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How We Built 3 New Socially Responsible Investing Portfolios
Betterment is moving the category forward for socially responsible investors by offering three SRI portfolios that are fully diversified and keeps ...How We Built 3 New Socially Responsible Investing Portfolios Betterment is moving the category forward for socially responsible investors by offering three SRI portfolios that are fully diversified and keeps costs low. It makes sense that some investors try to align their investments with the values and social ideals that shape their worldview. The way you live, the career you choose, and the people you care about align with your personal values; shouldn’t your investments do the same? Socially responsible investing (SRI) is an approach to investing that reduces exposure to companies that are deemed to have a negative social impact—e.g., companies that profit from poor labor standards or environmental devastation—while increasing exposure to companies that are deemed to have a positive social impact—e.g., companies that foster inclusive workplaces or commit to environmentally sustainable practices. The Betterment SRI portfolio strategy aims to maintain the diversified, low-fee approach of Betterment’s Core portfolio while increasing investments in companies that meet SRI criteria. Betterment has constructed three SRI portfolios, each with a different focus within the realm of Environmental, Social, and Governance (ESG) investing. Betterment’s Broad Impact portfolio offers increased exposure to companies that rank highly on all ESG criteria equally, while Betterment’s Climate and Social Impact portfolios focus on increasing exposure to companies with positive impact on a specific subset of ESG criteria. To learn more about how and why we’ve built the Betterment SRI portfolios, read on to the following sections. The technical details of our approach can be found in our full portfolio methodology as well as in our SRI disclosures. Why Did Betterment Develop SRI Portfolios? Betterment is dedicated to offering a personalized experience for our customers. This means providing options that help customers align our advice to their personal values. We decided to develop SRI portfolios because, currently, there are three major ways that investors attempt to execute an SRI strategy, and none meets an investor’s full needs: Some investors buy SRI mutual funds, settling for unreasonably high fees compared to performance and often losing out on important tax and cost optimization opportunities. Others opt for one of several SRI-specific investment managers whose SRI portfolios may fulfill the investors’ desire for SRI screening but do not always provide proper diversification against risk. Still others try to pick their own basket of SRI investments—a challenging, time-intensive, and inaccessible approach for most everyday investors. We set out to do better for SRI investors. You should not have to choose between holding an SRI portfolio and following a low-cost, diversified investment strategy with tax optimization in order to make sure your investments reflect your personal values. The Betterment SRI portfolio strategy is designed to achieve this balance. We allow socially conscious investors to express that preference in their portfolios without sacrificing the aspects of Betterment’s advice that protect their returns the most: proper diversification, tax optimization, and cost control. What Is Betterment’s Approach To SRI? While SRI has been around for decades, especially for institutions like churches and labor unions, the SRI funds available to individual investors have only emerged in the last 20 to 30 years. And most of these SRI products have been actively-managed mutual funds with high fees. Only recently have lower cost options, like ETFs for SRI, emerged in the market. As we developed each of Betterment’s SRI portfolios, we analyzed all low-cost ETFs available which align with the SRI mandate of each portfolio, searching for products that could replace components of our core strategy without disrupting the diversification or cost of the overall portfolio. In each of our SRI portfolios, some bond asset classes are not replaced with an SRI alternative either because an acceptable alternative doesn’t yet exist or because the respective fund’s fees or liquidity levels make for a prohibitively high cost to our customers. Broad Impact Portfolio In 2017, we launched our original SRI portfolio offering, which we’ve been steadily improving over the years. With this release, our original SRI portfolio benefits from a number of additional enhancements, and becomes our “Broad Impact” portfolio, to distinguish it from the new specific focus options, Climate Impact and Social Impact. As we’ve done since 2017, we continue to iterate on our SRI offerings, even if not all the fund products for an ideal portfolio are currently available. Figure 1 shows that we have increased the allocation to funds screened for ESG criteria each year since we launched our initial offering. Today all primary stock ETFs used in our Broad Impact, Climate Impact, and Social Impact portfolios are screened for some ESG criteria. 100% Stock Allocation in the Broad Impact Portfolio Over Time Figure 1. Calculations by Betterment. Portfolios from 2017-2019 represent Betterment’s original SRI portfolio. The 2020 portfolio represents a 100% stock allocation of Betterment’s Broad Impact portfolio. As additional SRI portfolios were introduced in 2020, Betterment’s SRI portfolio became known as the Broad Impact portfolio. As your portfolio allocation shifts to higher bond allocations, the percentage of your portfolio attributable to SRI funds decreases. Additionally, a 100% stock allocation of the Broad Impact portfolio in a taxable goal with Tax Loss Harvesting enabled may not be comprised of all SRI funds because of the lack of suitable secondary and tertiary SRI tickers in the developed and emerging market stock asset classes. Betterment’s Broad Impact portfolio is Betterment’s general ESG investing option. The portfolio seeks to give investors greater exposure to all of the different dimensions of social responsibility, such as lower carbon emissions, ethical labor management, or greater board diversity. By investing in funds that consider all aspects of ESG investing, we create a portfolio that grades well with respect to a number of dimensions that socially responsible investors consider when making investment decisions. When creating the Broad Impact portfolio, the asset classes (i.e., portfolio component) that we can confidently replace with an SRI alternative are: U.S. Stocks Emerging Market Stocks Developed Market Stocks U.S. High Quality Bonds U.S. Investment Grade Corporate Bonds Five asset classes use SRI-specific funds—the rest remain similar to the Betterment Core portfolio—and that difference has an impact on the social responsibility of your overall portfolio. For one, many investors are most concerned about the social responsibility of the largest U.S. companies in their portfolios, which often set standards for acceptable corporate behavior that other companies try to emulate. In our Broad Impact SRI portfolio, stocks of companies deemed to have strong social responsibility practices, such as Microsoft, Google, Proctor & Gamble, Merck, CocaCola, Intel, Cisco, Disney, and IBM may make up a larger portion of the SRI portfolio than they do for Betterment’s Core portfolio. In addition, a major reason why there are no acceptable SRI alternatives for other asset classes is that the demand for these products has not been sufficient to encourage fund managers to create them. By electing to use the Betterment SRI portfolio strategy, you signal to the investing world that there is a demand for high quality SRI investment options and may help to encourage the development of well-diversified, low-cost SRI funds in a wider variety of asset classes. If you’re interested in a more quantitative understanding of how the Broad Impact portfolio compares to our Core portfolio in terms of social responsibility, you can review the SRI ratings published by MSCI, shown below. MSCI’s ratings for the SRI funds used in Betterment’s SRI portfolio are higher than the ratings for the funds used in the Betterment portfolio. For more information on what the numbers mean, read our full whitepaper. MSCI ESG Quality Scores U.S. Stocks Betterment Core Portfolio: 5.94 Betterment Broad Impact Portfolio: 7.31 Emerging Markets Stocks Betterment Core Portfolio: 4.22 Betterment Broad Impact Portfolio: 6.31 Developed Markets Stocks Betterment Core Portfolio: 6.81 Betterment Broad Impact Portfolio: 8.33 US High Quality Bonds Betterment Core Portfolio: 6.13 Betterment Broad Impact Portfolio: 6.91 Sources: MSCI ESG Quality Scores courtesy of etf.com, values accurate as of August 25, 2020 and are subject to change. In order to present the most broadly applicable comparison, scores are with respect to each portfolio’s primary tickers exposure, and exclude any secondary or tertiary tickers that may be purchased in connection with tax loss harvesting. Climate Impact Portfolio Betterment’s Climate Impact portfolio offers investors an SRI portfolio that is more focused on being climate-conscious rather than focused on all ESG dimensions equally like the Broad Impact portfolio. The portfolio achieves this objective by investing in ETFs with a specific focus on mitigating climate change. When compared to the Core portfolio, all of the stock positions have been replaced with more climate-conscious alternatives. Half of the stocks in the portfolio are invested in a global low-carbon stock ETF, which systematically overweights companies with lower carbon emissions, while also underweighting their high-carbon emitting peers. The other half of the stocks in the portfolio are invested in fossil fuel reserve free ETFs. These ETFs replicate broad market indices, while divesting from owners of fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in the Climate Impact portfolio, investors are actively divesting assets away from holders of fossil fuel reserves while cutting their investments’ carbon emissions. Carbon emissions per dollar of revenue in the 100% stock Climate Impact portfolio are half of those in the 100% stock Betterment Core portfolio, based on weighted average carbon intensity data from MSCI. The other change from the Core portfolio, is that the Climate Impact portfolio replaces our International Developed Bond and US High Quality Bond exposure by investing in a global green bond ETF. Green bonds, as defined per MSCI, fund projects that support alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation. Social Impact Portfolio Betterment’s Social Impact portfolio offers investors an SRI portfolio that is more focused on supporting social equity and minority empowerment compared to the Broad Impact portfolio. The portfolio achieves this objective by augmenting the ESG exposure achieved in the Broad Impact portfolio with two additional ETFs each with a unique focus on diversity, NACP and SHE. NACP is a U.S. stock ETF offered by Impact Shares that tracks the Morningstar Minority Empowerment Index. The National Association for the Advancement of Colored People (NAACP) has developed a methodology for scoring companies based on a number of minority empowerment criteria. These scores are used to create the Morningstar Minority Empowerment Index, an index which seeks to maximize the minority empowerment score while maintaining market-like risk and strong diversification. The end result is an index which provides greater exposure to US companies with strong diversity policies that empower employees irrespective of race or nationality. By investing in NACP, investors are allocating more of their money to companies with a better track record of social equity as defined by the NAACP. SHE is a US Stock ETF that allows investors to invest in more female-led companies compared to the broader market. In order to achieve this objective, companies are ranked within each sector according to their ratio of women in senior leadership positions. Only companies that rank highly within each sector are eligible for inclusion in the fund. By investing in SHE, investors are allocating more of their money to companies that have demonstrated greater gender diversity within senior leadership than other firms in their sector. Let’s Make Investing More Socially Responsible As you review our SRI portfolios, you might ask yourself, “Is it more important that my portfolio is well-diversified with reasonable costs, or should my money be exclusively invested in SRI funds, regardless of the cost or level of diversification?” These are insightful questions that get at the heart of the tradeoffs involved in socially responsible investing today. Currently, most accessible SRI approaches make investors choose between a well-diversified, low-cost portfolio and an inadequately diversified and/or higher cost portfolio comprised of SRI funds. Diversification and controlled costs are investing fundamentals that all investors—SRI or not—deserve. They’re principles that live at the heart of fiduciary advice. The only reason other SRI solutions settle for higher costs and less diversification is because the industry isn’t challenged to offer something better. We at Betterment believe we can create a future that does not ask SRI investors to choose. We are committed to achieving more socially responsible investing through our research over time and are tracking the availability of better vehicles for these purposes. Since originally launching the legacySRI portfolio in 2017 (and now the Broad Impact portfolio) with ESG exposure to only U.S. large cap stocks, we’ve been able to expand the exposure to now cover also developed market stocks, emerging market stocks, and US high quality bonds. We’ve also been able to launch the Climate and Social Impact portfolios which add exposure to focused ESG issues by allocating to assets such as green bonds or gender-diverse U.S. Stocks. As always, we will continue to monitor additional ways to improve our portfolios. In the future, we will improve our SRI portfolio even further, iterating and adding new SRI funds that satisfy our cost and diversification requirements as they become available. Get started with the Betterment SRI Portfolio. Get started with our approach to SRI today, and join us as we work to expand our SRI approach together. If you don’t yet have a Betterment account, open an account to explore the portfolio options available to you. If you already have a Betterment account, you can enable a SRI portfolio when adding a new goal or by updating your existing goal’s portfolio strategy via the “Portfolio Analysis” tab of your Betterment account. Once on your “Portfolio Analysis” tab, you will see an “edit” option under the “Portfolio Strategy” section. Once you select “edit” you will be sent to the “Portfolio Strategy” flow where you can opt into a SRI portfolio.
Using Investment Goals At Betterment
Goal-based investing. The idea is prized among financial advisors—and our team at Betterment—but to the everyday investor, it’s often difficult to ...Using Investment Goals At Betterment Goal-based investing. The idea is prized among financial advisors—and our team at Betterment—but to the everyday investor, it’s often difficult to put into practice. TABLE OF CONTENTS What is goal-based investing? Goals and Investment Accounts at Betterment Retirement Savings Retirement Income Safety Net Major Purchase General Investing How to Set Effective Goals Using Betterment Mapping Out Your Financial Picture Goal-based investing. The idea is prized among financial advisors—and our team at Betterment—but to the everyday investor, it’s often difficult to put into practice. After all, being clear about the purpose of one’s savings can be a challenge. You might start saving for one reason, then decide halfway through your progress that the money is really for something else. Or, you might have so many goals you want to save for, you don’t know where to start. Often, people are stuck in a single-savings-account mentality, where your figurative pot of gold is for any and all savings goals—with no distinct purposes articulated. For many investors, goal-based investing takes a lot of discipline and even more introspection. Without the right tools in place, it can be difficult to keep your goals on track. At Betterment, we’re working to make setting and attaining your financial goals a natural and straightforward experience. In this article, we’ll guide you through how goal-based investing works at Betterment and how we’ve designed Betterment accounts to put your goals into action. What is goal-based investing again? Goal-based investing is the best way we know to help you set a personalized financial plan with investments that are aligned to help you fulfill that plan over the long-term. You can think of goals as the building blocks of a plan. When you set goals for your investments, you’re identifying what personal purpose you have for your money, and what you want to achieve. As your advisor, Betterment uses this information to recommend the right level of savings and proper mix of investments to help you reach your goals. The best investment plans consist of a prioritized set of personal goals, so you decide on which goals to focus on first to inform your investment behavior. Goal-based investing is based on a technique used by institutional investors called “asset-liability management,” which aims to match future assets with future expenditures. In other words, goal-based investing seeks to ensure that you have enough money when you plan to spend it in the future. The trouble with this notion of goal-based investing is that you may not think of your money in terms of goals, and even if you do, it’s likely that your goals aren’t always clearly defined. A goal like, “I want to buy a boat or house sometime in the future” isn’t specific enough to inform good numerical planning. If you were an advisor, imagine how challenging it would be to help somebody plan when he or she isn’t quite sure what they want or when they want it. It’s not unlike helping a friend or family member stick to a budget: If they never set a clear cap for their budget, it’s hard to say how much spending is too much spending. From our perspective as your advisor, the best way to help you set a good plan is to help you give your goals as much definition and detail as possible, then determine how they stack up together. What does an investing goal look like at Betterment? When you really think about it, the essence of a goal is your intention to make a future expenditure. For example, you want $50,000 for a future down payment on a house. Or, $300,000 for future payments on your child’s college tuition. Or $100,000 of annual retirement income for 30-40 years. Any future expenditure can be an investment goal. Our Investing Goals At Betterment, we aspire to help you build a personalized financial plan built on goals that reflects what it really feels like to save and spend money. Within your Betterment account, every investment goal you set has a target amount and target date(s) for which you desire to meet your goal. Within each goal is at least one investment account, depending on the type of goal you set. Investment accounts at Betterment include a variety of legally-defined account types, like taxable accounts (what other investment companies might call brokerage accounts), individual retirement accounts (both Roth and traditional), SEP IRAs, joint taxable accounts, and trusts. Different goal types may contain different investment account types. Currently, we have five types of goals: Retirement Savings – for those saving for retirement Retirement Income – for retirees making withdrawals Safety Net – for growing an emergency fund Major Purchase – for making a future expenditure General Investing – for investing when you’re not sure of the specific future expenditure When you sign up with Betterment, you can set up one or more of these goals for your investments. For any existing goal, you can change your goal type in the Plan tab of your Betterment account. You will see an option on the right that reads “Advice type: Edit” that leads you to the option to update your goal type. What we try to do—and we’re constantly working to improve—is to help you set your goals well while also advising you on the right accounts and investments you’ll use to help reach your goals. We recommend customizing the names of each of your goals to set your personal purpose for each. Here’s a breakdown of the default range of stock allocation advice, by goal type: Type of investing goal Most Aggressive Recommended Allocation (typical start of term, depending on age) Most Conservative Recommended Allocation (typical end of term, depending on age) Anticipated term Cash-out assumptions Retirement 90% Stocks, 10% Bonds 56% Stocks, 44% Bonds Up to 50 years Shift to a Retirement Income goal at the target date Retirement Income 56% Stocks, 44% Bonds 30% Stocks, 70% Bonds Up to 30 years Steady drawdown with dynamic withdrawal rate until target date Safety Net 30% Stocks, 70% Bonds 30% Stocks, 70% Bonds Targets date of achieving desired balance Up to full liquidation at any time General Investing 90% Stocks, 10% Bonds 55% Stocks, 45% Bonds Recommendation is based on investor age No liquidation Major Purchase (House, Education, Other) 90% Stocks, 10% Bonds 0% Stocks, 100% Bonds Between 1 and 35 years Full liquidation at target date Each of these investment goals requires a different strategy—that is the quintessence of smarter investing. Betterment’s automated advice and technology builds a unique investment portfolio for each type of goal. Underpinning each type of goal is a customized stock-to-bond allocation recommendation, which is designed to automatically adjust (in most cases) to help you reach your goal without taking on unnecessary risk. For each of these goal types, we provide a recommended maximum and minimum stock allocation, based on your term, while making certain cash-out assumptions. But we also give you the tools to adjust the dial, if desired, for a more aggressive or more conservative allocation in any goal type. You can also select additional portfolio strategies that are not generally recommended but may be more personalized to your views. Retirement Savings Goals For retirement savings goals, our methodology enables investors to work toward their goal using multiple accounts—including those held outside of Betterment (such as your spouse’s accounts) but synced into the goal. The reality is almost every future retiree will have multiple accounts—IRAs, 401(k)s, 403(b)s, HSAs, and/or taxable investment accounts—that help them achieve their retirement savings goal. So, we developed our methodology to match reality as closely as possible. In addition, retirement savings goals can utilize Tax Coordination™, Betterment’s approach to asset location, which aims to lower your taxes on retirement savings by keeping the highest-tax assets in tax-advantaged account types and the lower-tax assets in taxable accounts. When you have 20 or more years until you retire, we recommend 90% stocks. Our advice reduces your recommended risk level over time until your retirement date, where it shifts to a 56% stock allocation. Then, when you have arrived at your retirement age, you can make the shift to the next goal type, Retirement Income, which we developed to serve your needs in retirement. Example of Allocation Advice for Customer Retiring at Age 65 Figure above shows an example that assumes the customer is planning to live until age 90. Retirement Income Investing Goals Once you reach retirement and start making withdrawals, Betterment’s smart retirement withdrawal process recommends an appropriate allocation for where you are in retirement and recommends a regular withdrawal amount from your goal. Our methodology considers a number of factors to suggest a safe liquidation target or withdrawal amount: Current balance Desired monthly income amount Minimum acceptable income level Desired certainty about not falling beneath minimum income level Conditional life expectancy For example, a 65-year-old male has a remaining life expectancy of nearly 18 years, according to projections used by the Social Security Administration.1 That is 18 years over which he will be both liquidating his portfolio but also growing his assets to support future years of consumption. With regards to the stock allocation, we seek to: Continue to grow your portfolio while in retirement Lower portfolio risk as you are further into retirement Safety Net Investing Goals A Safety Net goal is one of the highest priority goals we recommend for investors. It’s slightly different from other goals because we assume the money may never be needed—but when it is, we assume a substantial portion of the balance will be liquidated all at once. Currently, a goal for your “safety net” or “emergency” fund contains just one account at Betterment. Your account in a Safety Net goal will be taxable, as there are no tax-advantaged accounts for general personal savings. Juxtaposed to this goal, you may also sync an external savings account if you would like to see this account included in your balance. Betterment’s allocation advice for Safety Net goals is conservative and does not adjust automatically over time, holding at 15% stocks, 85% bonds continuously. We recommend you add a 15% buffer to the balance to help preserve the minimum balance you need to have available. Allocation Advice For A Safety Net Goal Major Purchase Investing Goals For a major purchase—such as saving for a car, a house, or even your child’s education—Betterment enables one account for each goal. With any major purchase, an investor usually anticipates liquidating all at once when they reach their goal, usually for a short- or medium-term period of investing. Transaction Timeline Table Thus, Betterment’s allocation advice is more conservative for these goals than that of retirement goals. Since we expect you to fully liquidate your investment at your intended goal date, Betterment automatically shifts your allocation to low stock percentages as you near your goal date in line with our advice, unless you set your own allocation or turn off automatic allocation adjustment. Allocation Advice For A Major Purchase Goal General Investing While Betterment is designed to help you execute goal-based investing, we understand that there are plenty of investors who aren’t sure about their goals, and might have part of their savings invested with no clear purpose. Many investors have a clear understanding for some of their goals, but haven't yet sorted through the precise purposes for all other investments. For these investors, Betterment offers goals that are classified as “general investing” and contain just a single account. Since you can still personalize the name, allocation, and portfolio strategy in these situations, we still call them goals within your account, but our allocation advice on these goals has fewer assumptions than the advice for the distinct goal types above. You can consider general investing goals to be the utility players within your account, where the priority is wealth creation because you have no specific plans for a liquidation event in the future. This makes goals of the “general investing” type generally appropriate for objectives like long-term savings where you might plan to transfer wealth to the next generation or convert your assets into a trust account at a later date. While you can have multiple general investing goals, we often find that Betterment customers who might be using general investing goals could decrease unnecessary risks by using a more precise goal type. In general investing goals, our automated advice recommends a range of allocations from a maximum of 90% stocks to a minimum stock allocation of 55% stocks, depending on your age and how close you are to age 65. Allocation Advice For General Investing How To Set Effective Investing Goals Using Betterment As explained above, Betterment works hard to help you set goals in realistic ways that match your actual savings habits. To align with our research on goal-based investing, it’s important to understand what makes for an effective goal. One framework to thoughtfully determine a prioritized set of goals is called the S.M.A.R.T. approach. S.M.A.R.T. stands for: Specific Measurable Attainable Realistic Time-limited Make your goal specific. A specific goal is one with a clear description and a well-articulated set of circumstances. For example, if you’re saving for a child’s college education, a goal that is specific might look like the following on paper: “My goal is to pay for my child’s total higher education costs (including graduate school if chosen, room and board, social events/clubs, and any other fees).” By stating how many of the possible education costs you’re planning to pay for (i.e. “total”), the goal statement above provides much more information about the size and shape of the future expenditure. Make your goal measurable. Making a goal measurable means that you can tell how close you are to achieving the goal using numbers. Generally, this means quantifying the specific information you know about—setting an accurate estimate of the total of the expenditure you expect to make. Here’s what a measurable goal looks like using our example: “My goal is to save a total of $800,000 to pay for all three of my children’s total higher education costs.” The total expenditure should account for all the factors that went into making your goal specific, but it should turn the various social and philosophical decisions you’ve made about your goal into a numerical sum. You should also account for taxes in setting a precise, measurable goal. Ensure your goal is attainable. As you define a specific and measurable goal, you should make sure it’s actually attainable. Attainable goals are future expenditures you actually have the capability to achieve. For instance, if you make $80,000 in a year, saving $800,000 over five years is not attainable because even if you could save 100% of your income, you’d still come up short of your goal amount. However, if you have more time to save or if you make more money each year, then perhaps the goal could be attained. Consider whether your goal is realistic A goal is realistic if you have the time, resources, and discipline to achieve it. Generally, your goals will only be realistic if you take into account the other goals you have in your life. For example, when saving for college education, you probably will also need to invest for your retirement. If you don’t align and prioritize your goals, you may end up being less able to save as regularly or as much as you’d like—which lowers your chances of achieving either goal. Any goal should be time-limited. The last step in developing a S.M.A.R.T. goal is to make sure the goal is time-limited—i.e. Every goal needs a deadline or target date. Just as measurable goals quantify the total expenditure you expect to make, time-limited goals quantify the time you have to reach that expenditure amount. In most cases, you should try to set goals as far in advance as possible. For instance, rather than waiting until you have three children that will be going to college, it’s a good idea to start saving as soon as you start planning a family. A time-limited goal should also consider how frequently you can plan to contribute to the goal. Will you save a portion of every paycheck? Or will you save just once a year? An effective time-limited goal might read like the following: “My goal is to save a total of $800,000 over 18 years (by [due date]) to pay for all three of my children’s total higher education costs by putting aside at least $1,500 per paycheck per month.” Use Investing Goals to Map Out Your Financial Picture By using a framework like the S.M.A.R.T. approach to set each of your investment goals, you’ll push yourself to think broadly about all the factors of life that affect your financial future while ensuring each and every goal is quantifiable and feasible. Remember that it’s okay to use estimates or set educated guesses when creating goals you’re not quite sure of. In many cases, such as retirement or college savings, you might need additional research and external resources to predict how much money you’ll actually need to reach all the specific criteria of your goal. In getting started saving for a goal, it’s always better to be approximately right than to have no goal at all. If you set reasonable, customizable goals using the goal types available to you in your Betterment account, you’ll get savings and investment advice on each of the building blocks of a solid financial plan. Additional assistance with identifying your goals is available to Betterment Premium customers.
