are a few ways that Betterment uses a tax bracket estimate to give you better, more personalized advice. Tax-Loss Harvesting: This is a powerful strategy that seeks to use the ups/downs of your investments to save you taxes. However, it typically only makes sense if you are in the 22% tax bracket or higher. For those in the 10% & 12% tax brackets, capital gains are taxed differently, which could make this strategy not beneficial. Tax Coordination: This strategy reshuffles which investments you hold in which accounts to try to boost your after-tax returns. For the same reasons listed above, if you are in the 10% or 12% tax bracket, the benefits of this strategy are reduced significantly. Traditional vs. Roth Contributions: Choosing the proper retirement account to contribute to can also save you taxes both now and throughout your lifetime. Generally, if you expect to be in a higher tax bracket in the future, Roth accounts are best. If you expect to be in a lower tax bracket in the future, Traditional accounts are best. That’s why our automated retirement planning advice estimates your current tax bracket and where we expect you to be in the future, and uses that information to recommend which retirement accounts make the most sense for you.In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. Tax optimization is a critical part to your overall financial success, and knowing your tax bracket is a fundamental step toward optimizing your investment decisions. That’s why Betterment uses estimates of your bracket to recommend strategies tailored specifically to you. It’s just one way we partner with you to help maximize your money. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.
How Much Could You Be Losing To Fees?How Much Could You Be Losing To Fees? Unexpected or hidden fees can damage your long-term investment returns. Sync your outside accounts with Betterment now and see how much you’re being charged by other investment providers. When you invest in valuable items, it’s easy to overlook the hidden fees. Buying a house certainly requires property tax and insurance payments, but you may quickly discover hidden fees in your investment—such as home repair and maintenance costs—of which you were never aware nor did you expect. Purchasing a car results in a similar scenario, in that taxes and insurance are rarely the only expenses. Repair, cleaning, maintenance, and miscellaneous fees can catch you off guard. You’ll soon realize that it’s more expensive than you ever thought to manage these assets. The same is true with investment accounts. At Betterment, we think all investment accounts should be clearly and transparently priced, without any hidden fees. Now, we can help you discover if you’re paying high advisory or hidden fund fees across all of your investments. Here’s a deeper dive into the types of fees you may encounter in your investments with outside fund providers. Understanding Fund Fees Expense Ratios When investing in any mutual fund or exchange-traded fund (ETF), the investor pays fees that cover the management, administration, and operations of the fund. These fees are summarized in the expense ratio. This fee may also include marketing costs which go to the salesperson, known as 12b-1 fees. The expense ratio is visible in the fund’s prospectus, but in general people rarely read that long document. It often goes unnoticed because the fee is not explicitly charged from the balance, but is instead built into the fund’s daily pricing. Contrary to general assumptions, paying higher expense ratios does not guarantee higher returns in an investment portfolio. Since paying higher fees does not necessarily equal high returns, choosing funds with a lower expense ratio is a simple yet generally sound investment strategy. Advisory Fees If you hire an advisor to choose and manage your investments, including one such as Betterment, you’ll most likely pay for the service received. This is known as an “advisory fee.” If you pay advisory fees with an outside investment provider, you can include the fees after you sync your outside accounts with Betterment. We then summarize how much you are paying in fees per year, and also take that number into account when providing retirement advice. Some advisors do not charge fees in an overly transparent manner but earn revenues in other ways. This can include the 12b-1 fees mentioned above, which are built into the expense ratio of the fund, or through load charges, explained below. Lesser-Known Fees Aside from expense ratios and advisory fees, some investment funds have even less transparent costs. One reason Betterment chooses ETFs for our portfolios is because they do not contain the fees mentioned below1, and they are often tax-efficient. On the other hand, mutual funds can have additional fees and revenue-sharing relationships, due to the level of trading and activity involved with the fund’s management. When investing in mutual funds, they typically have the following costs which are borne of the investor, but not included in the expense ratio. These include: Sales load fee: A sales charge