How We Help Investors Seamlessly Transfer Accounts
Transitioning investment accounts from one provider to another can be tedious and complicated. Humans can help make it seamless and easy.How We Help Investors Seamlessly Transfer Accounts Transitioning investment accounts from one provider to another can be tedious and complicated. Humans can help make it seamless and easy. Transitioning investment accounts from one provider to another can be complicated. You may be in the early days of exploration, wondering if adopting a new investment strategy is worth it. Or, you may know that making a switch is what’s best but it’s unclear how Betterment will handle the trading and operational steps required to complete your transfer. How we help customers transition to Betterment. We’ve largely automated the process of transferring outside investment accounts to Betterment. For most customers, our automations fully address their specific needs and a transfer can be self-serviced entirely online. For others, our online tools provide a great foundation, but there’s still a desire for more personalized advice during their transition. Qualified customers, looking for more high-touch support, have access to our Licensed Concierge and partner transfer-specialist teams, who provide personalized and dedicated guidance to customers exploring large and complex transfers to Betterment. For IRAs and 401(k)s, which can be directly transferred without creating a taxable event, we focus on investment strategy comparisons, minimizing advisor pushback, and ensuring that the accounts are moved using the most efficient transfer method available. For taxable accounts, especially those with large embedded gains, we take things a step further, offering personalized tax-impact and break-even analyses. Breaking down our taxable account guidance. As your fiduciary, we believe that transparency is key to making well-informed investment decisions. Whether you’re in the early stages of exploring if Betterment’s right for you, or fully sold and ready to get started, knowing the potential tax implications, and the trading and operational steps required to complete your transfers is important. Below, we offer a step-by-step preview into the Licensed Concierge-specific process. Step 1: Review Current Situation When a Licensed Concierge associate is connected with a new customer, our first priority is to understand the customer’s situation. We start by reviewing their current investment accounts to see if they are properly aligned to their financial goals from a fee, investment mix, and risk perspective. Misalignment in any of these areas can impact a customer’s likelihood of reaching their goals. Upon closer look, the individuals we work with are often surprised to find themselves invested in high-fee and high-risk accounts. Sometimes we learn they were referred to their advisor who charged a 1% management fee. Sometimes we discover they were sold actively managed funds that charged 1% to 2% in fund fees. Some were even do-it-themselves investors, who didn’t have the time to maintain proper account rebalancing, dividend reinvestment, or timely tax-loss harvesting. Whatever the case may be, if you’re looking to review your current situation and find that collecting the necessary information is hard to do on your own, we recommend syncing your accounts to Betterment. Our free, automated tooling will analyze your account details and let you know if you’re taking on too much (or too little) risk, paying too high of fees, or don’t have proper portfolio diversification. Syncing your accounts to Betterment will also allow our human-facing teams to better guide you, if need be. Step 2: Establish A Plan Once we understand a customer’s current situation, our next step is to put together a comprehensive assessment and action plan. While the details are unique to each customer, at a high-level, the moving parts are largely the same. Based on the firm where an account is currently held, the type of taxable account (individual, joint, trust), and the underlying investments, we are able to tell our customers: Whether making a switch to Betterment comes highly recommended based on any red flags from our Step 1 review. Whether the firm and account type can be moved electronically to Betterment through the ACATS network. Which of the current holdings (if any) can be moved to Betterment, in-kind without having to sell at the current provider first. What to expect once we receive the transferred account and begin transitioning it into the target Betterment portfolio. What the estimated tax-impact (if any) will be to move forward with the transfer to Betterment. The above information is delivered to the customer without industry jargon, so that making an official decision is as straightforward as possible. Step 3: Executing The Plan Assuming the customer would like to proceed with a transfer to Betterment, we’ll do a final check to ensure their Betterment account is set up properly. Once everything is in order from our side, we can begin implementing the transfer plan. Since it’s highly likely that our team has performed transfers from the customer’s current provider to Betterment, we’re able to be specific about what to expect throughout the process. We’ll communicate all of the steps involved, the expected timeline to complete, and when possible, we’ll handle any heavy lifting. We’ll regularly check-in and once the transfer has arrived, we’ll confirm with the customer and ensure any outstanding questions are answered. Putting it all together. Deciding whether it’s right to move money to a new provider is tough enough on its own, which is why having access to a dedicated expert can be especially valuable. With extensive onboarding and transfer experience, the Licensed Concierge and partner teams are here to ensure you fully understand how Betterment works and that your accounts are transitioned seamlessly. Interest in learning more about transferring an account to Betterment? Email us at: email@example.com. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. This article is being provided solely for marketing and educational purposes and 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. 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.
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4 Ways Betterment Can Help Limit the Tax Impact Of Your Investments4 Ways Betterment Can Help Limit the Tax Impact Of Your Investments Betterment has a variety of processes in place to help limit the impact of your investments on your tax bill, depending on your situation. Let’s demystify these powerful strategies. In the US, approximately 33% of households have a taxable investment account—often referred to as a brokerage account—and approximately 50% of households also have at least one retirement account, like an IRA or an employer-sponsored retirement account. We know that the medley of account types can make it challenging for you to decide which account to contribute to or withdraw from at any given time. Let’s dive right in to get a further understanding of: What accounts are available and why you might choose them. The benefits of receiving dividends. Betterment’s powerful tax-sensitive features. How Are Different Investment Accounts Taxed? Taxable Accounts Taxable investment accounts are typically the easiest to set up and have the least amount of restrictions. Although you can easily contribute and withdraw at any time from the account, there are trade-offs. A taxable account is funded with after-tax dollars, and any capital gains you incur by selling assets, as well as any dividends you receive, are taxable on an annual basis. While there is no deferral of income like in a retirement plan, there are special tax benefits only available in taxable accounts such as reduced rates on long-term gains, qualified dividends, and municipal bond income. Key Considerations You would like the option to withdraw at any time with no IRS penalties. You already contributed the maximum amount to all tax-advantaged retirement accounts. Traditional Accounts Traditional accounts include Traditional IRAs, Traditional 401(k)s, Traditional 403(b)s, Traditional 457 Governmental Plans, and Traditional Thrift Savings Plans (TSPs). Traditional investment accounts for retirement are generally funded with pre-tax dollars. The investment income received is deferred until the time of distribution from the plan. Assuming all the contributions are funded with pre-tax dollars, the distributions are fully taxable as ordinary income. For investors under age 59.5, there may be an additional 10% early withdrawal penalty unless an exemption applies. Key Considerations You expect your tax rate to be lower in retirement than it is now. You recognize and accept the possibility of an early withdrawal penalty. Roth Accounts Includes Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457 Governmental Plans, and Roth Thrift Saving Plans (TSPs) Roth type investment accounts for retirement are always funded with after-tax dollars. Qualified distributions are tax-free. For investors under age 59.5, there may be ordinary income taxes on earnings and an additional 10% early withdrawal penalty on the earnings unless an exemption applies. Key Considerations You expect your tax rate to be higher in retirement than it is right now. You expect your modified adjusted gross income (AGI) to be below $140k (or $208k filing jointly). You desire the option to withdraw contributions without being taxed. You recognize the possibility of a penalty on earnings withdrawn early. Beyond account type decisions, we also use your dividends to keep your tax impact as small as possible. Four Strategies Betterment Uses To Help You Limit Your Tax Impact 1. We use any additional cash to rebalance your portfolio. When your account receives any cash—whether through a dividend or deposit—we automatically identify how to use the money to help you get back to your target weighting for each asset class. Dividends are your portion of a company’s earnings. Not all companies pay dividends, but as a Betterment investor, you almost always receive some because your money is invested across thousands of companies in the world. Your dividends are an essential ingredient in our tax-efficient rebalancing process. When you receive a dividend into your Betterment account, you are not only making money as an investor—your portfolio is also getting a quick micro-rebalance that helps keep your tax bill down at the end of the year. And, when market movements cause your portfolio’s actual allocation to drift away from your target allocation, we automatically use any incoming dividends or deposits to buy more shares of the lagging part of your portfolio. This helps to get the portfolio back to its target asset allocation without having to sell off shares. This is a sophisticated financial planning technique that traditionally has only been available to larger accounts, but our automation makes it possible to do it with any size account. Beyond dividends, Betterment also has a number of features to help you optimize for taxes. Let’s demystify these three powerful strategies. Performance of S&P 500 With Dividends Reinvested Source: Bloomberg. Performance is provided for illustrative purposes to represent broad market returns for the U.S. Stock Market. The performance is not attributable to any actual Betterment portfolio nor does it reflect any specific Betterment performance. As such, it is not net of any management fees. The performance of specific U.S. Stock Market funds in the Betterment portfolio will differ from the performance of the broad market returns reflected here. 2. Tax loss harvesting. Tax loss harvesting can lower your tax bill by “harvesting” investment losses for tax reporting purposes while keeping you fully invested. When selling an investment that has increased in value, you will owe taxes on the gains, known as capital gains tax. Fortunately, the tax code considers your gains and losses across all your investments together when assessing capital gains tax, which means that any losses (even in other investments) will reduce your gains and your tax bill. In fact, if losses outpace gains in a tax year you can eliminate your capital gains bill entirely. Any losses leftover can be used to reduce your taxable income by up to $3,000. Finally, any losses not used in the current tax year can be carried over indefinitely to reduce capital gains and taxable income in subsequent years. How do I do it? When an investment drops below its initial value—something that is very likely to happen to even the best investment at some point during your investment horizon—you sell that investment to realize a loss for tax purposes and buy a related investment to maintain your market exposure. Ideally, you would buy back the same investment you just sold. After all, you still think it’s a good investment. However, IRS rules prevent you from recognizing the tax loss if you buy back the same investment within 30 days of the sale. So, in order to keep your overall investment exposure, you buy a related but different investment. Think of selling Coke stock and then buying Pepsi stock. Overall, tax loss harvesting can help lower your tax bill by recognizing losses while keeping your overall market exposure. At Betterment, all you have to do is turn on Tax Loss Harvesting+ in your account. 3. Asset location. Asset location is a strategy where you put your most tax-inefficient investments (usually bonds) into a tax-efficient account (IRA or 401k) while maintaining your overall portfolio mix. For example, an investor may be saving for retirement in both an IRA and taxable account and has an overall portfolio mix of 60% stocks and 40% bonds. Instead of holding a 60/40 mix in both accounts, an investor using an asset location strategy would put tax-inefficient bonds in the IRA and put more tax-efficient stocks in the taxable account. In doing so, interest income from bonds—which is normally treated as ordinary income and subject to a higher tax rate—is shielded from taxes in the IRA. Meanwhile, qualified dividends from stocks in the taxable account are taxed at a lower rate, capital gains tax rates instead of ordinary income tax rates. The entire portfolio still maintains the 60/40 mix, but the underlying accounts have moved assets between each other to lower the portfolio’s tax burden. Here’s what asset location looks like in action: 4. We use ETFs instead of mutual funds. Have you ever paid capital gain taxes on a mutual fund that was down over the year? This frustrating situation happens when the fund sells investments inside the fund for a gain, even if the overall fund lost value. IRS rules mandate that the tax on these gains is passed through to the end investor, you. While the same rule applies to exchange traded funds (ETFs), the ETF fund structure makes such tax bills much less likely. In fact, most of the largest stock ETFs have not passed through any capital gains in over 10 years. In most cases, you can find ETFs with investment strategies that are similar or identical to a mutual fund, often with lower fees. We go the extra mile for your money. Following these four strategies can help eliminate or reduce your tax bill, depending on your situation. At Betterment, we’ve automated these and other tax strategies, which means tax loss harvesting and asset location are as easy as clicking a button to enable it. We do the work, and your wallet can stay a little fuller. Learn more about how Betterment helps you maximize your after-tax returns.
You Can Now Skip Individual Recurring DepositsYou Can Now Skip Individual Recurring Deposits Managing your Betterment auto-deposits just got easier. Now you can skip any individual auto-deposit in just a few easy steps. It gives me great joy to announce that you can now skip any individual recurring deposit before it happens. You can now skip any recurring deposit you’ve set up before it happens from a link in the email sent before your recurring deposit occurs. We’ve heard scenarios like this many times: I have an unusually high credit card bill I want to pay off (rather than save). I need to put a deposit down on my kids’ school tuition and need to skip this month. I need to pay taxes but otherwise want to continue saving regularly. Until today, if you had set up a recurring deposit with Betterment and didn’t want it to proceed, you needed to turn off your recurring deposit completely. This not only meant you needed to remember to come back and turn it on later, it also meant your plan would (incorrectly) be off track simply because you don’t want to save for one deposit. One of the cardinal rules of behavioral finance is never make someone make more decisions than necessary. If clients want to skip just one deposit, they should be able to do it. So from now on, you can skip any individual recurring deposit, so long as it is before 4 PM EST on the scheduled deposit date. How To Skip An Individual Deposit There are two places you can go to skip a recurring deposit. First, Betterment sends you an email a day before your scheduled recurring deposit takes place. In this email, you’ll find a link directly taking you to Betterment’s site where you can skip your upcoming deposit. Just click on it, sign in, and confirm. Second, you can see all pending recurring deposits on the “Transfer” tab of your Betterment homepage. So long as it is before 4PM EST on the deposit initiation date, you will have the option to hit the “skip” button on the right. Then, you'll see: Too many skips can knock you off track. For the vast majority of goals, missing one deposit won’t be enough to knock you off track. Our advice will automatically update to consider your new balance and the skipped deposit, and may slightly increase the recommendation for remaining recurring deposits (as you’d expect). But it is possible that skipping many recurring deposits will reduce the confidence that you’ll reach your target balance on the target date. However, you can always defer the goal a bit in order to make up for your current circumstances.
Portfolio Optimization: Our Secret to Driving Better PerformancePortfolio Optimization: Our Secret to Driving Better Performance We optimally blend funds to deliver higher expected investor returns for each asset class and ensure you get the best possible performance from your investments. Many investors use a combination of tactics to get the best performance they can from their portfolios, including asset allocation, diversification and other risk management techniques. But the difference between Betterment and individuals who are trying to navigate this alone, is the complexity and the scale on which we can do this for you. When you invest with Betterment, you’re getting a professional portfolio that has fully integrated these tactics, delivering you an investment vehicle that's already been optimized. We integrate a number of sophisticated strategies that few people can implement on their own as part of our portfolio optimization, including maximizing upside potential and minimizing the downside risk for each of your investment goals. Building the portfolio We know any DIY investor can choose a bunch of funds with enough personal time spent on research, whether it's through Fidelity or Vanguard or some other platform. In fact, DIY investors can and do apply the lessons of many years of research with respect to picking funds, like only sticking with index funds, or favoring a value tilt. But for many people, spending a couple of days a month on investment research and management is either not of interest or a practical use of their time. The alternatives are paying for an advisor, or using a basic target date fund. The former is expensive, while the latter is inflexible to your needs, and can also be unnecessarily pricey. That's where our portfolio and service are ideal. At Betterment, we offer 101 customizable allocations to customers, ranging from 100% stocks to 100% short-term Treasuries. First, it's helpful to understand how we built our overall portfolio and what's inside. We started with a practical foundation based on Nobel prize-winning research from the past seven decades. We began with the concept of diversifying as much as possible (Markowitz, Modern Portfolio Theory, 1950s), and then tilted toward value and small-cap stocks (Fama & French, 1970s). Since we know that most active mutual-fund managers tend to underperform, we then picked low cost, index-tracking, high liquidity ETFs for our portfolio. And because people often worry about potential losses about twice as much as potential gains (Kahneman, Prospect Theory, 2002), we worked on minimizing downside risk. Lastly, we assembled those funds in a way that gives you better performance by adding another level of analysis, or portfolio optimization. To do that, we used some of the most recent quantitative models for asset allocation and downside risk to squeeze even more performance—or diversification alpha—out of these assets. Learn more about the funds in our portfolio. Driving performance The two modern techniques we used are the Black-Litterman model and a downside-risk optimization model. These two models complement each other like yin and yang—one model helps us optimize for the upside, while the other helps us see what the downside might look like. The Black-Litterman Model: This model allows us to generate forward-looking returns estimates —the upside—based on actual data that includes the collective intelligence of all investors around globe. To be sure, this is a general description of this model; there is also an academic view as well. This complex formula has a very basic insight at its core: it looks at how all investors around the world behave, and based on that information, creates a kind of global asset allocation model. This makes it a very good anchor of where all the world’s money is invested in the aggregate at any given time. The model was introduced in 1990 and refined over the next decade, and also helps make up for some of the shortcomings in the classic Modern Portfolio Theory, which can underestimate the diversification benefits of some asset classes. Read more about our diversification strategy. In addition, Black-Litterman is the way to avoid a so-called home bias in investing. This refers to the preference investors have for favoring assets that are “close to home”, contra evidence that would suggest a more global allocation. In other words, it's a tool for using empirical evidence to make investing decisions, with no reference to regional likes or dislikes. U.S. stock markets are only about 48% of the world stock market—the remainder is international developed (43%) and emerging markets (9%). You can see this breakdown in the MSCI All-Country World Index. Minimizing potential for loss Downside Risk and Uncertainty Optimization: Modeling for worst-case scenarios allows us to generate forward-looking views of potential downside risk and uncertainty based on the combination of the historical returns of our chosen assets. When we model our future expected returns we want to know two things — what is the frontier for expected outcomes and what is the frontier for worse than expected scenarios (e.g. everything from a mild downturn to a massive drawdown). With this model, we can evaluate a full range of future outcomes. We can also stress-test our allocations through negative market scenarios to get an idea of how severe a drawdown could be, and what duration. We can also factor in the role our continuous, algorithm-based investment management will play, primarily via automatic rebalancing. The results An easy way to see the value-add of our strategies is to look at the difference between our efficient frontier and that of a so-called "naive" portfolio, one that is made up of only the S&P 500 and an index tracking all U.S. bonds (AGG). The expected returns of Betterment's portfolio significantly outperform a basic two-fund portfolio for every level of risk. This result is a function of portfolio optimization, along with our well-crafted selection of assets and funds. Even if it's clear that these strategies are out of reach for virtually all DIY investors, you might ask: why doesn't every advisor do portfolio optimization? There are several reasons. One is the issue of quantitative capacity—these methods are mathematically complex with multiple moving parts (that's why our investing team includes experts in mathematics, statistics and economics.) Second, portfolio optimization is time consuming—whenever a new asset class become available (FX-hedged international bonds, for example), or funds change their expense ratios, an advisor needs to rerun the optimization. Lastly, there's the cost of updating portfolios—we have built a sophisticated proprietary trading platform that automates these calculations on an ongoing basis, meaning that if we update our optimization, all our customers can instantly benefit. A traditional advisor would have to process many of these changes by hand. As you can see, investing well is not just a matter of picking the right funds—it's also a matter of applying some serious computing power to squeeze out optimal performance. For you, the result of this portfolio optimization is the security of knowing that for any level of risk you select, we've done a careful evaluation to provide the optimal risk-adjusted performance, and your portfolio is re-optimized on an ongoing basis.
Betterment’s Retirement Advice Tools ExplainedBetterment’s Retirement Advice Tools Explained Betterment aligns our investment advice with what it’s really like to pursue your financial goals. Learn about our retirement planning advice and how it can help you. TABLE OF CONTENTS Define What Retirement Means To You Setting Up Your Retirement Projections At Betterment Understanding Betterment’s Recommendations Taking Action Savings towards retirement is one of the most popular reasons people use Betterment. This makes sense, since almost everybody dreams of retiring some day (or at least having the option to quit working or switch careers, if they choose). That’s why Betterment offers retirement tools in your account that allow you to define what retirement means to you, and then run projections that give guidance on whether your goal is on-track or off-track. Our advanced projections include key inputs like Social Security, inflation, life expectancy, and even investment accounts not held at Betterment. Once you have your retirement projections setup in your retirement goal, Betterment will give you personalized advice on how much you should be saving towards retirement, which accounts are most optimal for you, and how you should be invested. You can even run different “what-if” scenarios to see how things like retiring earlier, or saving more, affect your projections. Of course, we make it easy for you to then take action and make your money work for you. For example, you can open various types of retirement accounts. You can also enable our many automated tools to help you save more, manage your investments, and manage taxes. We even work to make rolling over other retirement accounts as easy as possible. Let’s walk through each of these areas in more detail, so you can learn how to make the most of Betterment’s retirement planning tools. Define what retirement means to you. Each person’s retirement plan is unique. That’s why we allow you to tell us how and when you’d like to retire, and then we shape our advice around those inputs. Afterall, our advice will be very different if you plan on retiring at age 55 vs. age 75. This is what we call goal-based investing, where you tell us your various financial goals, and we give you advice on how to achieve them. For many individuals, the initial step of defining retirement can be difficult. This is understandable. We often hear questions like “how do I know how much money I’ll spend in retirement?” or “can I retire tomorrow?” Don’t worry. Betterment built tools to help you answer these tough questions. Once you open a retirement goal in your Betterment account, our retirement planning tool will walk you through how to estimate both your retirement spending and retirement age in order to set up your plan. Estimating Retirement Spending How much you would like to spend during your retirement is the most important driver of your retirement plan, but it is often the hardest part to predict. Maybe your kids will be independent by then, but health care may cost more. Maybe your house will be paid off, but you’ll also want to travel more. These are just a few examples of how some spending categories may decrease, while others may increase. If you’re one of the few who happen to have a good idea of what you’d like to spend during retirement, we allow you to simply input that number. For those who are unsure, we have a helpful calculator that will automatically estimate a spending number for you. This number can serve as a starting point, but you can always override it. We then estimate your retirement spending by running key data points through a spending estimate formula. This formula includes expected wage increases (which tend to be higher than general inflation), cost of living data for your particular zip code, and an estimated percentage of income used to support your lifestyle (i.e. spent on goods and services) based on data from individuals with similar income to you. While not an exhaustive list, these data points provide a useful spending overview that are factored into our advice. Estimating Retirement Age When you’ll retire is also difficult to predict. The choice isn’t always yours to make either, as can be the case with unexpected health issues or being forced out of work. As with your retirement spending, if you have a particular retirement age in mind, you can simply enter it into our system. For those who are unsure, we default you to age 68, which is just beyond Full Retirement Age (FRA), as defined by the Social Security Administration, for many of our customers. Making Changes And Updates We know that life happens, and things change. The retirement plan you set up in your 30’s or 40’s may become outdated. That’s why we build flexibility into our retirement projections, and allow you to make changes to your plan. You can easily update your desired retirement spending or desired retirement age at any time. When you do, we will automatically update our projections based on your new inputs. This way, you can ensure your retirement plan is always up-to-date. In fact, we encourage you to review your retirement projections periodically for this exact reason. As a general guideline, you should review your retirement projections once per year, or after any major life event like a promotion, change in marital status, birth of a child, or other similar event. Setting Up Your Retirement Projections At Betterment Now that you’ve defined what retirement means to you, it’s time to run some projections and determine if you seem on-track or off-track to meet your retirement goal. Betterment will calculate this for you, but first we need to gather some information about your situation. The more information you tell us, the more accurate our corresponding projections can be. Existing Savings: Tell us which accounts you already have for retirement, so we can give you credit for the savings you already have. This should not include accounts that are set aside for other purposes, like emergency funds, buying a house, or your kid’s college. But it should include retirement accounts, even if they are not held at Betterment. Common examples of this are 401(k)s and your spouse’s retirement accounts as well. We recommend syncing these accounts to your Betterment account. Planned Future Savings: We can also factor in future retirement savings that you expect to make. Under each account, you can tell us how much you plan to contribute per year. You can even include employer matches, if applicable, to your workplace retirement accounts. Social Security Benefits: Social Security plays a key role in retirement for millions of Americans. We use your current income to estimate Social Security benefits according to the U.S. Social Security Administration’s benefit rules. We also adjust expected Social Security benefits based on projections from the Trustees Report. However, this is just an estimate, and you may prefer to instead login to your online Social Security account to view your official estimate and use that instead. Other Retirement Income: Some individuals may have other sources of retirement income, such as a pension or rental income. If this applies, you can enter that information into your projection inputs as well. Life Expectancy: We default your life expectancy to age 90, which is a conservative estimate compared to average life expectancies. Women tend to live longer than men, so keep this in mind as you adjust your retirement plan. You can always override our default age, if you’d like. With all of these inputs, your retirement plan should be personalized to your situation. We then use our Goal Projection and Advice methodology to estimate if you appear to be on-track to reach your retirement goal or not. If you’re off-track, that’s okay. We’ll give you recommendations to get on-track, and make it easy to take action on those recommendations. We don’t expect change to happen overnight, and even knowing where you stand is a great first step. Understanding Betterment’s Recommendations With your retirement projections in place, Betterment can now give you personalized recommendations to help you get on-track, or even if you are already on-track, to help maximize your savings and investments. The recommendations we give should answer many common questions we hear from customers, such as: How much should I be saving? Which accounts should I contribute to? How should I be invested? How much should I be saving? One of the most important recommendations we can give is telling you how much we estimate you should be saving per year to be on-track for retirement. Betterment will give you this top line number so that you have a target in mind to strive towards. Which accounts should I contribute to? For many people, you will need to combine multiple accounts to reach your goals and optimize your savings. Once you know how much you should be saving, we will also tell you which mix of accounts you should be putting those savings into, and show that to you in a prioritized list. This list includes things like tax bracket, employer match info, account fees, contribution limits, and more. This helps make sure your money is working as hard as possible for you. In particular, the use of tax-advantaged retirement accounts are an important benefit to consider when saving for retirement. Contributions to Traditional 401(k), Traditional 403(b), and Traditional IRA accounts are typically tax-deductible, which means you contribute on a pre-tax basis and normally don’t pay taxes until you make withdrawals. Contributions to Roth 401(k), Roth 403(b), and Roth IRA accounts are not tax-deductible, which means you contribute on an after-tax basis but they grow tax-free. How you contribute to your retirement accounts now can make a big difference over time. The earlier you invest, the more possibility there is for your investments to appreciate. This is especially true for retirement savings, because when you use tax-advantaged retirement accounts, such as IRAs or 401(k)s, all that time spent in the market can lead to benefits in tax-free growth. How should I be invested? Another critical component of your retirement plan is making sure you are invested appropriately. Betterment’s tools will give you feedback on key areas of your investments, even on your non-Betterment accounts. Our tools will give you feedback on how risky your investments are and if that risk level is appropriate given your time horizon to retirement. As a default for our recommended actions, if you have 20 or more years until you retire, we recommend 90% stocks. Then, our investment advice reduces your risk over time until your retirement date, when it hits 56% stocks. Finally, it glides down to 30% stocks during retirement. Our tools will also analyze your external accounts to determine if you seem to be paying more fees than you have to, and if you have too much cash sitting in your retirement accounts. Taking Action Even the best retirement plan won’t do you much good if you don’t take action. With Betterment’s smooth interface and powerful automation, taking action has rarely been easier. Open multiple retirement accounts: Many people can benefit from having multiple retirement accounts, like Roth and Traditional accounts. This can help you optimize for taxes and save beyond the contribution limits that some accounts have. Enable tax management algorithms: Optimizing for taxes can help your money work harder for you. Betterment is known for our advanced tax strategies like tax loss harvesting and tax coordination, which can both be put on autopilot in your Betterment accounts at the flip of a switch. Select a portfolio strategy: Betterment offers multiple portfolio strategies, which allow you to customize your investments and choose the strategy that best fits your needs and preferences. Enable investment management algorithms: Betterment allows you to automate many areas of investment management like rebalancing and auto-adjusting your investments over time. Roll over retirement accounts: Consolidating your investment accounts into Betterment may help you ensure your retirement portfolio is working together in a seamless, automated manner. Enable automatic deposits: Making retirement savings automatic can help you save more, and make maxing out your retirement accounts easier. Add beneficiaries: Adding beneficiaries can help ensure your money goes where you want it to, even after you pass away. All of these actions are important in setting up a comprehensive retirement plan that incorporates savings, investments, taxes, and more. Generally speaking, the earlier you start, the better off you’ll be. Start taking the above actions to set up your retirement plan at Betterment today.
Tax Loss Harvesting+ MethodologyTax Loss Harvesting+ Methodology Tax loss harvesting is a sophisticated technique to get more value from your investments—but doing it well requires expertise. TABLE OF CONTENTS Navigating the Wash Sale Rule The Betterment Solution TLH+ Model Calibration TLH+ Results Best Practices for TLH+ Conclusion Disclosure Tax loss harvesting is a sophisticated technique to help you get more value from your investments—but doing it well requires expertise. There are many ways to get your investments to work harder for you—better diversification, downside risk management, and the right mix of asset classes for your risk level. Betterment does all of this automatically via its low-cost index fund ETF portfolio. But there is another way to get even more out of your portfolio—using investment losses to improve your after-tax returns with a method called tax loss harvesting. In this white paper, we introduce Betterment’s Tax Loss Harvesting+™ (TLH+™): a sophisticated, fully automated service for Betterment customers. Betterment’s TLH+ service scans portfolios regularly for opportunities (temporary dips that result from market volatility) to realize losses which can be valuable come tax time. While the concept of tax loss harvesting is not new for wealthy investors, TLH+ utilizes a number of innovations that typical implementations may lack. It takes a holistic approach to tax-efficiency, seeking to optimize every user-initiated transaction in addition to adding value through automated activity, such as rebalances. TLH+ not only improves on this powerful tax-saving strategy—between 2000 and 2013, it would have provided an estimated 0.77% to a typical customer's after-tax returns, annually—but also makes tax loss harvesting available to more investors than ever before. What is tax loss harvesting? Capital losses can lower your tax bill by offsetting gains, but the only way to realize a loss is to sell the depreciated asset. However, in a well-allocated portfolio, each asset plays an essential role in providing a piece of total market exposure. For that reason, an investor should not want to give up the expected returns associated with each asset just to realize a loss. At its most basic level, tax loss harvesting is selling a security that has experienced a loss—and then buying a correlated asset (i.e. one that provides similar exposure) to replace it. The strategy has two benefits: it allows the investor to “harvest” a valuable loss, and it keeps the portfolio balanced at the desired allocation. How does it lower your tax bill? Capital losses can be used to offset capital gains you’ve realized in other transactions over the course of a year—gains on which you would otherwise owe tax. Then, if there are losses left over (or if there were no gains to offset), you can offset up to $3,000 of ordinary income for the year. If any losses still remain, they can be carried forward indefinitely. Tax loss harvesting is primarily a tax deferral strategy, and its benefit depends entirely on individual circumstances. Over the long run, it can add value through some combination of these distinct benefits that it seeks to provide: Tax deferral: Losses harvested can be used to offset unavoidable gains in the portfolio, or capital gains elsewhere (e.g., from selling real estate), deferring the tax owed. Savings that are invested may grow, assuming a conservative growth rate of 5% over a 10-year period, a dollar of tax deferred would be worth $1.63. Even after belatedly parting with the dollar, and paying tax on the $0.63 of growth, you’re ahead. Pushing capital gains into a lower tax rate: If you’ve realized short-term capital gains (STCG) this year, they’ll generally be taxed at your highest rate. However, if you’ve harvested losses to offset them, the corresponding gain you owe in the future could be long-term capital gain (LTCG). You’ve effectively turned a gain that would have been taxed up to 50% today into a gain that will be taxed more lightly in the future (up to 30%). Converting ordinary income into long-term capital gains: A variation on the above: offsetting up to $3,000 from your ordinary income shields that amount from your top marginal rate, but the offsetting future gain will likely be taxed at the LTCG rate. Permanent tax avoidance in certain circumstances: Tax loss harvesting provides benefits now in exchange for increasing built-in gains, subject to tax later. However, under certain circumstances (charitable donation, bequest to heirs), these gains may avoid taxation entirely. Navigating the Wash Sale Rule Summary: Wash sale rule management is at the core of any tax loss harvesting strategy. Unsophisticated approaches can detract from the value of the harvest or place constraints on customer cash flows in order to function. If all it takes to realize a loss is to sell a security, it would seem that maintaining your asset allocation is as simple as immediately repurchasing it. However, the IRS limits a taxpayer’s ability to deduct a loss when it deems the transaction to have been without substance. At a high level, the so-called “wash sale rule” disallows a loss from selling a security if a “substantially identical” security is purchased 30 days after or before the sale. The rationale is that a taxpayer should not enjoy the benefit of deducting a loss if he did not truly dispose of the security. The wash sale rule applies not just to situations when a “substantially identical” purchase is made in the same account, but also when the purchase is made in the individual’s IRA/401(k) account, or even in a spouse’s account. This broad application of the wash sale rule seeks to ensure that investors cannot utilize nominally different accounts to maintain their ownership, and still benefit from the loss. A wash sale involving an IRA/401(k) account is particularly unfavorable. Generally, a “washed” loss is postponed until the replacement is sold, but if the replacement is purchased in an IRA/401(k) account, the loss is permanently disallowed. If not managed correctly, wash sales can undermine tax loss harvesting. Handling proceeds from the harvest is not the sole concern—any deposits made in the following 30 days (whether into the same account, or into the individual’s IRA/401(k)) also need to be allocated with care. Avoiding the wash The simplest way to avoid triggering a wash sale is to avoid purchasing any security at all for the 30 days following the harvest, keeping the proceeds (and any inflows during that period) in cash. This approach, however, would systematically keep a portion of the portfolio out of the market. Over the long term, this “cash drag” could hurt the portfolio’s performance. More advanced strategies repurchase an asset with similar exposure to the harvested security that is not “substantially identical” for purposes of the wash sale rule. In the case of an individual stock, it is clear that repurchasing stock of that same company would violate the rule. Less clear is the treatment of two index funds from different issuers (e.g., Vanguard and Schwab) that track the same index. While the IRS has not issued any guidance to suggest that such two funds are “substantially identical," a more conservative approach when dealing with an index fund portfolio would be to repurchase a fund whose performance correlates closely with that of the harvested fund, but tracks a different index.1 Selecting a viable replacement security, however, is just one piece of the accounting and optimization puzzle. Manually implementing a tax loss harvesting strategy is feasible with a handful of securities, little to no cash flows, and infrequent harvests. However, assets will often dip in value but recover by the end of the year, so annual strategies leave many losses on the table. The wash sale management and tax lot accounting necessary to support more frequent (and thus more effective) harvesting quickly become overwhelming in a multi-asset portfolio—especially with regular deposits, dividends, and rebalancing. Software is ideally suited for this complex task. But automation, while necessary, is not sufficient. The problem can get so complex that basic tax loss harvesting algorithms may choose to keep new deposits and dividends in cash for the 30 days following a harvest, rather than tackle the challenge of always maintaining full exposure at the desired allocation. An effective loss harvesting algorithm should be able to maximize harvesting opportunities across a full range of volatility scenarios, without sacrificing the investor’s precisely tuned global asset allocation. It should reinvest harvest proceeds into closely correlated alternate assets, all while handling unforeseen cash inflows from the investor without ever resorting to cash positions. It should also be able to monitor each tax lot individually, harvesting individual lots at an opportune time, which may depend on the volatility of the asset. And most of all, it should do everything to avoid leaving a taxpayer worse off. TLH+ was created because no available implementations seemed to solve all of these problems. Existing strategies and their limitations Every tax loss harvesting strategy shares the same basic goal: to maximize a portfolio’s after-tax returns by realizing built-in losses while minimizing the negative impact of wash sales. Approaches to tax loss harvesting differ primarily in how they handle the proceeds of the harvest to avoid a wash sale. Below are the three strategies commonly employed by manual and algorithmic implementations. After selling a security that has experienced a loss, existing strategies would likely have you... Existing strategy Problem Delay reinvesting the proceeds of a harvest for 30 days, thereby ensuring that the repurchase will not trigger a wash sale. While it’s the easiest method to implement, it has a major drawback: no market exposure—also called cash drag. Cash drag hurts portfolio returns over the long term, and could offset any potential benefit from tax loss harvesting. Reallocate the cash into one or more entirely different asset classes in the portfolio. This method throws off an investor's desired asset allocation. Additionally, such purchases may block other harvests over the next 30 days by setting up potential wash sales in those other asset classes. Switch back to original security after 30 days from the replacement security. Common manual approach, also used by some automated investing services. A switchback can trigger short-term capital gains when selling the replacement security, reducing the tax benefit of the harvest. Even worse, this strategy can leave an investor owing more tax than if it did nothing. The hazards of switchbacks In the 30 days leading up to the switchback, two things can happen: the replacement security can drop further, or go up. If it goes down, the switchback will realize an additional loss. However, if it goes up, which is what any asset with a positive expected return is expected to do