imposed by “Class A” or “Class B” mutual funds when you purchase shares. “Class C” shares can have a load fee when you withdraw your money from the fund. These loads are commissions that pay the professional adviser or broker who sold you the fund. Trading fee: Trading fees when you buy or sell stocks in a brokerage account, or when the manager of a mutual fund pays to make trades within the fund. These expenses are taken out of the daily pricing of the fund, but not included in the expense ratio. These fees are hard to estimate, but in general a fund that has a high turnover, like an actively managed fund, will have higher trading fees. Redemption fee: Also referred to as a “market-timing fee,” or “short-term trading fee,” mutual funds charge this fee to discourage investors from making short-term “round trip” transactions (i.e., a purchase, typically a transfer, followed by a sale within a short period of time). 4 Steps to Minimize Investment Fees As a smart investor, there are four steps you can take to help minimize your investment fees. Know where you stand. Look up the expense ratios for all of your investments, or simply sync your outside accounts with Betterment to see a summary of the total advisory and fund expenses you are currently paying. Choose low cost funds. Typically, index ETFs are cheaper than mutual fund equivalents. They generally have no loads or marketing expenses. They also have lower turnover, which means lower internal trading costs and low taxes. Avoid trading costs. If you envision lots of trading activity across your investments, try choosing a platform that has no trading costs. Trading costs can be a constant drag on returns, especially when you use smart strategies like rebalancing and tax loss harvesting. Betterment includes both smart rebalancing and Tax Loss Harvesting+ (TLH+) benefits at no additional cost for customers. Select a low cost advisor. If you have investments with other providers, inquire regarding what fees outside of expense ratios are being charged. You can then enter these additional fees to appear on your synced non-Betterment accounts. Betterment is the largest independent online financial advisor, and we also deliver enhanced value with transparent pricing and lower fees than traditional financial services. When you sync your accounts, not only can you see all of your wealth in one place—we’ll also help you discover which outside investments are charging you high fees so that you can take action accordingly. Get started with opening a Betterment account today. For existing Betterment customers, get started syncing your accounts now. 1Some brokerages charge trading fees for ETFs. Trading fees are included in Betterment’s flat advisory fee.
Investing in Your 30s: 3 Goals You Should Set TodayInvesting in Your 30s: 3 Goals You Should Set Today It’s never too early or too late to start investing for a better future. Here’s what you need to know about investing in your 30s. In your 30s, your finances get real. Your income may have increased significantly since your first job. You might have investments, stock compensation, or a small business. You may be using or have access to different kinds of financial accounts (e.g. 401(k), IRA, Roth IRA, HSA, 529, UTMA). In this decade of your life, chances are you’ll get married, and even start a family. Even if you’ve taken this complexity in stride, it’s good to take a step back to review where you are and where you want to go. This review of your plan (or reminder to create a plan) is essential to setting up your financial situation for future decades of financial success. Don’t Delay Creating A Plan: Three Goals For Your 30s As always, the best thing to do is start with your financial goals. Keep in mind that goals change through time, and this review is an important step to make updates based on where you are now. If you don’t have any goals yet, or need some guidance on which investing objectives might be important for you, here are three to consider. Emergency Fund Sometimes your plan doesn’t go as planned, and having an adequate emergency fund can help ensure those hiccups don’t affect the rest of your goals. An emergency fund (at Betterment, we call it a Safety Net) should contain enough money to cover your basic expenses for a minimum of three to six months. You may need more than that estimate depending on your career, which may or may not be one in which finding new work happens quickly. Also, depending on how much risk you want to take with these funds, you may need a buffer on top of that amount. Read more about how to calculate your target amount, or follow this simple formula: Monthly Expenditures x Re-Employment Period = Baseline Safety Net Amount As you review your goals, make sure you have established a safety net account. Good options for this include a high-yield cash account like Betterment Cash Reserve, or a Betterment Safety Net. Then, make sure you have enough saved in that account (or are regularly saving into it to build up the balance). Retirement Most people don’t want to work forever. Even if you enjoy your work, you’ll