over any given period, the switchback will realize short-term capital gains (STCG)—kryptonite to a tax-efficient portfolio management strategy. To be sure, the harvested loss should offset all (or at least some) of this subsequent gain, but it is easy to see that the result is a lower-yielding harvest. Like a faulty valve, this mechanism pumps out tax benefit, only to let some of it leak back. An algorithm that expects to switch back unconditionally must deal with the possibility that the resulting gain could exceed the harvested loss, leaving the taxpayer worse off. An attempt to mitigate this risk could be setting a higher threshold based on volatility of the asset class—only harvesting when the loss is so deep, that the asset is unlikely to entirely recover in 30 days. Of course, there is still no guarantee that it will not, and the price paid for this buffer is that your lower-yielding harvests will also be less frequent than they could be with a more sophisticated strategy. Examples of negative tax arbitrage Let’s look at how an automatic 30-day switchback can destroy the value of the harvested loss, and even increase tax owed, rather than reduce it. Below is actual performance for Emerging Markets—a relatively volatile asset class that’s expected to offer some of the biggest harvesting opportunities in a global portfolio. We assume a position in VWO, purchased prior to January 1, 2013. With no harvesting, it would have looked like this: No Tax Loss Harvesting Emerging Markets, 1/2/2014 - 5/21/2014 https://d1svladlv4b69d.cloudfront.net/src/d3/tlh-switchbacks/no-tlh.html A substantial drop in February presented an excellent opportunity to sell the entire position and harvest a $331 long-term loss. The proceeds were re-invested into IEMG, a highly correlated replacement (tracking a different index). By March, however, the dip proved temporary, and 30 days after the sale, the asset class more than recovered. The switchback sale results in STCG in excess of the loss that was harvested, and actually leaves the investor owing tax, whereas without the harvest, he would have owed nothing. TLH with 30-day Switchbacks Emerging Markets, 1/2/2014 - 5/21/2014 https://d1svladlv4b69d.cloudfront.net/src/d3/tlh-switchbacks/thirty-day-switchbacks.html Under certain circumstances, it can get even worse. Due to a technical nuance in the way gains and losses are netted, the 30-day switchback can result in negative tax arbitrage, by effectively pushing existing gains into a higher tax rate. When adding up gains and losses for the year, the rules require netting of like against like first. If any long-term capital gain (LTCG) is present for the year, you must net a long-term capital loss (LTCL) against that first, and only then against any STCG. In the scenario above, the harvested $331 LTCL was used to offset the $360 STCG from the switchback; long can be used to offset short, if we assume no LTCG for the year. Negative tax arbitrage when unrelated long-term gains are present Now let’s assume that in addition to the transactions above, the taxpayer also realized a LTCG of exactly $331 (from selling some other, unrelated asset). If no harvest takes place, the investor will owe tax on $331 at the lower LTCG rate. However, if you add the harvest and switchback trades, the rules now require that the harvested $331 LTCL is applied first against the unrelated $331 LTCG. The harvested LTCL gets used up entirely, exposing the entire $360 STCG from the switchback as taxable. Instead of sheltering the highly taxed gain on the switchback, the harvested loss got used up sheltering a lower-taxed gain, creating far greater tax liability than if no harvest had taken place. Tax Strategy STCG Realized LTCG Realized Taxes Owed No TLH $0 $331 $109 TLH with 30-day switchbacks $360 ($331-$331) $0 net $187 In the presence of unrelated transactions, unsophisticated harvesting can effectively convert existing LTCG into STCG. Some investors regularly generate significant LTCG (for instance, by gradually diversifying out of a highly appreciated position in a single stock). It’s these investors, in fact, who would benefit the most from effective tax loss harvesting. However, if their portfolios are harvested with unconditional 30-day switchbacks over the years, it’s not a question of “if” the switchbacks will convert some LTCG into STCG, but “when” and “how much.” Negative tax arbitrage with dividends Yet another instance of negative tax arbitrage can result in connection with dividend payments. If certain conditions are met, some ETF distributions are treated as “qualified dividends”, taxed at lower rates. One condition is holding the security for more than 60 days. If the dividend is paid while the position is in the replacement security, it will not get this favorable treatment: under a rigid 30-day switchback, the condition can never be met. As a result, up to 20% of the dividend is lost to tax (the difference between the higher and lower rate). The Betterment Solution Summary: Betterment believes TLH+ can substantially improve upon existing strategies by managing parallel positions within each asset class indefinitely, as tax considerations dictate. It approaches tax-efficiency holistically, seeking to optimize every transaction, including customer activity. The fundamental advance of Betterment’s TLH+ is that tax-optimal decision making should not be limited to the harvest itself—the algorithm should remain vigilant with respect to every transaction. An unconditional 30-day switchback, whatever the cost, is plainly suboptimal, and could even leave the investor owing more tax that year—unacceptable for an automated strategy that seeks to lower tax liability. Intelligently managing a bifurcated asset class following the harvest is every bit as crucial to maximizing tax alpha as the harvest itself. The innovations TLH+ seeks to deliver, include: No exposure to short-term capital gains in an attempt to harvest losses. Through our proprietary Parallel Position Management system, a dual-security asset class approach enforces preference for one security without needlessly triggering capital gains in an attempt to harvest losses, all without putting constraints on customer cash flows. No negative tax arbitrage traps associated with less sophisticated harvesting strategies (e.g., 30-day switchback), making TLH+ especially suited for those generating large long-term capital gains on an ongoing basis. Zero cash drag at all times. With fractional shares and seamless handling of all inflows during wash sale windows, every dollar is invested at the desired allocation risk level. Dynamic trigger thresholds for each asset-class, ensuring that both high- and low-volatility assets can be harvested at an opportune time to increase the chances of large tax offsets. Tax loss preservation logic extended to user-realized losses, not just harvested losses, automatically protecting both from the wash sale rule. In short, user withdrawals always sell any losses first. No disallowed losses through overlap with a Betterment IRA/401(k). We use a tertiary ticker system to eliminate the possibility of permanently disallowed losses triggered by subsequent IRA/401(k) activity.2 This makes TLH+ ideal for those who invest in both taxable and tax-advantaged accounts. Harvests also take the opportunity to rebalance across all asset classes, rather than re-invest solely within the same asset class. This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and higher tax alpha. Through these innovations, TLH+ creates significant value over manually-serviced or less sophisticated algorithmic implementations. TLH+ is accessible to investors —fully automated, effective, and at no additional cost. Parallel securities To ensure that each asset class is supported by optimal securities in both primary and alternate positions, we screened by expense ratio, liquidity (bid-ask spread), tracking error vs. benchmark, and most importantly, covariance of the alternate with the primary.3 With those four measures in place, we assumed annual portfolio turnover of 10% and aggregated them into a single number representing the total annual cost of ownership. While there are small cost differences between the primary and alternate securities, the cost of negative tax arbitrage from tax-agnostic switching vastly outweighs the cost of maintaining a dual position within an asset class. For a 70% stock portfolio composed only of primary securities, the average underlying expense ratio is 0.136%. If each asset class consisted of a 50/50 split between primary and alternate, that cost would be 0.152%—a difference of less than two basis points. Of the 12 asset classes in Betterment’s core taxable portfolio, nine were assigned alternate tickers. Short-term Treasuries (SHV) and Inflation-protected Bonds (VTIP) are insufficiently volatile to be viable harvesting candidates (and disappear entirely above a 57% stock allocation). There is currently no suitable alternative available for International Bonds (BNDX). Take a look at the primary and alternate securities in the Betterment portfolio. Additionally, TLH+ features a special mechanism for coordination with IRAs/401(k)s that required us to pick a third security in each harvestable asset class (except in municipal bonds, which are not in the IRA/401(k) portfolio). While these have a higher cost than the primary and alternate, they are not expected to be utilized often, and even then, for short durations (more below in IRA/401(k) protection). Parallel Position Management As demonstrated, the unconditional 30-day switchback to the primary security is problematic for a number of reasons. To fix those problems, we engineered a platform to support TLH+, which seeks to tax-optimize every user and system-initiated transaction: the Parallel Position Management (PPM) system. PPM allows each asset class to be comprised of two closely correlated securities indefinitely, should that result in a better after-tax outcome. Here's how a portfolio with PPM looks to a Betterment customer. PPM provides several improvements over the switchback strategy. First, unnecessary gains are minimized if not totally avoided. Second, the parallel security (could be primary or alternate) serves as a safe harbor to minimize wash sales—not just from harvest proceeds, but any cash inflows. Third, the mechanism seeks to protect not just harvested losses, but losses realized by the customer as well. PPM not only facilitates effective opportunities for tax loss harvesting, but also extends maximum tax-efficiency to customer-initiated transactions. Every customer withdrawal is a potential harvest (losses are sold first). And every customer deposit and dividend is routed to the parallel position that would minimize wash sales, while shoring up the target allocation. PPM has a preference for the primary security when rebalancing and for all cash flow events—but always subject to tax considerations. This is how PPM behaves under various conditions: Transaction PPM behavior Withdrawals and sales from rebalancing Sales default out of the alternate position (if such a position exists), but not at the expense of triggering STCG—in that case, PPM will sell lots of the primary security first. Rebalancing will always stop short of realizing STCG. Taxable gains are minimized at every decision point—STCG tax lots are the last to be sold on a user withdrawal. Deposits, buys from rebalancing, and dividend reinvestments PPM directs inflows to underweight asset classes, and within each asset class, into the primary, unless doing so incurs greater wash sale costs than buying the alternate. Harvest events TLH+ harvests can come out of the primary into the alternate, or vice versa, depending on which harvest has a greater expected value. After an initial harvest, it could make sense at some point to harvest back into the primary, to harvest more of the remaining primary into the alternate, or to do nothing. Harvests that would cause more washed losses than gained losses are minimized if not totally avoided. PPM eliminates the negative tax arbitrage issues previously discussed, while leaving open significantly more flexibility to engage in harvesting opportunities. TLH+ is able to harvest more frequently, and can safely realize smaller losses, all without putting any constraints on user cash flows. Let’s return to the Emerging Markets example from above, demonstrating how TLH+ harvests the loss, but remains in the appreciated alternate position (IEMG), thereby avoiding STCG. Smarter Harvesting - Avoid the Switchback Emerging Markets, 1/2/2014 - 5/21/2014 https://d1svladlv4b69d.cloudfront.net/src/d3/tlh-switchbacks/tlh-plus.html Better wash sale management Managing cash flows across both taxable and IRA/401(k) accounts without needlessly washing realized losses is a complex problem. Some automated tax loss harvesting services recommend that their customers make infrequent deposits (e.g., quarterly), since more frequent schedules would render their algorithms ineffective. TLH+ operates without constraining the way that customers prefer contributing to their portfolios, and without resorting to cash positions. With the benefit of parallel positions, it weighs wash sale implications of every deposit and withdrawal and dividend reinvestment, and seeks to systematically choose the optimal investment strategy. This system protects not just harvested losses, but also losses realized through withdrawals. IRA/401(k) protection The wash sale rule applies when a “substantially identical” replacement is purchased in an IRA/401(k) account. Taxpayers must calculate such wash sales, but brokers are not required to report them. Even the largest ones leave this task to their customers.4 This is administratively complicated for taxpayers and leads to tax issues. At Betterment, we felt we could do more than the bare minimum. Being equipped to perform this calculation, we do it so that our customers don't have to. Because IRA/401(k) wash sales are particularly unfavorable—the loss is disallowed permanently—TLH+ goes another step further, and seeks to ensure that no loss realized in the taxable account is washed by a subsequent deposit into a Betterment IRA/401(k). In doing so, TLH+ always maintains target allocation in the IRA/401(k), without cash drag. No harvesting is done in an IRA/401(k), so if it weren't for the potential interaction with taxable transactions, there would be no need for IRA/401(k) alternate securities. However, on the day of an IRA/401(k) inflow, both the primary and the alternate security in the taxable account could have realized losses in the prior 30 days. Accordingly, each asset class supports a third correlated security (tracking a third index). The tertiary security is only utilized to hold IRA/401(k) deposits within the wash window temporarily. Let’s look at an example of how TLH+ handles a potentially disruptive IRA inflow when there are realized losses to protect, using real market data for the Developed Markets asset class. The customer starts with a position in VEA, the primary security, in both the taxable and IRA accounts. We then harvest a loss by selling the entire taxable position, and repurchase the alternate security, SCHF. Loss Harvested in VEA Two weeks pass, and the customer makes a withdrawal from the taxable account (the entire position, for simplicity), intending to fund the IRA. In those two weeks, the asset class dropped more, so the sale of SCHF also realizes a loss. The VEA position in the IRA remains unchanged. Customer Withdrawal Sells SCHF at a Loss A few days later, the customer contributes to his IRA, and $1,000 is allocated to the Developed Markets asset class, which already contains some VEA. Despite the fact that the customer no longer holds any VEA or SCHF in his taxable account, buying either one in the IRA would permanently wash a valuable realized loss. The Tertiary Ticker System automatically allocates the inflow into the third option for developed markets, IEFA. IRA Deposit into Tertiary Ticker Both losses have been preserved, and the customer now holds VEA and IEFA in his IRA, maintaining desired allocation at all times. Because no capital gains are realized in an IRA/401(k), there is no harm in switching out of the IEFA position and consolidating the entire asset class in VEA when there is no danger of a wash sale. The result: Customers using TLH+ who also have their IRA/401(k) assets with Betterment can know that Betterment will seek to protect valuable realized losses whenever they deposit into their IRA/401(k), whether it’s lump rollover, auto-deposits or even dividend reinvestments. Smart rebalancing Lastly, TLH+ directs the proceeds of every harvest to rebalance the entire portfolio, the same way that a Betterment account handles any incoming cash flow (deposit, dividend). Most of the cash is expected to stay in that asset class and be reinvested into the parallel asset, but some of it may not. Recognizing every harvest as a rebalancing opportunity further reduces the need for additional selling in times of volatility, further reducing tax liability. As always, fractional shares allow the inflows to be allocated with perfect precision. TLH+ Model Calibration Summary: To make harvesting decisions, TLH+ optimizes around multiple inputs, derived from rigorous Monte Carlo simulations. The decision to harvest is made when the benefit, net of cost, exceeds a certain threshold. The potential benefit of a harvest is discussed in detail below ("Results"). Unlike a 30-day switchback strategy, TLH+ does not incur the expected STCG cost of the switchback trade. Therefore, “cost” consists of three components: trading expense, execution expense, and increased cost of ownership for the replacement asset (if any). All trades are free for Betterment customers. TLH+ is engineered to factor in the other two components, configurable at the asset level, and the resulting cost approaches negligible. Bid-ask spreads for the bulk of harvestable assets are extremely narrow. Expense ratios for the major primary/alternate ETF pairs are extremely close, and in the case where a harvest back to the primary ticker is being evaluated, that difference is actually a benefit, not a cost. A harder cost to quantify could result from what can be thought of as an "overly itchy TLH trigger finger." Without the STCG switchback limitation, even very small losses appear to be worth harvesting, but only in a vacuum. Harvesting a loss “too early” could mean passing up a bigger (temporary) loss—made unavailable due to wash sale constraints stemming from the first harvest. This is especially true for more volatile assets, where a static TLH trigger could mean that the asset is being harvested at a fraction of the benefit that could be achieved by harvesting just a few days later, after a larger decline. Optimizing the thresholds to maximize loss yield becomes a statistical problem, ripe for an exhaustive simulation. There are two general approaches to testing a model’s performance: historical backtesting and forward-looking simulation. Optimizing a system to deliver the best results for only past historical periods is relatively trivial, but doing so would be a classic instance of data snooping bias. The maturation of the global ETF market is a relatively recent phenomenon. Relying solely on a historical backtest of a portfolio composed of ETFs that allow for 10 to 20 years of reliable data when designing a system intended to provide 40 to 50 years of benefit would mean making a number of indefensible assumptions about general market behavior. The superset of decision variables driving TLH+ is beyond the scope of this paper—optimizing around these variables required exhaustive analysis. TLH+ was calibrated via Betterment’s rigorous Monte Carlo simulation framework, spinning up thousands of server instances in the cloud to run through tens of thousands of forward-looking scenarios testing model performance. TLH+ Results Summary: In backtesting performance between 2000 and 2013, we found Betterment's TLH+ produced twice as many tax offsets as a commonly used 30-day switchback strategy. While forward-looking simulations are a far better approach to design and calibration, pure backtesting allows us to observe model performance during familiar market conditions.4 The precise value of harvesting depends on many variables that are unknown at the time of the trade (and could remain unknown for decades)—in particular, assumptions about liquidation or other disposition of assets in the portfolio. Other key assumptions include when the loss will be used, and which type of gain the loss will offset, since in the absence of matching gains, a short-term loss could offset a long-term gain, and vice versa. Tax alpha and IRR It is relatively simple to evaluate the immediate benefit of tax loss harvesting for a single year, ignoring any offsetting future costs. The task becomes more difficult when a number of these years are strung together, and when subsequent events (i.e. taxable liquidation) significantly impact overall performance. A measure called the Internal Rate of Return (IRR) is well-suited for the task, in particular when assuming ongoing deposits into the portfolio. To properly measure tax alpha, we used IRR to calculate the excess return that a TLH+ portfolio would have generated relative to the baseline Betterment portfolio over the last 13 years. For both portfolios, we assumed a constant 70% stock allocation, an initial $50,000 investment on 1/1/2000, and twice monthly auto-deposits of $750, escalated 5% annually (to account for inflation and salary growth). All dividends were reinvested to rebalance the portfolio (buying underweight assets rather than all assets pro-rata) and taxed under the current rules over the entire period. For tax rates, we assumed a single California resident (where Betterment has the most customers) making $100,000/year (federal: 28% on income, 15% on LTCG; state: 9.3%). Please note that these tax rates were the tax rates in effect during the backtest period which was between 2000 and 2013. For fees, in backtesting performance from 2000 to 2013, we assumed 25 basis points assessed quarterly. Savvy investors avoid STCG, and Betterment will never trigger it on behalf of customers, so we assumed that there is never any STCG to offset. Instead, we assumed that harvested losses are offset against ordinary income up to $3,000, and the excess, if any, against LTCG outside the portfolio. This mimics a typical scenario where the investor waits until the end of the year, when he knows exactly how much LTCG he can realize tax-free, and still leave enough losses to fully utilize the more valuable ordinary income offset (for example, if harvested losses add up to $8,000 by year-end, he would trigger $5,000 in LTCG). All tax savings were reinvested into the portfolio the following year. Finally, to factor in liquidation of embedded gains, we calculated IRR for three scenarios: (1) full liquidation on 1/1/2014, (2) liquidation of 50% of the portfolio on 1/1/2014, and (3) no liquidation. Note that the comparison is like-for-like: the non-TLH+ portfolio is also liquidated, and taxes paid. Even with full liquidation, TLH+ would have delivered tax alpha of 0.62%. Tax alpha for investor earning $100,000 (2000-13) A few words on top of standard disclosure are in order. No reliable data was available prior to 2000 that could adequately represent the performance of the full Betterment portfolio, constraining our ability to backtest over a longer period. The annualized results benefit from the fact that much of the value of harvesting came in the first few years of the period (the bear market of 2000-02). That