likely work less as you age, presumably reducing your income. To maintain your standard of living, or spend more on travel, hobbies or grandkids, you’ll need to spend from savings. Saving for your retirement early in your career—especially in your 30s–is essential. Thanks to medical improvements and healthier living, we are living longer in retirement, which means we need to save even more. Luckily, you have a secret weapon—compounding—but you have to use it. Compounding can be simply understood as “interest earning interest,”a snowball effect that can build your account balance more quickly over time. The earlier you start saving, the more time you have, and the more compounding can work for you. In your goal review, you’ll want to make sure you are on track to retire according to your plan, and make savings adjustments if not. You’ll also want to make sure you are using the best retirement accounts for your current financial situation, such as your workplace retirement plan, an IRA, or a Roth IRA. Your household income, tax rate, future tax rate and availability of accounts for you and your spouse will determine what is best for you. Use Betterment’s Retirement Planner, which helps answer all of these questions. Also, if you’ve changed jobs, make sure you are not leaving your retirement savings behind, especially if it has high fees. Often, consolidating your old 401(k)s and IRAs into one account can make it easier to manage, and might even reduce your costs. You can consolidate retirement accounts tax-free with a rollover. If you have questions about your plan or the results using our tools, consider getting help from an expert through our Advice Packages. Major Purchases A wedding, a house, a big trip, or college for your kids. Each of these goals has a different amount needed, and a different time horizon. Our goal-based savings advice can help you figure out how to invest and how much to save each month to achieve them. Take the chance in your goal review to decide which of these goals is most important to you, and make sure you set them up as goals in your Betterment account. Our goal features allow you to see, track, and manage each goal, even if the savings aren’t at Betterment. Get Started with Betterment It can be easy to set up your Safety Net, Retirement, and Major Purchase investment goals on Betterment. Get started now. Please note that Betterment is not a tax advisor. Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the CFP® certification mark, the CERTIFIED FINANCIAL PLANNER™ certification mark, and the CFP® certification mark (with plaque design) logo in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements. This article is provided solely for educational purposes. It does not address the details of your personal situation and is not intended to be an individualized recommendation that you take any particular action, including rolling over an existing account. When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. Specific factors that may be relevant to you include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account, consult tax and other advisors with any questions about your personal situation, and review our Form CRS relationship summary and other disclosures. If you currently participate in a 401(k) plan administered or advised by Betterment (or its affiliate), please understand that this article is part of a general educational offering and that neither Betterment nor any of its affiliates are acting as a fiduciary, or providing investment advice or recommendations, with respect to your decision to roll over assets in your 401(k) account or any other retirement account. Add Cash Reserve Disclosure to this article.
Financial Resources For Women’s History MonthFinancial Resources For Women’s History Month Join us as we celebrate Women’s History Month. Explore our personal recommendations for featured organizations, financial content, and more below. What better way to celebrate Women’s History Month than by considering women’s financial well-being? Though many women are increasingly independent, they’re also often supporting both themselves and other family members. General financial planning often ignores gender-specific issues that continue to challenge long-term financial security for women. Here’s Betterment’s guide to help you navigate the month. Meet Women+ of Betterment The Women+ of Betterment ERSG works to improve the company by partnering across the organization to amplify the voices of and advance equity for all women+, however you identify. We work alongside ERSGs of Betterment to ensure proposed solutions are intersectional. We provide women+ opportunities to strengthen relationships, lead, and broaden their network. Organizations We’re Supporting This Month Even though the COVID-19 pandemic has permeated all aspects of American society, research has shown how women have been disproportionately impacted by working on the front lines and mass unemployment. Here are three organizations you can donate to today who are working to address social and economic gaps for women: Bottomless Closet - Helps women in New York prepare for job interviews and sets them up for success in their careers. Moms Helping Moms - Supports hundreds of thousands of individuals in New Jersey by providing them with essential items for their children and families. Days for Girls - Provides women and girls with reusable menstrual products, health education programs, and training classes. Trans Lifeline - Offers direct emotional and financial support to trans people in crisis – for the trans community, by the trans community. Ladies Who Launch - Facilitates the connections needed to support female entrepreneurs as they follow their passions and launch their businesses. Organizations Supporting Women On Betterment’s Platform Through our Charitable Giving feature, customers can donate shares held for longer than one year to any organization we partner with. Below are three charities working to improve women’s lives: Breast Cancer Research Foundation - Fund the best ideas in breast cancer research. Hour Children - Reunify families impacted by incarceration. Boys & Girls Clubs of America - Provide a safe space for kids and teens during out-of-school time. Invest in gender equity this month with our Social Impact Portfolio. If you’re passionate about issues like gender and racial equity and want to support companies who demonstrate a commitment to gender diversity within senior leadership, you can invest your money in Betterment’s Social Impact Portfolio. There are also two other socially responsible investing portfolios that may align with your values: the Broad Impact Portfolio and Climate Impact Portfolio. What better way to celebrate Women’s History Month than by considering women’s financial well-being? Though many women are increasingly independent, they’re also often supporting both themselves and other family members. General financial planning often ignores gender-specific issues that continue to challenge long-term financial security for women. Here’s Betterment’s guide to help you navigate the month. Meet Women+ of Betterment The Women+ of Betterment ERSG works to improve the company by partnering across the organization to amplify the voices of and advance equity for all women+, however you identify. We work alongside ERSGs of Betterment to ensure proposed solutions are intersectional. We provide women+ opportunities to strengthen relationships, lead, and broaden their network. Organizations We’re Supporting This Month Even though the COVID-19 pandemic has permeated all aspects of American society, research has shown how women have been disproportionately impacted by working on the front lines and mass unemployment. Here are three organizations you can donate to today who are working to address social and economic gaps for women: Bottomless Closet – Helps women in New York prepare for job interviews and sets them up for success in their careers. Moms Helping Moms – Supports hundreds of thousands of individuals in New Jersey by providing them with essential items for their children and families. Days for Girls – Provides women and girls with reusable menstrual products, health education programs, and training classes. Trans Lifeline – Offers direct emotional and financial support to trans people in crisis – for the trans community, by the trans community. Ladies Who Launch – Facilitates the connections needed to support female entrepreneurs as they follow their passions and launch their businesses. Organizations Supporting Women On Betterment’s Platform Through our Charitable Giving feature, customers can donate shares held for longer than one year to any organization we partner with. Below are three charities working to improve women’s lives: Breast Cancer Research Foundation – Fund the best ideas in breast cancer research. Hour Children – Reunify families impacted by incarceration. Boys & Girls Clubs of America – Provide a safe space for kids and teens during out-of-school time. Invest in gender equity this month with our Social Impact Portfolio. If you’re passionate about issues like gender and racial equity and want to support companies who demonstrate a commitment to gender diversity within senior leadership, you can invest your money in Betterment’s Social Impact Portfolio. There are also two other socially responsible investing portfolios that may align with your values: the Broad Impact Portfolio and Climate Impact Portfolio.
How to Use Your Bonus Wisely to Get a Tax BreakHow to Use Your Bonus Wisely to Get a Tax Break Bonuses are tricky. Here's how you can make your bonus work harder for you by reducing the tax impact. How are you planning to spend your annual bonus? Like with any cash windfall, we all want to use it wisely. But bonuses can be tricky because of taxes. To use a bonus most tax-efficiently, you’ll need to juggle multiple objectives and concerns. If you’re expecting to get more than one bonus per year, it’s important to consider all of the possible ways to invest a bonus to maximize its potential value. In this article, we’ll review how bonuses are typically taxed, what factors you should be aware of, and how to take advantage of different accounts and investing strategies to make your bonus work harder for you. How Does a Bonus Get Taxed? Bonuses are considered “supplemental income” by the IRS, which means they could be withheld differently than your regular salary. The IRS suggests a flat withholding of 22% from bonuses, and many employers follow that method. (Remember that withholdings are meant to be an estimate of how much you’ll owe at the end of the year, not the actual tax itself.) But some employers use the aggregate method, in which your whole bonus is added to your regular paycheck, and the combined amount is withheld at the normal income rate, as though that amount is representative of what you make every paycheck, which could be higher (or lower) than 22%. Some people believe that bonuses are taxed at a higher rate than ordinary wages, but that’s not the case. The aggregate method of withholding can result in bumping you into a higher estimated tax bracket, which creates the illusion that you “keep less of it,” but no special tax rates apply just because a payment from your employer is characterized as a bonus. A bonus is like a raise, but when your income goes up, it could do more that just move you to a higher tax bracket—you could potentially lose certain deductions and tax credits. Bear in mind, while we hope you find this information helpful, you should consult a tax professional to understand your individual circumstances. Betterment is not a tax advisor, so while we like to offer helpful information to get you started, this should not be considered tax advice. With that said, here are some simple suggestions for how you can use tax-deferred or even taxable accounts to help preserve and grow your windfall. 1. Boost Your 401(k) Before you add your bonus to your 401(k), check with your employer about how bonuses are handled. In some cases, your company may not allow you to make 401(k) contributions using your bonus. In others, your 401(k) plan may be set up to withhold the same percentage from your bonus as from your paycheck. Thus, if you typically contribute 10% from every paycheck to your 401(k), that same amount could be withheld from your bonus (unless you say otherwise). In the case of a $15,000 bonus, $1,500 would go into your 401(k), which may be too little for your aims. The Max Contribution Limit for a 401(k) Of course, you can’t contribute more than the annual limit, so be sure to check how much you’ve contributed for the year to date. The contribution limit for your 401(k) for 2020 is $19,500 ($26,000 if you’re 50 or older). You can choose any combination of pre-tax or Roth contributions as part of your total contribution limit. Not sure which type is good for you? Many participants “split the difference” and contribute 50% pre-tax and 50% Roth. To figure out what kind of contribution might work well for you, use Betterment’s traditional vs. Roth 401(k) calculator. Also, don’t assume that a lump-sum deposit is best, especially if your employer matches your 401(k) contributions. A single large deposit might not get the same amount of matching dollars that a comparable amount would if you spread the deposits over time. Betterment’s resident CFP® professional Nick Holeman notes that it depends on your employer’s matching structure. Certain plans offer a “true-up” for matching contributions if you max out early in the year while many plans do not offer that feature. Talk to your employer to find out exactly how they calculate the match. 2. Take Advantage of Multiple Accounts Now here’s the part you may not be aware of: depending on your income and whether you or your spouse is participating in a company retirement plan, you might be able to reduce your taxable income further by contributing to your flexible spending account this year (the maximum is $2,750 for 2020), a health savings account (the maximum for a family is $7,100 for 2020), and a traditional or Roth IRA. Many people don’t realize that you can participate in a company plan and still fund a traditional or Roth IRA. You could contribute to your 401(k) this year, and contribute to a traditional or Roth IRA as well, or a combination of those. As the IRS notes: You can contribute to a traditional or Roth IRA whether or not you participate in another retirement plan through your employer or business. However, you might not be able to deduct all of your traditional IRA contributions if you or your spouse participates in another retirement plan at work. Roth IRA contributions might be limited if your income exceeds a certain level. 3. Invest in a “Happiness Annuity” If it’s not possible or advantageous to put your money only into tax-deferred accounts, use your windfall to invest by creating “a gift that keeps on giving.” You could spend it all, sure, but by investing your windfall in a well-diversified portfolio, you can create an additional source of cash flow that steadily adds to your quality of life, year after year: i.e. a happiness annuity. Studies show that steady cash flow increases often feel better than a lump sum that’s here today, spent on the Canary Islands tomorrow.