allowed maximum time for the reinvested savings to compound, thus maximizing the benefit of tax deferral. The next 13 years may look nothing like the last 13. On the other hand, 13 years is brief compared to a lifetime of tax deferral—an investor in his thirties can reasonably expect his tax savings to compound for 30 years before liquidating. To strike a balance, we believe that a tax alpha of 0.77% (50% liquidation after 13 years) is a reasonable estimate of what TLH+ can deliver to a typical Betterment customer. These assumptions apply to many, but not all Betterment customers. Higher earners will likely see more benefit. To further demonstrate how tax loss harvesting adds value, we changed just one assumption: using the maximum California tax rates (federal: 39.6% on income, 23.8% on LTCG; state: 12.3%). Please note that these tax rates were the tax rates in effect during the backtest period which was between 2000 and 2013. As expected, the tax alpha under all liquidation scenarios jumps significantly. Tax alpha for investor earning $500,000+ (2000-13) While passive investors should be able to avoid STCG entirely, deferring these highly taxed gains with harvested losses is especially valuable. To layer on this benefit, we ran the backtest again, this time assuming that no matter how much STCL is harvested in a given year, there is always sufficient STCG available for offset. Tax alpha climbs higher, reaching nearly 1% with full liquidation. Tax alpha for investor earning $500,000+, with STCG available (2000-13) Annual Tax Offsets While IRR is the correct way to measure after-tax returns over a multi-year period, it can be useful to examine how a tax loss harvesting strategy behaved in a given year, ignoring the uncertainty of liquidation. The expected value of a loss is calculated by multiplying the amount of the loss by either the short-term or long-term rate, whichever is applicable. This approximates the direct tax savings from the loss in the year it is harvested, without accounting for the future liability that the harvest embeds into the portfolio. The total tax offset for the year's harvesting activity is calculated via this formula: Assuming the maximum California tax rates, and the same initial deposit and auto-deposit schedule as above, we calculated the annual tax offsets that a Betterment portfolio with TLH+ would have generated over the last 13 years. TLH+ was able to provide positive tax offsets in 11 out of 13 years, though as one would expect, most of the value came during the years of the 2000-03 bear market, and the 2008 financial crisis. Because TLH+ avoids tax-indifferent switchbacks, it never caused negative tax offsets over the period, even though the portfolio was regularly rebalanced. The mean annual tax offset was 1.94%. It is very important to emphasize that an annual tax offset is not a true "after-tax" measure, because it does not take into account that some of the benefit will be clawed back. It assumes that tax deferral is synonymous with permanent tax avoidance, which is misleading. By definition, it will be a higher number than any measure that attempts to factor in liquidation. However, because it is sometimes erroneously referred to as "tax alpha", it can be useful for apples-to-apples comparisons between various strategies. We also ran the same 70% Betterment portfolio, with all the same assumptions, but with a strategy utilizing the 30-day switchback. It is not surprising that TLH+ would outperform the 30-day switchback approach, given the discussion of the latter’s limitations. The extent of the advantage, however, is striking—the mean annual tax offset is double. Best Practices for TLH+ Summary: Tax loss harvesting can add some value for most investors, but high earners with a combination of long time horizons, ongoing realized gains, and plans for some charitable disposition will reap the largest benefits. This is a good point to reiterate that tax loss harvesting delivers value primarily due to tax deferral, not tax avoidance. A harvested loss can be beneficial in the current tax year to varying degrees, but harvesting that loss generally means creating an offsetting gain at some point in the future. If and when the portfolio is liquidated, the gain realized will be higher than if the harvest never took place. Let's look at an example: Year 1: Buy asset A for $100. Year 2: Asset A drops to $90. Harvest $10 loss, repurchase similar Asset B for $90. Year 20: Asset B is worth $500 and is liquidated. Gains of $410 realized (sale price minus cost basis of $90) Had the harvest never happened, we'd be selling A with a basis of $100, and gains realized would only be $400 (assuming similar performance from the two correlated assets.) Harvesting the $10 loss allows us to offset some unrelated $10 gain today, but at a price of an offsetting $10 gain at some point in the future. The value of a harvest largely depends on two things. First, what income, if any, is available for offset? Second, how much time will elapse before the portfolio is liquidated? As the deferral period grows, so does the benefit—the reinvested savings from the tax deferral have more time to grow. While nothing herein should be interpreted as tax advice, examining some sample investor profiles is a good way to appreciate the nature of the benefit of TLH+. Who benefits most? The Bottomless Gains Investor A capital loss is only as valuable as the tax saved on the gain it offsets. Some investors may incur substantial capital gains every year from selling highly appreciated assets—other securities, or perhaps real estate. These investors can immediately use all the harvested losses, offsetting gains and generating substantial tax savings. The High Income Earner Harvesting can have real benefit even in the absence of gains. Each year, up to $3,000 of capital losses can be deducted from ordinary income. Earners in high income tax states (such as New York or California) could be subject to a combined marginal tax bracket of up to 50%. Taking the full deduction, these investors could save $1,500 on their tax bill that year. What’s more, this deduction could benefit from positive rate arbitrage. The offsetting gain is likely to be LTCG, taxed at around 30% for the high earner—less than $1,000—a real tax savings of over $500, on top of any deferral value. The Steady Saver An initial investment may present some harvesting opportunities in the first few years, but over the long term, it’s increasingly unlikely that the value of an asset drops below the initial purchase price, even in down years. Regular deposits create multiple price points, which offer continuous harvesting opportunities. (This is not a rationale for keeping money out of the market and dripping it in over time—tax loss harvesting is an optimization around returns, not a substitute for market exposure.) The Philanthropist In each scenario above, any benefit is amplified by the length of the deferral period before the offsetting gains are eventually realized. However, if the appreciated securities are donated to charity or passed down to heirs, the tax can be avoided entirely. When coupled with this outcome, the scenarios above deliver the maximum benefit of TLH+. Wealthy investors have long used the dual strategy of loss harvesting and charitable giving. Even if an investor expects to mostly liquidate, any gifting will unlock some of this benefit. Using losses today, in exchange for built-in gains, offers the partial philanthropist a number of tax-efficient options later in life. Who benefits least? The Aspiring Tax Bracket Climber Tax deferral is undesirable if your future tax bracket will be higher than your current. If you expect to achieve (or return to) substantially higher income in the future, tax loss harvesting may be exactly the wrong strategy—it may, in fact, make sense to harvest gains, not losses. In particular, we do not advise you to use TLH+ if you can currently realize capital gains at a 0% tax rate. Under 2021 tax brackets, this may be the case if your taxable income is below $40,400 as a single filer or $80,800 if you are married filing jointly. See the IRS website for more details. Graduate students, those taking parental leave, or just starting out in their careers should ask “What tax rate am I offsetting today” versus “What rate can I reasonably expect to pay in the future?” The Scattered Portfolio TLH+ is carefully calibrated to manage wash sales across all assets managed by Betterment, including IRA assets. However, the algorithms cannot take into account information that is not available. To the extent that a Betterment customer’s holdings (or a spouse’s holdings) in another account overlap with the Betterment portfolio, there can be no guarantee that TLH+ activity will not conflict with sales and purchases in those other accounts (including dividend reinvestments), and result in unforeseen wash sales that reverse some or all of the benefits of TLH+. We do not recommend TLH+ to a customer who holds (or whose spouse holds) any of the ETFs in the Betterment portfolio in non-Betterment accounts. You can ask Betterment to coordinate TLH+ with your spouse's account at Betterment. You'll be asked for your spouse's account information after you enable TLH+ so that we can help optimize your investments across your accounts. The Portfolio Strategy Collector Electing different portfolio strategies for multiple Betterment goals may cause TLH+ to identify fewer opportunities to harvest losses than it might if you elect the same portfolio strategy for all of your Betterment goals. The Rapid Liquidator What happens if all of the additional gains due to harvesting are realized over the course of a single year? The federal LTCG rate for the majority of taxpayers is currently 15%, but goes as high as 23.8%. In a full liquidation of a long-standing portfolio, the additional gains due to harvesting could push the taxpayer into a higher bracket, potentially reversing the benefit of TLH+. For those who expect to draw down with more flexibility, smart automation will be there to help optimize the tax consequences. The Imminent Withdrawal The harvesting of tax losses resets the one-year holding period that is used to distinguish between LTCG and STCG. For most investors, this isn’t an issue: by the time that they sell the impacted investments, the one-year holding period has elapsed and they pay taxes at the lower LTCG rate. This is particularly true for Betterment customers because our TaxMin feature automatically realizes LTCG ahead of STCG in response to a withdrawal request. However, if you are planning to withdraw a large portion of your taxable assets in the next 12 months, you should wait to turn on TLH+ until after the withdrawal is complete to reduce the possibility of realizing STCG. Other Impacts to Consider Investors with assets held in different portfolio strategies should understand how it impacts the operation of TLH. To learn more, please see Betterment’s SRI disclosures, Flexible portfolio disclosures, the Goldman Sachs smart beta disclosures, and the BlackRock target income portfolio disclosures for further detail. Clients in Advisor-designed custom portfolios through Betterment for Advisors should consult their Advisors to understand the limitations of TLH with respect to any custom portfolio. Additionally, as described above, electing one portfolio strategy for one or more goals in your account while simultaneously electing a different portfolio for other goals in your account may reduce opportunities for TLH to harvest losses due to wash sale avoidance. Due to Betterment’s new monthly cadence for billing fees for advisory services, through the liquidation of securities, tax loss harvesting opportunities may be adversely affected for customers with particularly high stock allocations, third party portfolios, or flexible portfolios. As a result of assessing fees on a monthly cadence for a customer with only equity security exposure, which tends to be more opportunistic for tax loss harvesting, certain securities may be sold that could have been used to tax loss harvest at a later date, thereby delaying the harvesting opportunity into the future. This delay would be due to avoidance of triggering the wash sale rule, which forbids a security from being sold only to be replaced with a “substantially similar” security within a 30-day period. See Betterment’s TLH disclosures for further detail. Conclusion Summary: Tax loss harvesting can be a highly effective way to improve your investor returns without taking additional downside risk. Tax loss harvesting may get the spotlight, but under the hood, our algorithms labor to minimize taxes on every transaction, in every conceivable way. Historically, tax loss harvesting has only been available to extremely high net worth clients. Betterment is able to take advantage of economies of scale with technology and provide this service to all qualified customers while striving to: Do no harm: we regularly work to avoid triggering short-term capital gains (others often do, through unsophisticated automation). Do it holistically: we don't just look for opportunities to harvest regularly—we seek to make every transaction tax efficient—withdrawals, deposits, rebalancing, and more. Coordinate wash sale management across both taxable and IRA/401(k) accounts as seamlessly as possible. 1 TLH+ is generally designed around this index-based logic, although it cannot avoid potential wash sales arising from transactions in tickers that track the same index where one of the tickers is not currently a primary, secondary, or tertiary ticker (as those terms are defined in this white paper). This situation could arise, for example, when other tickers are transferred to Betterment or where they were previously a primary, secondary, or tertiary ticker. Additionally, for some portfolios constructed by third parties (e.g., Vanguard, Blackrock, or Goldman Sachs), certain secondary and tertiary tickers track the same index. 2 Certain asset classes in portfolios constructed by third parties (e.g., Vanguard, Blackrock, or Goldman Sachs) do not have tertiary tickers, such that permanently disallowed losses could occur if there were overlapping holdings in taxable and tax-advantaged accounts. 3 Covariance is a measure of co-movement, which takes into account not only correlation, but also whether or not the two securities have similar absolute levels of risk. A covariance of 1 indicates that the two securities not only move together, but also have a similar range of returns. 4 "Vanguard doesn't track wash sales across accounts with different registrations—for example, between your individual account and your joint account or between your individual account and your IRA/401(k). However, you're still obligated to correctly account for all wash sales when filing your income tax return.” (See “What are wash sales?” ) 4 Learn how we backtest performance.
9 Reasons Goal-Based Investing Leads to Success9 Reasons Goal-Based Investing Leads to Success What exactly are you saving and investing for? This is a serious moment of self inquiry. Defining goals enables better wealth management. Here's why. Before you start putting money into the market, ask yourself one question: What exactly are you saving and investing for? This is a serious moment of self inquiry. In order to invest for the future you are cutting back on spending your wealth now. There must be some future purpose for this sacrifice—some goal of tomorrow's spending which outweighs the pleasure of today's spending. Goal-based wealth management is not just a cute way to help you manage your investments as easily as you manage your Gmail account—it is necessary for maximizing how effectively you manage your money and investments, including knowing when you can afford to spend more than you might think today. For those who are new to goal-based wealth management, goals allow you to bucket your money according to its purpose and when you will need a given amount. Each goal you select has its own portfolio of stocks and bonds customized for the time horizon you set. "Goals" are a kind of budgeting methodology that have been used for decades (one old version is called the envelope system). Betterment has elevated the framework to apply it to good savings and investment strategy as well. Why? Because research shows it improves outcomes by encouraging optimal behavior and more precise wealth management (see the reference list below). Below are some of the behavioral and financial reasons why goal-based wealth management is better. 1. Avoid under-saving. Goal-based wealth management forces you to think about and enumerate your goals, often far in advance. This prevents you from underestimating how much money you'll need at any point in the future—or misaligning your expectations with your savings ability. It means that present-day you and future you have more common ground. 2. Plan ahead, save less, achieve more. Using goal-based wealth management, you'll likely see future liabilities coming down the road. And the further in advance you start saving for a goal, the less you'll actually have to save. Why? The power of returns. The earlier you start saving , the more time you give the market to grow your savings for you. For example, imagine you know you will want cash to buy a new car—let's say $65,000 for a very cool Tesla Model S. Being smart, you are not going to finance it (where you pay interest), but rather save up ahead of time. Below you can see the recommended monthly savings required depending on how far in advance you start saving. If you save monthly for one year, you're essentially saving dollar for dollar for your new car. But if you plan ahead, and start saving five years out, the market can help you—and you only need save $54,720. 3. Use a data-driven target. When you set up an investment goal at Betterment—for example, saving $150,000 for a home down payment in 10 years—we give you several pieces of advice: The first is a suggested allocation based on your time horizon and the second is advice on how much you need to save on a monthly basis to reach that goal. We also suggest an initial deposit. When you take guesswork out of your plan, it means you are more likely to hit your target. 4. Save for a tangible outcome. Goals make it far more likely you'll save for—and achieve— every one of your goals. When you can attach a real outcome to the purpose of your saving, you're more likely to actually work toward that goal rather than blind saving. In behavioral psychology, this is called affect—or the concept that we are more motivated by real things than abstract numbers. 5. Guilt-free spending. While some might find it surprising, there are people who actually feel guilty and are uncomfortable with spending large amounts of money. This is true even when it's for a planned, known expenditure. When it comes time to spend your savings, if it comes from an account specifically earmarked for that purpose, you're not overspending. Goals also make it more likely you only spend the amount saved in the goal, rather than scooping out a lump sum from a general savings account. 6. Benefits to an automated plan. For most people, it’s much easier and more practical to invest $125 a week, or $500 a month, than summon up a one-time deposit of $6,000 each year. Automating your saving makes it effortless to do the right thing—save the right amount every month. This kind of of drip-system is not only useful for budgeting and saving on an ongoing basis—it’s also great investment strategy. First, it ensures your money has maximal time in the market. Second, it is a form of dollar-cost averaging, which diversifies your cost-basis entry points over time compared to a lump-sum purchase. With Betterment, regular auto-deposits also provide an opportunity for rebalancing and tax-loss harvesting, which are investing practices that can improve returns and lower your tax bill over time. 7. Turn a bias into a strength. Goal-based wealth management makes use of 'partitioning' and leverages mental accounting to improve your savings behavior. Mental accounting means that you make decisions based on the red or black of each individual account, rather than view them in the aggregate. While this could lead to unwise decisions as it may limit a holistic view of your finances, you can also use mental accounting as a strength. By creating many different mental accounts, you ensure that you are saving optimally for each of them—and do not rely on one account to cover all your required future liabilities. 8. Better match assets and liabilities, avoid debt. Goals makes it easier to close the gap between the money you can afford to spend and the money you want to spend. In investing, we call this matching assets to liabilities. By clearly earmarking the assets of today to the liabilities of tomorrow, we ensure that we aren't going to go into debt or fail at those goals. This can also help determine if you're in danger of paying interest on something you cannot afford. For example, if you fall short of target or goal, like saving $25,000 for a luxury vacation, you have to decide whether to make up the shortfall with credit—or cut back on what you can afford. When you use credit or unexpectedly downsize, you are using a form of debt. The first is financial and the second is psychological. Goals help you manifest your intentions without incurring debt of any kind. 9. Achieve optimal returns. Goal-based wealth management matches your time horizon to your asset allocation, which means you take on the optimum amount of risk. When you misallocate, it can mean saving too much or too little, missing out on returns with too conservative a setting, or missing your goal if you take on too much risk. Occasionally, critics of goal-based investing claim that it causes users to deviate from an optimal allocation because they don't look at their portfolio holistically. In fact, it has has been shown through a series of papers (see below) that when done correctly, goal-based investing is just as efficient as holistic portfolio management. Betterment’s algorithms are smart enough to avoid these hazards of goal-based investing. For example, we look across all your goals when utilizing tax-lot information—for example, using TaxMin to withdraw—to ensure that one goal is not mis-coordinated with others. You get all the benefit of goal-based wealth management, and none of the downside. A reading list If you would like to get into the nitty-gritty on any of these points, here are my references: Rha, J.-Y., Montalto, C. P., & Hanna, S. D. (2006). The Effect of Self-Control Mechanisms on Household Saving Behavior. Journal of Financial Counseling and Planning. Shefrin, H. M., & Thaler, R. H. (1992). Mental accounting, saving, and self-control. In G. Loewenstein & J. Elster (Eds.), Choice over time (pp. 287-330). Russell Sage Foundation. Shafir, E., & Thaler, R. H. (2006). Invest now, drink later, spend never: On the mental accounting of delayed consumption. Journal of Economic Psychology,27(5), 694-712 Thaler, R. H. (1990). Anomalies: Saving, Fungibility, and Mental Accounts. Journal of Economic Perspectives. Fox, C. R., Ratner, R. K., & Lieb, D. S. (2005). How subjective grouping of options influences choice and allocation: diversification bias and the phenomenon of partition dependence. Journal of experimental psychology. General, 134(4), 538-55 Das, S., Markowitz, H., Scheid, J., & Statman, M. (2010). Portfolio Optimization with Mental Accounts. Journal of Financial and Quantitative Analysis. Brunel, J. L. (2006). How Suboptimal—if at all—is goal-based asset allocation?. The Journal of Wealth Management, 9(2), 19-34.