Investing in Your 20s: 4 Major Financial Questions AnsweredInvesting in Your 20s: 4 Major Financial Questions Answered When you're in your 20s, you may be starting to invest or you might have some existing assets you need to take better care of. Pay attention to these major issues. For most of us, our 20s is the first decade of life where investing might become a priority. You may have just graduated college, and having landed your first few full-time jobs, you’re starting to get serious about putting your money to work. More likely than not, you’re motivated and eager to start forging your financial future. Unfortunately, eagerness alone isn’t enough to be a successful investor. Once you make the decision to start investing, and you’ve done a bit of research, dozens of new questions emerge. Questions like, “Should I invest or pay down debt?” or “What should I do to start a nest egg?” In this article, we’ll cover the top four questions we hear from investors in their twenties that we believe are important questions to be asking—and answering. “Should I invest aggressively just because I’m young?” “Should I pay down my debts or start investing?” “Should I contribute to a Roth or Traditional retirement account?” “How long should it take to see results?” Let’s explore these to help you develop a clearer path through your 20s. 1. “Should I invest aggressively just because I’m young?” Young investors often hear that they should invest aggressively because they “have time on their side.” That usually means investing in a high percentage of stocks and a small percentage of bonds or cash. While the logic is sound, it’s really only half of the story. And the half that is missing is the most important part: the foundation of your finances. The portion of your money that is for long-term goals, such as retirement, should most likely be invested aggressively. But in your twenties you have other financial goals besides just retirement. Let’s look at some common goals that should not have aggressive, high risk investments just because you’re young. A safety net. It’s extremely important to build up an emergency fund that covers 3-6 months of your expenses. We usually recommend your safety net should have a portfolio allocation of no more than 40% stocks. Wedding costs. According to the U.S. Census Bureau, the median age of a first marriage for men is 29, and for women, it’s 27. You don’t want to have to delay matrimony just because the stock market took a dip, so money set aside for these goals should also probably be invested conservatively. A home down payment. The median age for purchasing a first home is age 32, according to the New York Times. That means most people should start saving for that house in their twenties. When saving for a relatively short-term goal—especially one as important as your first home—it likely doesn’t make sense to invest very aggressively. So how should you invest for these shorter-term goals? If you plan on keeping your savings in cash, make sure your money is working for you. Consider using a cash account like Cash Reserve, which could earn a higher rate than traditional savings accounts. If you want to invest your money, you should separate your savings into different buckets for each goal, and invest each bucket according to its time horizon. An example looks like this. The above graph is Betterment’s recommendation for how stock-to-bond allocations should change over time for a major purchase goal. And don’t forget to adjust your risk as your goal gets closer—or if you use Betterment, we’ll adjust your risk automatically for you. 2. “Should I pay down my debts or start investing?” The right risk level for your investments depends not just on your age, but on the purpose of that particular bucket of money. But should you even be investing in the first place? Or, would it be better to focus on paying down debt? According to Northwestern Mutual’s 2018 Planning & Progress Study, millennials have an average of $36,000 in debt, mainly from student loans and credit cards. In some cases, paying down debt should be prioritized over investing, but that’s not always the case. Here’s one example: “Should I pay down a 4.5% mortgage or contribute to my 401(k) to get a 100% employer match?” Mathematically, the employer match is usually the right move. The return on a 100% employer match is usually better than saving 4.5% by paying extra on your mortgage if you’re planning to pay the same amount for either option. It comes down to what is the most optimal use of your next dollar. We've discussed the topic in more detail previously, but the quick summary is that, when deciding to pay off debt or invest, use this prioritized framework: Always make your minimum debt payments on time. Maximise the match in your employer-sponsored retirement plan. Pay off high-cost debt (anything 5%-6% or greater). Build your safety net. Save for retirement. Save for your other goals (home purchase, kid’s college). Read more about investing and paying off debt. 3. “Should I contribute to a Roth or Traditional retirement account?” Speaking of employer matches in your retirement account, which type of retirement account is best for you? Should you choose a Roth retirement account (e.g. Roth 401(k), Roth IRA) in your twenties? Or should you use a traditional account? As a quick refresher, here’s how Roth and traditional retirement accounts generally work: Traditional: Contributions to these accounts are usually pre-tax. In exchange for this upfront tax break, you usually must pay taxes on all future withdrawals. Roth: Contributions to these accounts are generally after-tax. Instead of getting a tax break today, all of the future earnings and qualified withdrawals will be tax-free. So you can’t avoid paying taxes, but at least you can choose when you pay them. Either now when you make the contribution, or in the future when you make the withdrawal. As a general rule: If your current tax bracket is higher than your expected tax bracket in retirement, you should choose the Traditional option. If your current tax bracket is the same or lower than your expected tax bracket in retirement, you should choose the Roth option. The good news is that Betterment’s retirement planning tool can do this all for you and recommend which is likely best for your situation. We estimate your current and future tax bracket, and even factor in additional factors like employer matches, fees and even your spouse’s accounts, if applicable. 4. “How long should it take to see investing results?” Humans are wired to seek immediate gratification. We want to see results and we want them fast. The investments we choose are no different. We want to see our money grow, even double or triple as fast as possible! We are always taught of the magic of compound interest, and how if you save $x amount over time, you’ll have so much money by the time you retire. That is great for initial motivation, but it’s important to understand that most of that growth happens later in life. In fact very little growth occurs while you are just starting. The graph below shows what happens over 30 years if you save $250/month in today’s dollars and earn a 7% rate of return. By the end you’ll have over $372,000! But it’s not until year 5 that you would earn more money than you contributed that year. And it would take 18 years for the total earnings in your account to be larger than your total contributions. How Compounding Works: Contributions vs. Future Earnings The figure shows a hypothetical example of compounding, based on a $3,000 annual contribution over 30 years with an assumed growth rate of 7%, compounded each year. This example is hypothetical and illustrates the general pattern of how compounding seems to work in the short term versus the long term. This figure is not based on or related to any Betterment portfolio or offering. The point is it can take time to see the fruits of your investing labor. That’s entirely normal. But don’t let that discourage you. Some things you can do early on to help are to make your saving automatic and reduce your fees. Both of these things will help you save more and make your money work harder. Use Your 20s To Your Advantage Your 20s are an important time in your financial life. It is the decade where you can build a strong foundation for decades to come. Whether that’s choosing the proper risk level for your goals, deciding to pay down debt or invest, or selecting the right retirement accounts. Making the right decisions now can save you the headache of having to correct these things later. Lastly, remember to stay the course. It can take time to see the type of growth you want in your account.
Why the 4% Rule Is BrokenWhy the 4% Rule Is Broken There are fundamental flaws in the popular 4% rule for retirement income, including its reliance on a higher yield environment. In today's economy, you need a better, more dynamic approach to planning your retirement income. For the last 20 years, many retirees have relied on the so-called 4% rule when determining how much of their nest egg to spend each year. As the name implies, the rule is notable for its simplicity: as long as you withdraw no more than 4% of your initial portfolio, adjusted for inflation, you shouldn't run out of money. That rule is now being called into doubt—and for good reason. In today’s more volatile, lower-yield climate, this flat-rate withdrawal approach can put you at greater risk of outliving your money, or living on less than you could. Recent research has caused considerable debate, and sparked some much-needed innovation around that old guideline. A rigorous new study led by Betterment’s quantitative portfolio specialist Lisa Huang finds that applying the 4% rule under current market conditions is expected to prematurely deplete a retirement portfolio 30% of the time, assuming 3% inflation and a 30-year retirement.1 To arrive at this conclusion, we ran a Monte Carlo simulation to test thousands of trial futures, with the results presented in the chart below. Our research led to the creation of Betterment’s new retirement income product, released in April 2014. Our online retirement solution automates withdrawals, calculated based on a dynamic formula, fully integrated with an automated, low-cost, liquid portfolio. The algorithms are optimized to ensure that there is less than a 4% chance of running out of money—and a 90% chance that the annual withdrawal amount never drops below 2% of the initial portfolio balance (with the annual withdrawals expected to be above 4% on average, often significantly so.) The quest for stability Credit for the 4% rule belongs to Bill Bengen, a financial planner in California, whose research on the topic was first published in the Journal of Financial Planning in the early 1990's. Bengen came up with a formula for what seemed to be a safe withdrawal rate that would accomplish the top goals of retirees: Provide a fixed rate of withdrawal, like an annuity Rely on an easy-to-use withdrawal formula (unlike, say, required minimum distributions) Minimize retirees’ risk of running out of money However, while the 4% figure remained fixed in the public's imagination, the rates it relied on were anything but. Twenty years ago, the yield on a three-month Treasury bill was 6%. So while Bengen’s model called for a 50/50 stock allocation, even those with a more conservative asset allocation could still draw down 4% annually adjusted for inflation, and reasonably expect to preserve their