ETF Selection For Portfolio Construction: A MethodologyETF Selection For Portfolio Construction: A Methodology Betterment seeks to maximize investor take-home returns, which drives our criteria and process for selecting ETFs (the funds in your portfolio). TABLE OF CONTENTS Why ETFs ETF Selection Total Annual Cost of Ownership Mitigating Market Impact Conclusion One of Betterment’s central objectives is to help investors achieve the best possible take-home returns. At the most fundamental level, we do this through the allocation advice we provide for every portfolio. However, another key component of performance is the investment vehicles we use in our portfolio. They are an essential—but often overlooked—element in maximizing the risk-adjusted, after-tax, net-of-costs return for our customers. In the following piece, we detail Betterment’s investment selection methodology, including: Why we use exchange-traded funds (ETFs) Why expense ratios are not the whole story How Betterment estimates an investment vehicle’s total annual cost of ownership (TACO). Why Do We Invest in ETFs? An ETF is a security that generally tracks a broad-market stock or bond index or a basket of assets just like an index mutual fund, but trades just like a stock on a listed exchange. By design, index ETFs closely track their benchmarks—such as the S&P 500 or the Dow Jones Industrial Average—and are bought and sold like stocks throughout the day. Betterment only uses open-ended ETFs (which carry no restrictions around issuing or redeeming shares) as they have many embedded structural advantages when compared to mutual funds. These include: Clear Goals and Mandates Unlike many actively managed mutual funds, the ETFs we use have definite mandates to passively track broad-market benchmark indexes. A passive mandate explicitly restricts the fund administrator to the singular goal of replicating a benchmark rather than making active investment decisions constituting market timing, building concentration in either a single name, group of names, or themes in an effort to beat the fund’s underlying benchmark. Adherence to this mandate ensures the same level of investment diversification as the benchmark indexes, makes performance more predictable, and reduces idiosyncratic risk associated with active manager decisions. Intraday Availability ETFs are transactable during all open market hours just like any other stock. As such, they are heavily traded by the full spectrum of equity market participants including market makers, short-term traders, buy-and-hold investors, and fund administrators themselves creating and redeeming units as needed (or increasing or decreasing the supply of ETFs based on market demand). This diverse trading activity leads to most ETFs carrying low liquidity premiums (or lower costs to transact due to competition from readily available market participants pushing prices downward) and equity-like transaction times irrespective of the underlying holdings of each fund. This generally makes ETFs fairly liquid, which makes them cheaper and easier to trade on-demand for activities like creating a new portfolio or rebalancing an existing one. In comparison, mutual funds transact only once per day, which introduces significant lag between desired and filled price. Moreover, certain portfolio management strategies like tax loss harvesting require liquid securities that trade more than once a day. Low and Unbiased Fee Structures Below is the expense ratio for the 70% stock Betterment IRA portfolio in 50% primary and 50% secondary tickers and the asset-weighted average expense ratio for all ETFs. Expense Ratio Comparison The chart above compares the asset-weighted expense ratios of the Betterment Portfolio Strategy versus the average ETF, based on data collected by the Investment Company Institute in their 2018 Factbook. The range for average expense ratios of Betterment’s recommended portfolios at the time of this 2018 comparison was 0.07% to 0.15%, depending on allocation. Note that the range is subject to change depending on current fund prices. Because most benchmarks update constituents (i.e., the specific stocks and related weights that make up a broad-market index) fairly infrequently, passive index-tracking ETFs also register lower annual turnover (or the rate a fund tends to transact its holdings) and thus fewer associated costs passed through to investors. In addition, ETFs are generally managed by their administrators as a single share class that holds all assets as a single entity. This structure naturally lends itself as a defense against administrators practicing fee discrimination across the spectrum of available investors. As an example, some index-tracking mutual fund administrators segment their funds into several share classes where institutional and high net-worth investors can secure lower fees and more lenient terms in exchange for investing a higher amount upfront. Retail investors with lower available investment balances are funneled into higher fee share classes with more stringent terms. By comparison, with only one share class, ETFs are investor-type agnostic. The result is that ETF administrators provide the same exposures and low fees to the entire spectrum of potential buyers. The fund and administration structure of ETFs also eliminates concerns stemming from potential conflict of interest in the standard sales and access channels utilized by mutual funds. While mutual funds can be sold directly to investors by their administrators, most investments in mutual funds are recommended and placed through a multi-tiered sales and distribution network. Each layer of the network tacks on a host of opaquely documented fees. These fee amounts are entirely non-standard across funds and networks, and are largely the result of negotiations between marketing and sales executives who are divorced from the investment functions of the fund administrators. These network fees come in the form of front and back loaded costs, or immediate one-time fees assessed for initial investment or redemptions. Sales channels are subject to compensation incentives that tend to favor investment recommendations that yield allocation to funds where they can collect more fees over selections that might ultimately be in the best interest of their clients. Tax Efficiency In the case when a fund (irrespective of its specific structure) sells holdings that have experienced capital appreciation, the capital gains generated from those sales must, by law, be accrued and distributed to shareholders by year-end in the form of distributions. These distributions increase tax liabilities for all of the fund’s shareholders. With respect to these distributions, ETFs offer a significant tax advantage for shareholders over mutual funds. Because mutual funds are not exchange traded, the only available counterparty available for a buyer or seller is the fund administrator. When a shareholder in a mutual fund wishes to liquidate their holdings in the fund, the fund’s administrator must sell securities in order to generate the cash required to satisfy the redemption request. These redemption-driven sales generate capital gains that lead to distributions for not just the redeeming investor, but all shareholders in the fund. Mutual funds thus effectively socialize the fund’s tax liability to all shareholders, leading to passive, long-term investors having to help pay a tax bill for all intermediate (and potentially short-term) shareholder transactions. Because ETFs are exchange traded, the entire market serves as potential counterparties to a buyer or seller. When a shareholder in an ETF wishes to liquidate their holdings in the fund, they simply sell their shares to another investor just like that of a single company’s equity shares. The resulting transaction would only generate a capital gain or loss for the seller and not all investors in the fund. Mutual fund distributions are generally decided by the fund administrator and can introduce material variability in an investor’s tax profile. ETF tax profiles are fairly static with most of the tax realization/deferral control being held by the individual investor. In addition, ETFs enjoy a slight advantage when it comes to taxation on dividends paid out to investors. After the passing of the Jobs and Growth Tax Relief Reconciliation Act of 2003, certain qualified dividend payments from corporations to investors are only subject to the lower long-term capital gains tax rather than standard income tax (which is still in force for ordinary, non-qualified dividends). Qualified dividends have to be paid by a domestic corporation (or foreign corporation listed on a domestic stock exchange) and must be held by both the investor and the fund for 61 of the 120 days surrounding the dividend payout date. As a result of active mutual funds’ higher turnover, a higher percentage of dividends paid out to their investors violate the holding period requirement and increase investor tax profiles. Investment Flexibility The maturation and growth of the global ETF market over the last two decades has led to the development of an immense spectrum of products covering different asset classes, markets, styles, and geographies. The result is a robust market of potential portfolio components which are versatile, extremely liquid, and easily substitutable. ETFs Have Seen Significant Growth Source: Investment Company Institute 2016 Investment Company Fact Book, Chapter 3: Exchange-Traded Funds, Figure 3.2 Selecting Across the ETF Universe Despite all the advantages of ETFs, it is still important to note that not all ETFs are exactly alike or equally beneficial to an investor. The primary task of Betterment’s investment selection process is to pick the set of funds or vehicles that provide exposure to the desired asset classes with the least amount of difference between underlying asset class behavior and portfolio performance. In other words, we attempt to minimize the “frictions” (the collection of systematic and idiosyncratic factors that lead to performance deviations) between ETFs and their benchmarks. The principal component of frictions between tracked asset classes and investor returns is the fund’s expense ratio: The higher the expenses charged to the investor, the lower the resulting returns that pass through. However, relying on just expense ratio to make an instrument selection could yield to a less efficient portfolio. There are other material frictions that factor in that Betterment also considers, discussed below. Betterment’s measure of these frictions is summarized as the total annual cost of ownership, or TACO: a composition of all relevant frictions used to rank and select ETF candidates for the Betterment portfolio. Total Annual Cost of Ownership The total annual cost of ownership (TACO) is Betterment’s fund scoring method, used to rate funds for inclusion in the Betterment portfolio. TACO takes into account an ETF’s transactional and liquidity costs as well as costs associated with holding funds. TACO is determined by two components, or frictions as mentioned above, and they are a fund’s cost-to-trade and cost-to-hold. The first, cost-to-trade, represents the cost associated with trading in and out of funds during the course of regular investing activities, such as rebalancing, cash inflows or withdrawals, and tax loss harvesting. Cost-to-trade is generally influenced by two factors: Volume: A measure of how many shares change hands each day. Bid-ask spread: The difference between the price at which you can buy a security and the price at which you can sell the same security at any given time. The second component, cost-to-hold, represents the annual costs associated with owning the fund and is generally influenced by these two factors: Expense ratios: Fund expenses imposed by an ETF administrator. Tracking difference: The deviation in performance from the fund’s benchmark index. Let’s review the specific inputs to each component in more detail: Cost-to-Trade: Volume and Bid-Ask Spread Volume Volume is a historical measure of how many shares may change hands each day. This helps assess how easy it might be to find a buyer or seller in the future. This is important because it tends to indicate the availability of counterparties to buy (e.g., when Betterment is selling ETFs) and sell (e.g., when Betterment is buying ETFs). The more shares of an ETF Betterment needs to buy on behalf of our customers, the more volume is needed to complete the trades without impacting market prices. As such, we measure average market volume for each ETF as a percentage of Betterment’s normal trading activity. Funds with low average daily trading volume compared to Betterment’s trading volume will have a higher cost, because Betterment’s higher trading volume is more likely to influence market prices. Bid-Ask Spread Generally market transactions are associated with two prices: the price at which people are willing to sell a security, and the price others are willing to pay to buy it. The difference between these two numbers is known as the bid-ask spread, and can be expressed in currency or percentage terms. For example, a trader may be happy to sell a share at $100.02, but only wishes to buy it at $99.98. The bid-ask currency spread here is $.04, which coincidentally also represents a bid-ask percentage of 0.04%. In this example, if you were to buy a share, and immediately sell it, you’d end up with 0.04% less due to the spread. This is how traders and market makers make money—by providing liquid access to markets for small margins. Generally, heavily traded securities with more competitive counterparties willing to transact will carry lower bid-ask spreads. Unlike the expense ratio, the degree to which you care about bid-ask spread likely depends on how actively you trade. Buy-and-hold investors typically care about it less compared to active traders, because they will accrue significantly fewer transactions over their intended investment horizons. Minimizing these costs is beneficial to building an efficient portfolio which is why Betterment attempts to select ETFs with narrower bid-ask spreads. Cost-to-Hold: Expense Ratio and Tracking Difference Expense Ratio An expense ratio is the set percentage of the price of a single share paid by shareholders to the fund administrators every year. ETFs often collect these fees from the dividends passed through from the underlying assets to holders of the security, which result in lower total returns to shareholders. Since expenses are a principal component in reducing investor returns, ETFs with higher expenses generally tend to perform worse. For context, a Betterment 70% equity tax-advantaged portfolio contains ETFs with expense ratios that average to 0.11%. Tracking Difference Tracking difference is the underperformance or outperformance of a fund relative to the benchmark index it seeks to track. Funds may deviate from their benchmark indexes for a number of reasons, including any trades with respect to the fund’s holdings, deviations in weights between fund holdings and the benchmark index, and rebates from securities lending. It’s important to note that, over any given period, tracking difference isn’t necessarily negative; in some periods, it could lead to outperformance. However, tracking difference can introduce systematic deviation in the long-term returns of the overall portfolio when compared purely with a comparable basket of benchmark indexes other than ETFs. Finding TACO We calculate TACO as the sum of the above components: TACO = "Cost-to-Trade" + "Cost-to-Hold" As mentioned above, cost-to-trade estimates the costs associated with buying and selling funds in the open market. This amount is weighted to appropriately represent the aggregate investing activities of the average Betterment customer in terms of cash flows, rebalances, and tax loss harvests. The cost-to-hold represents our expectations of the annual costs an investor will incur from owning a fund. Expense ratio makes up the majority of this cost, as it is the most explicit and often the largest cost associated with holding a fund. We also account for tracking difference between the fund and its benchmark index. In many cases, cost-to-hold, which includes an ETF’s expense ratio, will be the dominant factor in the total cost calculations. Of course, one can’t hold a security without first purchasing it, so we must also account for transaction costs, which we accomplish with our cost-to-trade component. Minimizing Market Impact Market impact, or the change in price caused by an investor buying or selling a fund, is incorporated into Betterment’s total cost number through the cost-to-trade component. This is specifically through the interaction of bid-ask spreads and volume. However, we take additional considerations to control for market impact when evaluating our universe of investable funds. A key factor in Betterment’s decision-making is whether the ETF has relatively high levels of existing assets under management and average daily traded volumes. This helps to ensure that Betterment’s trading activity and holdings will not dominate the security’s natural market efficiency, which could either drive the price of the ETF up or down when trading. We define market impact for any given investment vehicle as the Betterment platform’s relative size (RSRS) in two key areas. Our share of the fund’s assets under managements is calculated quite simply as RS of AUM = ('AUM of Betterment' / 'AUM of ETF') while our share of the fund’s daily traded volume is calculated as RS Vol = ('Vol of Betterment' / 'Vol of ETF') Minimizing investor frictions is one of the core goals of the Betterment investment methodology. ETFs without an appropriate level of assets or daily trade volume might lead to a situation where Betterment’s activity on behalf of customers moves the existing market in the security. In an attempt to avoid potentially negative effects upon our investors, we do not consider ETFs with smaller asset bases and limited trading activity. Any market impact measure that does not satisfy our criteria disqualifies the security from consideration. Betterment Portfolio ETFs Account Type: Taxable Asset Class Ticker ETF Fund Name Index Expense Ratio U.S. Total Stock Market Primary VTI Vanguard Total Stock Market ETF CRSP U.S. Total Market 0.03% Alternate ITOT iShares Core S&P Total U.S. Stock Mkt ETF Dow Jones U.S. Broad Stock Market 0.03% U.S. Large-Cap Value Stocks Primary VTV Vanguard Value ETF CRSP U.S. Large Value 0.04% Alternate SPYV SPDR® Portfolio S&P 500 Value ETF S&P 500 Value 0.04% U.S. Mid-Cap Value Stocks Primary VOE Vanguard Mid-Cap Value ETF CRSP U.S. Mid Value 0.07% Alternate IWS iShares Russell Mid-Cap Value ETF Russell Midcap Value 0.24% U.S. Small-Cap Value Stocks Primary VBR Vanguard Small-Cap Value ETF CRSP U.S. Small Value 0.07% Alternate IWN iShares Russell 2000 Value ETF Russell 2000 Value 0.24% International Developed Stocks Primary VEA Vanguard FTSE Developed Markets ETF FTSE Developed ex U.S. All Cap Net Tax (U.S. RIC) Index 0.05% Alternate IEFA iShares Core MSCI EAFE ETF MSCI EAFE IMI 0.07% Emerging Market Stocks Primary VWO Vanguard FTSE Emerging Markets ETF FTSE Custom Emerging Markets All Cap China A Inclusion Net Tax (U.S. RIC) Index 0.10% Alternate IEMG iShares Core MSCI Emerging Markets ETF MSCI EM (Emerging Markets) IMI 0.11% Short-Term Treasuries Primary GBIL Goldman Sachs Access Treasury 0-1 Year ETF FTSE US Treasury 0-1 Year Composite Select Index 0.12% U.S. Short-Term Bonds Primary JPST JPMorgan Ultra-Short Income ETF N.A. 0.18% Inflation Protected Bonds Primary VTIP Vanguard Short-Term Infl-Prot Secs ETF Bloomberg Barclays U.S. Treasury TIPS (0-5 Y) 0.05% U.S. Municipal Bonds Primary MUB iShares National Muni Bond ETF S&P National AMT-Free Municipal Bond 0.07% Alternate TFI SPDR® Nuveen Blmbg Barclays Muni Bd ETF Bloomberg Barclays Municipal Managed Money 1-25 Years Index 0.23% U.S. High Quality Bonds Primary AGG iShares Core U.S. Aggregate Bond ETF Bloomberg Barclays U.S. Aggregate 0.04% International Developed Bonds Primary BNDX Vanguard Total International Bond ETF Bloomberg Barclays Global Aggregate x USD Float Adjusted RIC Capped 0.08% Emerging Market Bonds Primary EMB iShares JP Morgan USD Em Mkts Bd ETF JP Morgan EMBI Global Core Index 0.39% Alternate VWOB Vanguard Emerging Mkts Govt Bd ETF Bloomberg Barclays USD Emerging Markets Government RIC Capped Bond 0.25% Account Type: IRA Asset Class Ticker ETF Fund Name Index Expense Ratio U.S. Total Stock Market Primary VTI Vanguard Total Stock Market ETF CRSP U.S. Total Market 0.03% Alternate SCHB Schwab US Broad Market ETF™ S&P TMI 0.03% U.S. Large-Cap Value Stocks Primary VTV Vanguard Value ETF CRSP U.S. Large Value 0.04% Alternate SCHV Schwab US Large-Cap Value ETF™ Dow Jones U.S. Total Stock Market Large-Cap Value 0.04% U.S. Mid-Cap Value Stocks Primary VOE Vanguard Mid-Cap Value ETF CRSP U.S. Mid Value 0.07% Alternate IJJ iShares S&P Mid-Cap 400 Value ETF S&P Mid Cap 400 Value 0.18% U.S. Small-Cap Value Stocks Primary VBR Vanguard Small-Cap Value ETF CRSP U.S. Small Value 0.07% Alternate SLYV SPDR® S&P 600 Small Cap Value ETF S&P Small Cap 600 Value 0.15% International Developed Stocks Primary VEA Vanguard FTSE Developed Markets ETF FTSE Developed ex U.S. All Cap Net Tax (U.S. RIC) Index 0.05% Alternate SCHF Schwab International Equity ETF™ FTSE Developed ex US Index 0.06% Emerging Market Stocks Primary VWO Vanguard FTSE Emerging Markets ETF FTSE Custom Emerging Markets All Cap China A Inclusion Net Tax (U.S. RIC) Index 0.10% Alternate SPEM SPDR® S&P Emerging Markets ETF S&P Emerging Markets BMI 0.11% Short-Term Treasuries Primary GBIL Goldman Sachs Access Treasury 0-1 Year ETF FTSE US Treasury 0-1 Year Composite Select Index 0.12% U.S. Short-Term Bonds Primary JPST JPMorgan Ultra-Short Income ETF N.A. 0.18% Inflation Protected Bonds Primary VTIP Vanguard Short-Term Infl-Prot Secs ETF Bloomberg Barclays U.S. Treasury TIPS (0-5 Y) 0.05% U.S. High Quality Bonds Primary AGG iShares Core U.S. Aggregate Bond ETF Bloomberg Barclays U.S. Aggregate 0.04% International Developed Bonds Primary BNDX Vanguard Total International Bond ETF Bloomberg Barclays Global Aggregate x USD Float Adjusted RIC Capped 0.08% Emerging Market Bonds Primary EMB iShares JP Morgan USD Em Mkts Bd ETF JP Morgan EMBI Global Core Index 0.39% Alternate PCY PowerShares Emerging Markets Sov Dbt ETF DB Emerging Market USD Liquid Balanced Index 0.50% Source: Cost information is from Xignite. Last updated May, 2021. Conclusion We are constantly monitoring our investment choices. Our selection analysis is run quarterly to assess the following: validity of existing selections, potential changes by fund administrators (raising or lowering expense ratios), and changes in specific ETF market factors (including tighter bid-ask spreads, lower tracking differences, growing asset bases, or reduced selection-driven market impact). We also consider the tax implications of portfolio selection changes and estimate the net benefit of transitioning between investment vehicles for our customers. The power of this methodology is how quickly it arrives at a total cost figure that synthesizes several dissimilar factors across many different candidate securities. The ability to quickly assess candidate suitability across the wider universe of potential options for each asset class is novel and incredibly useful in fulfilling our objectives of constantly providing a robust investment product, platform, advice, performance, and process control. We will continue to drive innovation when trying to improve investor take-home returns by finding ways to lower costs and frequently re-evaluating our portfolio choices. We use the ETFs that result from this process in our allocation advice that is based on your investment horizon, balance, and goal. ETFs are subject to market risk, including the possible loss of principal. The value of the portfolio will fluctuate with the value of the underlying securities. ETFs may trade for less than their net asset value (NAV). There is always a risk that an ETF will not meet its stated objective on any given trading day.
How Tax Impact Preview Works to Help Avoid SurprisesHow Tax Impact Preview Works to Help Avoid Surprises Betterment continues to make investing more transparent and tax-efficient, and empowers you to make smarter financial decisions. Two words that don’t belong together: taxes and surprise. But all too often, a transaction made in your investment account has unexpected, costly consequences many months later. Selling securities has tax implications. Typically, these announce themselves the following year, when you get your tax statement. Today, we are changing that, with Tax Impact Preview. Betterment’s Tax Impact Preview feature provides a real-time tax estimate for a withdrawal or allocation change—before you confirm the transaction. Tax Impact Preview shows you exactly the information you should be focusing on to make an informed decision—potentially lowering your tax bill. Tax-Aware Investors Can Consider: Do the benefits outweigh the costs? Should I wait to avoid short-term capital gains? Is there another source of funds I could use that might have a lower or no tax impact? “Customers can become overly focused on short-term returns and change allocations or make withdrawals in reaction to fluctuations in the market,” says Alex Benke, CFP®, product manager for this new feature, “Tax Impact Preview will help these customers stay focused on the big picture and avoid unpleasant surprises on their tax bill.” Tax Impact Preview: An Industry First Betterment is the only investment platform to offer this kind of real-time tax information—and it joins a suite of tools which already helps investors minimize their taxes, including Tax Coordination™, Tax Loss Harvesting+, TaxMin, and more. Tax Impact Preview is available to all Betterment customers at no additional cost. Learn more about the suite of tax-efficiency features available for your portfolio. How It Works When you initiate a sale of securities (a withdrawal or allocation change), our algorithms first determine which ETFs to sell (rebalancing you in the process, by first selling the overweight components of your portfolio). Within each ETF, our lot selection algorithm, which we call TaxMin, will select the most tax-efficient lots, selling losses first, and short-term gains last. Transaction Timeline Table With Tax Impact Preview, you will now see an “Estimate tax impact” button when you initiate an allocation change or withdrawal, which will give you detailed estimates of expected gains and/or losses, breaking them down by short and long-term. Using this timely information, you can better decide if the tax result makes sense for you. If your transaction results in a net gain, we estimate the maximum tax you might owe. Why Estimated? The precise tax owed depends on many circumstances specific to you: not just your tax bracket, but also the presence of past and future capital gains or losses for the year across all of your investment accounts. We use the highest applicable rates, to give you an upper-bound estimate. You might ask—why are the gains and losses about to be realized not exact, even if the resulting tax is only an estimate? The gains and losses depend on the exact price that the various ETFs will sell at. If the estimate is done after market close, the prices are sure to move a bit by the time the market opens. Even during the day, a few minutes will pass between the preview and the trades, and prices will shift some, so the estimates will no longer be 100% accurate. Finally, while we are able to factor in wash sale implications from prior purchases in your Betterment account, the estimates could change substantially due to future purchases, and we do not factor in activity in non-Betterment accounts. That is why every number we show you, while useful, is an estimate. Tax Impact Preview is not tax advice, and you should consult a tax professional on how these estimates apply to your individual situation. Why You Should Avoid Short-Term Capital Gains Smart investors take every opportunity to defer a gain from short-term to long-term—it can make a substantive difference in the return from that investment. To demonstrate, let’s assume a long-term rate of 20% and a short-term rate of 40%. A $10,000 investment with a 10% return—or $1,000—will result in a $400 tax if you sell 360 days after you invested. But if you wait 370 days to sell, the tax will be only $200. That’s the difference between a 6% and 8% after-tax return. Until now, making the smart choice meant doing your own calculations for every trade you were about to make. This is the kind of stuff most people hate doing, and automation excels at, so we built it into our product. A Sample Scenario Betterment customer Jenny, 34, has been watching the recent market news and feels nervous about her "Build Wealth" goal, which has a balance of $95,290. She is currently at 90% stocks—the optimal allocation for an investor with more than a 20 year horizon. Jenny decides to temporarily move her allocation to 10% stocks to minimize her exposure to the roller coaster on Wall Street. What Jenny may not realize is that changing allocation will cost her very real money—in the form of a tax bill. And even if she suspects it, she cannot appreciate the extent of the cost. The taxes are abstract, but the anxiety from the rocky market is real. Before finalizing the allocation change, Jenny clicks “Estimate tax impact” and sees that she is about to realize $4,641 in capital gains, with $4,290 of that short-term, which could incur up to $2,304 in taxes if she goes through with the trades. Putting a real dollar cost on knee-jerk reactions to market volatility is exactly what we as investors need at the critical moment when we are about to deviate from our long-term plan. Market timing is not a good idea, and most of us know this. However, emotions can get the better of even the most sophisticated investors, and we can all use some help in making the right decisions. Smarter Design for Better Decisions, Lower Taxes We believe that unhelpful emotion can be mitigated by good product design, which emphasizes the right information at just the right time. For instance, we never show you the individual daily performance of the ETFs in your portfolio—you are more likely to see losses that way, even if your overall portfolio is up. Seeing losses causes stress, which leads to emotional behavior, which can hurt your long-term returns. And yet, every other investment platform shows you individual asset performance front and center. On the other hand, showing you the estimated tax impact of a transaction before you commit to it encourages better decisions, and yet nobody except Betterment shows you this information. This distinction is at the core of our mission. Building the perfect investment service is not just about a pretty web interface, or a slick mobile app (though these are nice too!). It means rethinking every convention from the ground up. We are very excited about Tax Impact Preview, because it’s already helping our customers make better choices, and lessen their tax burden.
Understand Your Finances By Connecting Your AccountsUnderstand Your Finances By Connecting Your Accounts Connecting your outside accounts lets you see your holistic financial picture in one place. It also lets us give you more accurate advice. As an added bonus, you may even spot high fees you didn’t know about, or extra cash that could be doing more. Securely connecting your outside investment accounts—such as 401(k)s, IRAs, and taxable accounts held at other institutions—helps us give you better investment advice. For instance, the way we recommend that you save for retirement depends on what sort of account types you have available to you. Knowing that you are making annual contributions to your 401(k) account and getting a 3% match, for example, will drastically alter your retirement projections. The list goes on! In addition to investment accounts, you can also securely connect debt accounts, such as mortgages and loans. This helps you see your overall financial picture, putting you more in control of your wealth. Your connected account data is regularly updated automatically, so you’ll always know where you stand. Step-by-step instructions for how to sync your accounts. See your wealth in one place. What is your net worth? When you connect all of your other accounts to your Betterment account, you’ll have the power of seeing all of your wealth in one place. Whether your net worth is positive or negative, or mostly managed at Betterment or not—seeing this information can help you see the big picture when it comes to your personal finances. Seeing all your wealth in one place can help you better understand if you’re on track to meet your financial goals, and which goals might need some more attention. . Receive personalized advice. We understand that you currently may be saving towards your financial goals in more accounts than one. For example, with retirement plans, we’ve found that customers often have investments spread out across multiple institutions, especially in the case of 401(k) accounts. It can be cumbersome to manage your finances across many accounts. When you connect your accounts, we’ll analyze your holdings and display each account’s individual risk profile for you. You can also assign any account you connect to a specific Betterment goal. This allows you to see your overall risk profile across all related accounts. We’ll provide an assessment of how your current risk profile compares to our recommendations so that you can make informed decisions about whether any adjustments need to be made. For example, you might find that your overall portfolio is riskier than you thought, and may want to reallocate some of your funds into more conservative investments. Knowing your portfolio’s true allocation can help you better understand the risks you are taking and will help you make informed decisions about how to save for the future. Reveal hidden fees. Fees are sometimes hidden between the lines of confusing jargon and can be hard to locate on your statements. In the financial industry, many institutions thrive off high or hidden fees. At Betterment, we believe in transparency. This is why when you sync your external accounts, we’ll clearly display the expense ratios of the funds you are invested in, as well as how much you are paying in management fees, whenever that data is available to us. Using this information, we’ll analyze how much you could potentially save using low-cost ETFs and a low cost advisor like Betterment. Identify excess cash. A buffer of cash is good to keep in your checking account for regular transactions and short-term spending needs. However, holding cash in any long-term investment account is likely impacting your potential returns because it’s not being invested. This is known as “idle cash” or “cash drag”. When you instantly connect your funding accounts, we’ll analyze your accounts to determine if you’re holding onto too much cash. We classify any cash or cash-equivalent securities as idle cash. It is “idle” because it’s not invested, and therefore, not working as hard for you as it could be. The opportunity costs of idle cash can be significant—especially over long periods of time and because of inflation. Gain peace of mind. At Betterment, your privacy comes first. We will never sell, rent, or trade your information without your permission. We are a fiduciary financial advisor, so we're obligated to—and want to—act in your best interests Additionally, we strive to exceed the safest standards for protecting your account and financial data. Instantly connecting a financial account through our partner Plaid creates a secure, read-only connection with your institution, and we will never store your credentials, nor share your connected data. Connect your accounts. It only takes a few minutes. To connect your accounts, you must first either sign up or log in. On your home page after logging in, scroll down to the "Other Connected Accounts" and click "Connect New." Search for your firm, making sure you choose the firm name and option that has a matching URL to the one you use to log in to their website. Enter your username and password for that firm, and complete any additional security prompts that appear. You can manage and edit your connected accounts from "Connected Accounts" under "Settings." Need more help connecting your accounts?
Goal Projection and Advice MethodologyGoal Projection and Advice Methodology Betterment helps you get on track to meet your goals by providing projections and advice on allocation, savings, and withdrawals. Our methodology for doing so involves some assumptions worth exploring. TABLE OF CONTENTS Projection Methodology and Assumptions Methodology and Assumptions Withdrawal Advice Methodology and Assumptions For Retirement Goals Graph Explanation Goal Status - On Track or Off Track Limitations Betterment provides allocation, savings and withdrawal advice alongside a projection graph when customers view their goal projection under “Plan.” The graph is intended to show the possible future investment values in order to illustrate the impact of different contribution and withdrawal choices, investment time horizons, and portfolio allocations. Actual individual investor performance has and will vary depending on market performance, the time of the initial investment, amount and frequency of contributions or withdrawals, intra-period allocation changes and taxes. An indication of “On Track” is not a guarantee of achieving a goal in the future. Acting on savings and withdrawal advice is not a guarantee that goals will be met or that the investment will meet cost of living needs throughout one’s life. See our Terms and Conditions. In the following sections, we’ll provide an overview of our methodology and assumptions for each component under “Plan” in a Betterment goal. Projection Methodology and Assumptions The expected investment portfolio returns used in the portfolio value projection results are based on the expected returns and risk free rate assumptions for your target Betterment portfolio allocation. (See more about how the expected returns are derived). This portfolio is set by the user-selected allocation to “stocks” and “bonds”. The allocation choice corresponds to weights of the underlying Exchange Traded Funds (ETFs), as defined in our Portfolio. The recommended allocation mix is based on user investment profile including age, the goal type and time horizon. For Cash Goals, the expected return is based on the current APY on Cash Reserve, Betterment’s high-yield cash account, and risk free rate assumptions. The returns used are net of your current annual fee and we assume that fee holds throughout the investment. Cash Goals have no fee on your account balance (For Cash Reserve (“CR”), Betterment LLC only receives compensation from our program banks; Betterment LLC and Betterment Securities do not charge fees on your CR balance.), and our projections thus use the current APY when forecasting your Cash Goal account balance. In projecting your balance, we estimate the uncertainty in returns for both your investment portfolio and the underlying risk free rate. For Cash Goals, we assume in our projections that the interest rate for Cash Reserve will vary over time commensurate with any changes to the underlying risk free rate. Monthly Contributions or Withdrawals, if specified, are assumed to be made at the end of the month. We project your balance in monthly increments, never going below twelve months. We project allocation changes on a monthly basis. For users with remaining goal terms of less than one year, our projection assumes that you maintain the allocation at the end of the goal term rather than liquidate. We sometimes map external assets to proxy assets. For investments with available data, we map holdings to our asset classes for risk analysis. In some cases we do not have data for a specific investment, usually because the holding is a non-publicly-listed vehicle, such as a private 401(k) plan. In those cases, we use proxy tickers to determine the appropriate asset class exposures. Proxy tickers are provided by Plaid, our third-party data provider for connected accounts. Plaid uses a proprietary process to identify similar public securities to the unknown ticker using structural information (including security type and fund name) and to qualify the confidence level of the similarity. Betterment uses Plaid’s proxy tickers only for securities that pass a threshold confidence level of similarity. Plaid’s methodology may change over time, and Betterment will continuously evaluate any such changes. The monthly contributions estimate is based on a 60% likelihood of the portfolio value reaching the goal target at the end of the investment term. Calculations assume that you maintain the same portfolio strategy over time. If the portfolio strategy changes over time or has different expected returns, outcomes may be adjusted. Calculations will always be updated based on the current portfolio. Charts and graphs are in nominal terms. Withdrawal Advice Methodology And Assumptions For Retirement Income Goals Only The monthly safe withdrawal is based on a 96% likelihood of having $0 or more at the end of the time horizon, assuming the following assumptions hold true. The safe withdrawal amount assumes the user adjusts the withdrawal rate and allocation according to our advice at least once per month. The safe withdrawal amount assumes the user does not live past the specified time horizon (“plan-to-age”). Calculations assume the current Betterment portfolio. If the portfolio changes over time or has different expected returns, outcomes may be adjusted. Calculations will always be updated based on the current portfolio held. Withdrawal advice and graphs are in real terms, using an inflation rate of 2% The default time horizon (“plan-to age”) is 90 years of age, or age + 50 years if younger than 40, or age + 10 if older than 80. The model will use this value or the value entered by the user. Graph Explanation The Graph exhibits the possible range of projected portfolio values using color. The dark line indicates the projected portfolio value under average market conditions. This means that there is a 50% likelihood of portfolio values greater than this, and a 50% likelihood of portfolio values less than this. The lighter, shaded region indicates the range within which there is 80% likelihood of the projected portfolio value. This means that there is a 10% likelihood of portfolio values greater than the top of this region, and a 90% likelihood of portfolio values at least as high as the bottom of this region. Goal Status (Savings Goals): On Track Or Off Track The Betterment Savings Advice tool constantly tracks the portfolio performance and indicates the ability of the portfolio to reach the Goal target, assuming average market performance. The portfolio performance is categorized as “On Track” or “Off Track”, and Betterment makes recommendations to increase the likelihood of reaching the Goal target. The portfolio performance is “On Track” when the total projected portfolio value exceeds the Goal target assuming average market performance. This is equivalent to a likelihood of 50% and above of reaching the Goal target. The portfolio performance is “Off Track” when the future projected portfolio value (i.e. current balance plus future contributions, plus investment growth) is not sufficient to reach the Goal target assuming average market performance. This is equivalent to having less than 50% likelihood of reaching the Goal target. Betterment provides advice for bringing the goal back on track in three areas – either increasing the amount of future monthly contributions, or increasing the term of the investment or increasing the current balance in the account by making a one-time deposit. These recommendations are based on a relatively conservative stance, e.g. a 60% likelihood of projected portfolio value to reach the Goal target, compared to the 50% chance used by other models. Limitations The Goal target is a user input and may not be sufficient to provide income for actual spending or retirement income needs. The model does not account for any taxes, except for retirement goals. All non-retirement goal values are assumed to be pre-tax. The model does not account for forced withdrawals such as Required Minimum Distributions that must be taken from pre-tax qualified retirement accounts after a certain age. The model does not account for auto-deposits that are skipped. The savings model is in nominal terms and therefore does not have a direct inflation assumption. (The withdrawal model is in real terms, and uses a 2% inflation assumption). The withdrawal model does not take into account other sources of income outside the Betterment account. A full income plan should include all sources of income and a spending needs analysis. Past performance is not indicative of future results. These projections do not guarantee investment performance. Extreme market conditions, sustained high inflation, or other unforeseen events may reduce portfolio value and withdrawals. Income is not guaranteed.
4 Betterment Investing Options If You Have Low Risk Tolerance4 Betterment Investing Options If You Have Low Risk Tolerance If you’re an investor with low risk tolerance, Betterment has options that can help move forward your investing and savings goals, mediating between potential returns and your desired risk level. One of the more hazy concepts to quantify in behavioral investing is the concept of risk tolerance. Though it’s clear that people in general like to win more than they like to lose, there is also a well-known phenomenon that some people are more risk averse than others. Some investors are content to endure losses of more than half of their investment portfolio if they believe that the potential reward is high enough. Others may feel uneasy with even a loss of one percent. In general, we expect that investors who take more risk can often gain higher returns, but that doesn’t mean seeking a low-risk portfolio is the wrong move. On the contrary, steadily investing in a low-risk portfolio can be an appropriate strategy if it’s an approach you can stick with for the long-term. Betterment’s tools can help you determine the amount of risk that’s right for your financial goals and how much you should save to help reach them. If recent market volatility has made you rethink your risk tolerance, here are four options at Betterment that can offer lower risk. Cash Reserve If you’re looking to earn interest on your short-term cash or general savings, consider using Cash Reserve. It’s a high-yield cash account that can help you earn one of the highest variable rates available in the marketplace— 0.10% *. You’ll have the ability to easily transfer your cash to any of your investment goals when you’re ready to take on more risk, but keep in mind that the transfer can take up to two business days to complete. And, not only does Cash Reserve earn a high rate, but it also has FDIC insurance up to $1,000,000† once deposited at our program banks. Cash Reserve is only available to clients of Betterment LLC, which is not a bank, and cash transfers to program banks are conducted through the clients’ brokerage accounts at Betterment Securities. Safety Net Betterment’s Safety Net goal is designed with the specific purpose of building you a financial emergency fund. We recommend that you think of this as a pot of money you save for an emergency, such as a temporary loss of employment or a large unexpected expense. After you decide how much money to put into your Safety Net goal, we invest the money into a 30% stock/70% bond ETF portfolio. While this portfolio is riskier than a 0% stock portfolio, it’s likely a more appropriate allocation for your emergency fund as it can be better at combating a hidden risk to your savings goal: inflation. As Dan Egan, VP of Behavioral Finance & Investing wrote recently, “At least a market crash has the decency of showing up in your balance. Inflation doesn’t tell you that it’s cost you”. While Cash Reserve is built to help keep up with inflation in the short-term, the Safety Net goal can offer the opportunity to potentially exceed inflation while seeking to give you a buffer for rainy days. General Investing Using Betterment’s Portfolio At Low Stock Allocation If you’re now thinking that Cash Reserve is too conservative for your needs but the 30% stock allocation of the Safety Net goal is too aggressive, another option is to set your own stock allocation with Betterment’s allocation slider. For every financial goal you set, Betterment recommends a target stock allocation but lets you adjust it from 0% to 100% stocks. Whatever allocation you choose, Betterment will help you along the way. As you move the slider, we will inform you whether your choice is “Very Conservative”, “Appropriately Conservative”, “Moderate”, “Appropriately Aggressive” or “Too Aggressive”. While we don’t recommend that you change your allocation too drastically one way or the other, feel free to try out different allocations in our preview mode to find the portfolio that’s right for you. Using Flexible Portfolios to Choose Assets We build portfolios that balance a number of different asset classes—like U.S. bonds and international stocks—to achieve a high level of diversification. However, if you want to change exposures to specific asset classes, Flexible Portfolios allows you to make changes to your allocation, and you can choose to only hold what are typically low volatility assets. Another valid use of a Flexible Portfolio is to adjust to high concentrations in your holdings outside of Betterment. For example, if you have a large investment in U.S. bonds in an outside account, you could use a Flexible Portfolio to shift your allocation at Betterment towards more international bonds and away from U.S. bonds. A Flexible Portfolio starts with the Betterment Portfolio Strategy as a baseline, and then we allow you to tune the specific allocation to your preferences. While we don’t recommend you make asset class changes, if you have specific views, you could choose only assets that generally have less volatility. However, you should note that we have specific guidelines for appropriate uses of Flexible Portfolios, and generally, our recommendation is to only decrease risk by adjusting your allocation using your goal slider. As you change the allocation, we will analyze the holdings and inform you whether the risk of the portfolio is suited for your goal, as well as whether the portfolio is adequately diversified. Conclusion Deciding where to place your hard earned cash can be an emotional experience for even the most seasoned financial planner. Choosing a portfolio or high-yield cash account that you can stick with can be particularly important to reaching your financial goals. No matter which of the options above you choose, Betterment will give you advice and support to help you reach your financial goals.
The Recommended Allocation To Keep Up With Inflation Has ChangedThe Recommended Allocation To Keep Up With Inflation Has Changed For funds that seek to match or beat inflation, like a Safety Net goal or Emergency goal, we seek to take on minimal risk while allowing your portfolio the potential growth needed to keep up with inflation. Learn about our updated portfolio allocation recommendations for your emergency funds. At Betterment, we are routinely evaluating our investment strategies to help you achieve your financial goals. As part of that routine evaluation process, we have recently updated our recommended portfolio allocation for goals that seek to keep up with inflation. Goals like our Safety Net goal or an emergency fund are designed to be an account you can withdraw from in the case of an unexpected financial situation, such as a large medical bill or the loss of a job. If your emergency money is sitting out of the market and it’s not invested, it runs the risk of losing buying power over time because of inflation. A key risk to this money is that it loses purchasing power as time goes on. A key aim for such goals is to match—or beat—inflation, so that your dollars can keep as much buying power over time as possible. We updated our recommended allocation for goals that seek to keep up with inflation from 15% stocks to 30% stocks. Based on updated analysis below that considers the current yield curve and inflation expectations, our recommendation is that a 30% stock portfolio is the appropriate allocation for your emergency funds. The chosen allocation is designed to match our assumptions regarding long term inflation. We revisit these assumptions annually, and our assumption for long term inflation is still 2%. As interest rates have moved lower, the yield on low asset assets has also gone down. Now, an investor must take slightly more risk to achieve a return that may beat inflation. Just as they have in the past, these economic conditions could change again in the future—which is why we routinely evaluate our strategies over time. Keeping Inflation At Bay In order to determine the right level of portfolio risk, we need two key pieces of information: The expected return of the portfolio The expected rate of inflation Our current inflation assumption is 2% per year. We review our inflation assumptions annually to make sure they reflect the current economic environment, which is always changing. The expected return of the portfolio has two key components: the risk-free rate and the expected return on risky assets. Yield on U.S. Treasury bonds determines the risk-free rate. Since U.S. Treasury bonds are backed by the U.S. government, they are considered to be virtually risk-free. We also estimate how much additional return we might expect from holding risky assets, such as stocks or corporate bonds. Putting these two pieces together gives us the total expected return for the portfolio. As of January 2021, short-term U.S. Treasury bonds were expected to have a 0.10% annual yield. This means that holding these bonds until they mature will produce about a 0.10% annualized return, which is less than the 2% we need in order to combat inflation, based on our current inflation assumptions. By taking slightly more risk, Betterment seeks to improve on the 0.10% risk-free investment return. Based on our asset class return assumptions, we expect that the total returns for our 30% stock portfolio could potentially be 2.1% after fees*, which is slightly higher than our inflation expectations. We Recommend A Buffer Unfortunately, we can’t predict the future, so the actual performance of our 30% stock portfolio may turn out to be different than our projected assumptions. We can use history to help us understand the range of potential outcomes. Our 30% stock portfolio’s worst performance in a historical backtest would have been -22.9%, during the Great Financial Crisis.** To help protect against a temporary market drop, we recommend that you hold an additional buffer that’s 30% of your target amount—which generally represents at least three months of normal expenses—to insulate against down markets. For example, if three months of expenses is $10,000, we recommend that you hold $13,000 in our goal. Why not just hold cash? Finally, you might be wondering, “Why not just use a bank account for my emergency funds?” It’s a valid question. After all, money in a checking or savings account isn’t subject to market volatility. Most traditional bank accounts don’t pay a high enough interest rate to keep up with inflation. The national average interest rate is 0.04%, which is far below the 2% annual return we need in order to simply match inflation. This means that even though the amount of cash you’re holding is stable, its buying power is still declining over time. We’ll help keep you on track while keeping you informed. Having funds set aside for emergencies is the cornerstone of any financial plan, since it provides an important cushion against unforeseen circumstances—circumstances that might otherwise require you to dip into a long term account, such as retirement. In fact, our advisors routinely recommend that the first investing goal our customers set up should be a goal to protect oneself against unexpected costs, like a medical bill, or loss of income. If you currently have a goal that’s set to the target allocation of our old recommendation—15% stocks—we’ll alert you that your allocation is now considered conservative, and that a more appropriate target allocation for your goal is now 30% stocks. While we won’t adjust your target allocation for you, you’ll be able to adjust your target allocation within your goal either on a web browser or on your mobile app. Before making this update, please note that there may be a tax impact. We’ll show you the estimated tax impact before you complete the change inside of your account. As the economic environment changes, we will continue to review our recommendations. Because we believe in transparency, we’ll keep our customers updated if economic condition shifts lead to a chance in our advice and recommendations. We calculate expected excess returns for the assets in our portfolio by applying a Black-Litterman model, as described in “Computing Forward-Looking Return Inputs” of our . By multiplying these expected returns by our portfolio weights, we can calculate the gross expected excess returns for the portfolio. We can then calculate the expected total return of the portfolio by adding to the expected excess return our estimate of the forward-looking risk-free rate. In this example, we used the lowest point on the US Treasury yield curve as our assumption. The expected returns are net of a 0.25% annual management fee and fund level expenses, and assumes reinvestment of dividends.This expected return is based on a model, rather than actual client performance. Model returns may not always reflect material market or economic factors. All investing involves risk, and there is always a chance for loss, as well as gain. Actual returns can vary. Past performance does not indicate future results. ** The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indices tracked by each asset class in Betterment’s portfolio as of January 2021. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. See additional disclosure https://www.betterment.com/returns-calculation/.