capital. Even in 2002, the 5-year US Treasury yield was still 4.5%. That’s no longer the case—today a three-month Treasury is .04% and a 5-year is around 1.67%. In fact at least one paper has speculated that the apparent success of the 4% rule during the last 20 years may have been dependent on specific market conditions—which have become less and less favorable—and called its success an “anomaly.” It makes sense that the rule’s rise to popularity was a happy accident when you consider that the first decade after Bengen created his model was an exceptional time of low inflation and high corporate earnings in the U.S. A fly in the ointment But even without changes in the economic climate, the last couple of decades have highlighted several other, fundamental flaws in Bengen's approach: The 4% rule is based on the portfolio’s initial balance; subsequent market performance isn’t dynamically factored into the withdrawal rate—even though it can dramatically affect the portfolio’s balance. Flat-rate withdrawals that ignore dramatic market changes can lead to premature portfolio depletion. Likewise, a flat withdrawal rate doesn’t take into account personal changes in health or lifestyle that naturally occur with age. Many retirees need more flexibility in their cash flow to handle the inevitable ups and downs of life. In particular, an unfavorable market climate in the early years of retirement, coupled with a rigid withdrawal formula, increases the risk of asset depletion, because capital preservation during those early years is critical to the portfolio’s ongoing growth. Conversely, if returns are higher than expected in the early phase of retirement, but your withdrawals are static, you run the risk leaving money on the table at the end of your life that could have been used for greater enjoyment in previous years. The quest for a sustainable spending model Understandably, many retirees prefer fixed withdrawal rates because they’re predictable—that’s why annuities are popular. But several companies, including Betterment, find that retirees fare much better with a dynamic withdrawal strategy over the long-term (without the restrictions of annuities). Betterment’s Retirement Income service continually factors in a retirement portfolio's balance, projected inflation as well as retirees’ personal information, to come up with a dynamic asset allocation and spending plan that retirees can follow automatically—or further customize with a few clicks on their digital dashboard. Learn more about Betterment's new Retirement Income service. Generally, you can expect to withdraw more than 4% per year, depending on your age and risk profile. The initial portfolio starts with a 56% stock allocation and we use highly responsive algorithms within the product to factor in portfolio performance and create a glide path that’s designed to stave off longevity risk and preserve capital. By contrast, the two other companies that now offer retirees a similar, dynamic spending model only approach the issue from a financial planning standpoint, as opposed to advice that is actually implemented in an automated fashion. Last fall, Vanguard announced a new dynamic spending model for retirees which combines aspects of the 4% rule with the percentage-of-portfolio approach, in which you calculate a new withdrawal percentage each year, but don’t factor in inflation. This hybrid strategy sets a floor and a ceiling for withdrawals, based on the prior year. And in March 2014, J.P. Morgan Asset Management announced a dynamic retirement income withdrawal strategy. This proprietary model combines five key factors (including life expectancy, assets and forward-looking market projections) to create a customized portfolio and spending plan that retirees can adjust as needed with their advisers. However, neither of these two products are currently integrated with a live portfolio that automates the advice and the glide path—as well as the withdrawals—the way Betterment does. Out with the old, in with the new Dealing with a variable retirement income from year to year is a relatively new idea. Fortunately the Betterment model is designed to provide stability. The algorithms are optimized to balance the dual objectives of maximizing lifetime withdrawals, and keeping the withdrawal amount within a consistent range year after year. Best of all, by working with some natural ups and downs in your income from year to year, you’re actually improving your overall outcome. With the Betterment income strategy, there is less than 4% chance you will run out of money. 1We found the expected failure rate of the 4% rule under current conditions to be 31% when applied to a Betterment portfolio with a 30% stock allocation. Though analysis marshaled in support of the 4% heuristic in the 1990's tended to recommend a 50% stock allocation (e.g. the seminal Trinity study from 1998), these studies generally assumed a simple two-asset allocation between an S&P 500 fund and high grade bonds - sometimes referred to as the "naive" portfolio. The Betterment portfolio, with global diversification in both the stock and bond basket, has both higher volatility and higher expected returns at the same allocation to stocks. A 50% stock naive portfolio has the expected volatility of a 33% stock Betterment portfolio and the expected returns of a 26% stock Betterment portfolio. Accordingly, to test the assumptions of the 4% rule as applied to a two-asset portfolio at 50% stocks, we are highlighting the Monte Carlo results using a 30% stock Betterment portfolio. Notably, we found that applying the 4% rule even to a 50% stock Betterment portfolio is expected to fail 21% of the time under modern market conditions.
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