How To Make The Most Of Your Spending With Cash Back OffersHow To Make The Most Of Your Spending With Cash Back Offers Betterment has partnered with Dosh to offer cash back offers for Checking customers. Learn how to make the most of your spending with cash back offers. We built our no-fee‡, hassle-free Checking account because we believe that you shouldn’t have to pay to access your money. Now, with help from our friends at Dosh, you can make the most of the money you spend by getting automatic cash back at thousands of your favorite brands. Plus thousands more brands Before making your purchase, we recommend checking your app to make sure a specific offer is still available. Merchants subject to change. With cash back offers from Dosh, you can shop from thousands of personalized online and in-person offers within your Betterment account. Plus, there’s no activation required—just shop, pay, and you can see your cash back come through as quickly as the next day. “Our goal at Betterment is to continuously find new ways to help our clients make the most of their money and have their best interests at heart,” said Katherine Kornas, Vice President of Growth at Betterment. “Providing Betterment Checking customers with a rewards program powered by Dosh builds upon this mission, by helping people save more money on everyday purchases. We’re excited to work with Dosh on implementing this benefit for our users.” “We’re passionate about putting cash back in the wallets of consumers when they shop, dine and travel, while making it a frictionless and delightful experience,” said Ryan Wuerch, CEO and founder at Dosh. “We’re so proud to provide Betterment Checking customers with automatic cash back at more than 10,000 of their favorite brands and retailers.” Interested in seeing where you could be earning cash back? Open a Betterment Checking account, browse our offers, and start earning. Cash Back Eligible when using your Betterment Checking Visa Debit Card. Cashback merchants and offers may vary. You’ll see rewards, which are deposited back into your Checking account, in as little as one day after making the qualifying purchase, but it may take up to 90 days depending on the merchant. In order to find you relevant offers, we share your Betterment Visa Debit Card transaction information (and location, if you choose) with our rewards partner, Dosh. Shared data is anonymized and Dosh is prohibited from selling shared data to any third parties. See Terms and Conditions to learn more. Any references to other merchants or merchant websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those merchant sites, or endorses any information contained on those merchant sites, unless expressly stated otherwise.
Betterment Socially Responsible Investing Portfolio StrategyBetterment Socially Responsible Investing Portfolio Strategy Many investors prefer to invest according to their values. Socially and environmentally conscious customers are able to take advantage of our Socially Responsible Investing (SRI) options. TABLE OF CONTENTS How do we define SRI? The Challenges of SRI Portfolio Construction How is Betterment’s Broad Impact portfolio constructed? How socially responsible is the SRI portfolio? Should we expect any difference in an SRI portfolio’s performance? Climate Impact Portfolio Social Impact Portfolio Conclusion In today’s landscape, design and ongoing management of a values-driven investing strategy continues to face many challenges. Even the relevant terminology is in flux. Socially Responsible Investing (SRI), the most historically established term used to describe the integration of values into one’s investments, is today often used interchangeably with Environmental, Social and Governance (ESG), which strictly speaking, is more of an implementation, than the broad concept. Industry professionals are increasingly consolidating on “sustainable investing” as the umbrella designation of choice, though the public at large often associates that term with a narrower environmental focus, further adding to the confusion. Betterment first made a values-driven portfolio available to our customers in 2017, under the SRI label. When we expanded our offerings in 2020, and introduced a new class of engagement focused investments in 2021, we maintained SRI as the umbrella term for the category, including throughout this paper. That there remains no agreed-upon terminology which is broadly understood by retail investors, is as good a symbol as any that this is still an emerging field, with surging demand a relatively recent phenomenon. That the values-driven investing landscape is expected to continue evolving, both in terms of superficial labels, and in substance, continues to inform the core of Betterment’s aspirational approach to SRI. It is as much a process, as it is a product—designed to be iterated on over time, without sacrificing the core principles of our advice: balanced cost and proper global diversification. Despite the nascent state of SRI, Betterment’s portfolios represent a diversified, low-cost solution that will be continually improved upon as costs drop, more and better data emerges, and as a result, the availability of SRI funds broadens (in this paper, “funds” refer to ETFs, and “SRI funds” refer to either ETFs screened for some form of ESG criteria or ETFs with an SRI-focused shareholder engagement strategy). In developing our SRI portfolios, we had to research, analyze, and ultimately answer five important questions: How should we define SRI for a portfolio? What are the challenges for implementing SRI today? Which SRI funds are among the best for an effective portfolio? How should we assess the “social responsibility” of an SRI portfolio? Should we expect any difference in an SRI portfolio’s performance? The resulting answers to these questions, explained in the sections that follow as well as in our SRI disclosures, informed how we created the Betterment SRI portfolios for our customers, including legacy versions of the SRI portfolios. In the first five sections we answer these questions both generally for all our SRI portfolios and with respect to Betterment’s Broad Impact offering, which focuses on investment options that consider broad social responsibility factors and engagement strategies. Betterment also offers two additional, more focused SRI portfolio options, a Social Impact SRI portfolio (focused on social governance criteria) and a Climate Impact SRI portfolio (focused on climate-conscious investments). These strategies are further elaborated on in Sections VI and VII. I. How do we define SRI? Our approach to SRI has three fundamental dimensions: Reducing exposure to companies involved in unsustainable activities and environmental, social, or governmental controversies. Increasing investments in companies that work to address solutions for core environmental and social challenges in measurable ways. Allocating to investments that use shareholder engagement tools, such as shareholder proposals and proxy voting, to incentivize socially responsible corporate behavior. We first define our SRI approach using a set of industry criteria known as “ESG”, which stands for Environmental, Social and Governance, and then expand upon the ESG-investing framework with complementary shareholder engagement tools. Though SRI and ESG are often used interchangeably in general financial literature, experts will point out that there is a clear distinction between how each term is defined. SRI is the traditional name for the broad concept of values-driven investing (many experts now favor “sustainable investing” as the name for the entire category). ESG refers specifically to the quantifiable dimensions of a company’s standing along each of its three components. In our SRI portfolios, we use ESG factors to define and score the degree to which our portfolios incorporate socially responsible ETFs. We also complement our ESG factor-scored socially responsible ETFs with engagement-based socially responsible ETFs, where a fund manager uses shareholder engagement tools to express a socially responsible preference. Using ESG Factors In An SRI Approach A significant and obvious aspect of improving a portfolio’s ESG score is reducing exposure to companies that engage in unsustainable activities in your investment portfolio. Companies can be considered undesirable because their businesses do not align with specific values—e.g. selling tobacco, military weapons, or civilian firearms. Other companies may be undesirable because they have been involved in recent and ongoing ESG controversies and have yet to make amends in a meaningful way. ESG controversies include: Environmental controversies related to energy and climate change, land use, biodiversity, toxic spills and releases, water stress, and/or operational waste. A recent example is the BP (Deepwater Horizon) oil spill from 2010. Corporate governance controversies involving fraud, bribery, and controversial investments. A recent example is Wells Fargo’s recent controversy where the company may have created as many as 3.5 million fraudulent accounts in the last 15 years. Labor controversies like discrimination and other violations of International Labor Organization standards. For example, the class action lawsuit against Sterling Jewelers, alleging gender discrimination and sexual harassment within the company. Customer controversies involving anticompetitive practices, privacy and data security, and product safety. Remember the massive Yahoo data security breach from 2016 where 500 million user accounts were hacked? SRI is about more than just adjusting your portfolio to minimize companies with a poor social impact. Based on the framework of MSCI, a leading provider of ESG data and analytics, a socially responsible investment approach also emphasizes the inclusion of companies that have a high overall ESG score, which represents an aggregation of scores for multiple thematic issues across E, S, and G pillars as shown in Table 1 below. Table 1. A Broad Set of Criteria Across E, S and G pillars 3 Pillars 10 Themes 37 Key ESG Issues Environment Climate Change Carbon Emissions Energy Efficiency Product Carbon Footprint Natural Resources Water Stress Biodiversity & Land Use Pollution & Waste Toxic Emissions & Waste Electronic Waste Packaging Material & Waste Environmental Opportunities Opportunities in Clean Technology Opportunities in Renewable Energy Opportunities in Green Building Social Human Capital Labor Management Human Capital Development Health & Safety Supply Chain Labor Standards Product Liability Product Safety & Quality Privacy & Data Security Chemical Safety Responsible Investment Financial Product Safety Health & Demographic Risk Stakeholder Opposition Controversial Sourcing Social Opportunities Access to Communications Access to Health Care Access to Finance Opportunities in Nutrition & Health Governance Corporate Governance Board* Ownership* Pay* Accounting* Corporate Behavior Business Ethics Corruption & Instability Anti-Competitive Practices Financial System Instability *Board, Ownership, Pay, and Accounting carry weight in the ESG Rating model for all companies. Currently, they contribute to the Corporate Governance score directly and 0-10 sub-scores are not available. Source: MSCI Ratings Methodology Shareholder Engagement When an investor purchases shares of common stock in a company, they become a partial owner of that company. As a partial owner, they have not only a claim on the profits of the company but also a right to influence the company’s broader decision-making through shareholder engagement. The most direct ways a shareholder can influence a company’s decision making is through shareholder proposals and proxy voting. Publicly traded companies have annual meetings where they report on the business’ activities to shareholders. As a part of these meetings, shareholders can vote on a number of topics such as share ownership, the composition of the board of directors, and executive level compensation. Investors receive information on the topics to be voted on prior to the meeting in the form of a proxy statement, and can vote on these topics through a proxy card. A shareholder proposal is an explicit recommendation from an investor for the company to take a specific course of action. Shareholders can also propose their own nominees to the company’s board of directors. Once a shareholder proposal is submitted, the proposal or nominee is included in the company’s proxy information and is voted on at the next annual shareholders meeting. But how does this work for investors who own ETFs rather than individual companies? ETF shareholders themselves do not vote in the proxy voting process of underlying companies, but rather the ETF fund issuer participates in the proxy voting process on behalf of their shareholders. Shareholder voting is a powerful tool that has been underused on ESG issues until recently. While support for ESG shareholder resolutions from fund issuers was generally on the rise in 2020, Blackrock and Vanguard, two of the largest ETF issuers, were dead last, voting in favor of just 12% and 15% of such resolutions, respectively. As investors signal increasing interest in ESG engagement, additional ETF fund issuers have emerged that play a more active role engaging with underlying companies through proxy voting to advocate for more socially responsible corporate practices. These issuers use engagement-based strategies, such as shareholder proposals and director nominees, to engage with companies to bring about ESG change and allow investors in the ETF to express a socially responsible preference. II. The Challenges of SRI Portfolio Construction Although using ESG factors to select portfolio funds may sound like a brilliantly straightforward, quantitative approach to constructing a portfolio, unfortunately, in today’s market, there are a number of limitations that plague the process of executing SRI. In spite of these limitations, we still strive to maximize the expression of your SRI values with some of the best available investing tools. For Betterment, three limitations had a large influence on our overall approach to building an SRI portfolio: 1. Poor quality data underlying ESG scoring. Because SRI is still gaining traction, data for constructing ESG scores are at a nascent stage of development. There are no uniform standards for data quality yet. Some companies disclose data on the various ESG metrics, others do not. And companies that do disclose their data may do so in inconsistent ways. As a result, ESG metrics may not necessarily capture the desired concepts and ideals with 100% accuracy. In order to standardize the process of assessing companies’ social responsibility practices, Betterment uses ESG factor scores from MSCI, an industry-leading provider of financial data and ESG analytics that has served the financial industry for more than 40 years. MSCI collects data from multiple sources, company disclosures, and over 1,600 media sources monitored daily. They also employ a robust monitoring and data quality review process. See the MSCI ESG Fund Ratings Executive Summary for more detail. By adopting MSCI’s framework for calculating ESG metrics, we’re putting our best foot forward toward assuring the data is as accurate as currently possible. 2. Many existing SRI offerings in the market have serious shortcomings. Many SRI offerings today sacrifice sufficient diversification appropriate for investors who seek market returns, allocate based on competing ESG issues and themes that reduce a portfolio’s effectiveness, and do not provide investors an avenue to use collective action to bring about ESG change. Some solutions do not use a diversified range of asset classes—for example, holding mostly or entirely US Large Cap funds–or invest only in a handful of individual stocks within an asset class. At Betterment, diversification is a fundamental pillar of our advice, and we do not believe it’s in our customers’ best interests to offer them an under-diversified portfolio. Our approach has the advantage of maintaining global diversification at a relatively low cost. Some approaches to SRI may seek to address a broad set of values by using a combination of more focused, single issue funds as the core of the portfolio (for example, an environmentally focused ETF, a social equity focused ETF, etc). However, some companies rank highly with respect to their environmental practices, but poorly on another, like board diversity, or vice versa. Rather than doubling down on multiple areas of impact, combining funds with a distinct focus can instead dilute each intent, by increasing the likelihood of offsetting positions in the same asset class. Lastly, many ESG offerings today do not provide investors an avenue with which to influence corporate decision-making and bring about sustainable change. Screening-based SRI solutions only work to exclude or include certain industries or categories of companies, but do not give investors the ability to express an ESG preference through collective action. Betterment’s SRI portfolios do not sacrifice global diversification and all three portfolios include a partial allocation to an engagement-based socially responsible ETF using shareholder advocacy as a means to bring about ESG-change in corporate behavior. These approaches allow Betterment investors to take a diversified approach to sustainable investing and use their investments to bring about ESG-change. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly, even if particular shareholder campaigns are unsuccessful. The Broad Impact portfolio seeks to balance each of the three dimensions of ESG without diluting different dimensions of social responsibility. With our Social Impact portfolio, we sharpen the focus on social equity with partial allocations to gender and racial diversity focused funds. With our Climate Impact portfolio, we sharpen the focus on controlling carbon emissions and fostering green solutions. 3. Integrating values into an ETF portfolio may not always meet every investor’s expectations, though it offers unique advantage For investors who prioritize an absolute exclusion of specific types of companies above all else, the ESG Scoring approach will inevitably fall short of expectations. For example, many of the largest ESG funds focused on US Large Cap stocks include some energy companies that engage in oil and natural gas exploration, like Hess. While Hess might rate relatively poorly along the “E” pillar of ESG, it could still rate highly in terms of the “S” and the “G.” Furthermore, maintaining our core principle of global diversification, to ensure both domestic and international bond exposure, we’re still allocating to some funds without an ESG mandate, until satisfactory solutions are available within those asset classes. There is a view across the asset management industry, with a certainty approaching conventional wisdom, that only unbundling ETFs and holding the underlying securities directly, will offer the general public the ability to fully align their values with their investments. This approach is increasingly described as “direct indexing”, though the practice of tracking an index by trading the individual stocks in so-called SMAs (separately managed accounts) is decades old. An established index might serve as a starting point, after which, an investor’s specific bundle of preferences can be applied. This is particularly effective with respect to absolute exclusions. While ESG index providers such as MSCI or Morningstar might deem some particular company as worthy of inclusion, direct indexing offers the ability to override it. The hyper-personalization of direct indexing no doubt has its applications, but for most investors, an ETF-based approach to values-driven investing offers some unique advantages. We’ve heard from our customers that while knowing that they have personally limited or eliminated exposure to certain companies is important, it also matters to them that their investing choices contribute towards driving positive change. Investing in ETFs with ESG mandates maximizes the external impact of such choices. Publicly traded corporations employ entire Investor Relations teams, whose jobs include monitoring how their stock is faring across widely adopted indexes. Just as a company’s inclusion into the S&P 500 typically results in a price jump, a downgrade or outright exclusion from an influential ESG index is highly visible, and thus a cause for concern for a company’s management team. But an index is only as influential as the volume of assets that track it, and no assets are as easily counted, and as directly attributable to that index, as those invested in publicly traded funds. Tracking a values-driven index by buying and selling stocks in your personal account allows for additional customization, but when you invest in a fund that tracks that values-driven index, you are pooling your values with those of others in one of the most effective ways, empowering that index, and providing leverage to those who actively engage with companies, pushing them to improve their ESG metrics. Banding together with like-minded investors through a fund, amplifies your voice on issues that matter to you—like a form of collective bargaining. Furthermore, as more dollars flow into ETFs with ESG mandates, issuers are responding with more specialized offerings, allowing for ever more customization when integrating values into globally diversified ETF portfolios. However, that evolution will take time. This is precisely why we’ve approached our values-driven offering as a journey, not a final destination. We are committed to achieving ever more alignment with our customers’ values over time, through ongoing research tracking the availability of better vehicles, and this approach has been validated. When we launched our first SRI portfolio in 2017, only the US Large Cap asset class was allocated to an ETF with a sustainable mandate. It was the beginning of a conversation—an invitation to our customers to signal to the investing industry that this matters to them, and that there is demand for high quality values-driven ETFs. We expected that increased asset flows across the industry into such funds would continue to drive down expense ratios and increase liquidity. Since that original offering, which was the predecessor to what is now our Broad Impact portfolio, we’ve been able to expand the ESG exposure to now also cover Developed Market stocks, Emerging Market stocks, and US High Quality Bonds. We also now include ESG exposure to an engagement-based fund. Sufficient options also exist for us to branch out in two different areas of focus—Climate Impact, and Social Impact. 4. Most available SRI-oriented ETFs present liquidity limitations. In an effort to control the overall cost for SRI investors, a large portion of our research focused on low-cost exchange-traded funds (ETFs) oriented toward SRI. As with any of our portfolios, we aim to help maximize investors’ take-home returns by lowering the costs of the underlying funds. While SRI-oriented ETFs indeed have relatively low expense ratios compared to SRI mutual funds, our analysis revealed insufficient liquidity in many ETFs currently on the market. Without sufficient liquidity, every execution becomes more expensive, creating a drag on returns. Median daily dollar volume is one way of estimating liquidity. Higher volume on a given asset means that you can quickly buy (sell) more of that asset in the market without driving the price up (down). Of course, the degree to which you can drive the price up or down with your buying or selling must be treated as a cost that can drag down on your returns. Figures 1 and 2 below put the liquidity issues associated with trading two of the most widely traded SRI ETFs—ESGU and ESGD—into perspective by comparing their liquidity to the liquidity of other ETFs used in Betterment portfolios. Figure 1 compares the most liquid ESG funds, ESGU and ESGD, to the funds in Betterment’s Core portfolio, showing that ESG funds in general are less liquid than traditional market-cap based funds. Figure 1. In this figure we compare the median daily dollar volumes of the primary funds in the Betterment Core IRA portfolios as of June 2021 against those of ESGD and ESGU. As you can see, most funds that we currently trade in the Betterment portfolios have liquidity that surpasses that of ESGD or ESGU. Data: Factset. Median dollar value traded is measured over the past 45 trading days over the period ending June 3, 2021. However when compared to other ESG funds in Figure 2, ESGU and ESGD are some of the most liquid ETFs compared to other socially responsible ETF products. Liquidity is concentrated in the top few SRI funds Figure 2. ESGU, ESGE, and ESGD are more liquid than other fund options with SRI mandates. Certain SRI-oriented bond ETFs have more recently become liquid enough for inclusion in Betterment’s SRI portfolio, but the vast majority of these funds still lack sufficient liquidity. Data: Factset. Median dollar value traded is measured over the past 45 trading days over the period ending June 3, 2021. Please note that the tickers VSGX and SUSB in this figure are not included in the Betterment Broad Impact portfolio. In balancing cost and value for the Broad Impact portfolio, the options were limited to funds that focus on US stocks , Developed Market stocks, Emerging Market stocks, US Investment Grade Corporate Bonds, and US High Quality bonds. Accordingly, ESGU, ESGV, SUSA, ESGD, ESGE, ,EAGG, and SUSC are the ETFs with SRI mandates that we have selected for the Broad Impact portfolio. They are some of the ETFs with the largest AUM among broadly diversified SRI options, and our investment selection process shows that they have the highest liquidity relative to their size in the Betterment Broad Impact SRI portfolio. III. How is Betterment’s Broad Impact portfolio constructed? In 2017, we launched our original SRI portfolio offering, which we’ve been steadily improving over the years. In 2020, we released two additional Impact portfolios and improved our original SRI portfolio, the improved iteration now called our “Broad Impact” portfolio to distinguish it from the new specific focus options, Climate Impact and Social Impact, and the legacy SRI portfolio for those investors who elected not to upgrade their historical version of the SRI portfolio (“legacy SRI portfolio”). For more information about the differences between our Broad Impact portfolio and the legacy SRI portfolio, please see our disclosures. As we’ve done since 2017, we continue to iterate on our SRI offerings, even if not all the fund products for an ideal portfolio are currently available. Figure 3 shows that we have increased the allocation to ESG focused funds each year since we launched our initial offering. Today all primary stock ETFs used in our Broad Impact, Climate Impact, and Social Impact portfolios have an ESG focus. 100% Stock Allocation in the Broad Impact Portfolio Over Time Figure 3. Calculations by Betterment. Portfolios from 2017-2019 represent Betterment’s original SRI portfolio. The 2020 portfolio represents a 100% stock allocation of Betterment’s Broad Impact portfolio. As additional SRI portfolios were introduced in 2020, Betterment’s SRI portfolio became known as the Broad Impact portfolio. As your portfolio allocation shifts to higher bond allocations, the percentage of your portfolio attributable to SRI funds decreases. Additionally, a 100% stock allocation of the Broad Impact portfolio in a taxable goal with tax loss harvesting enabled may not be comprised of all SRI funds because of the lack of suitable secondary and tertiary SRI tickers in the developed and emerging market stock asset classes. Betterment has built a Broad Impact portfolio, which focuses on ETFs that rate highly on a scale that considers all three ESG pillars, and includes an allocation to an engagement-based SRI ETF. Broad ESG investing solutions are currently the most liquid, highlighting their popularity amongst investors. Due to this, we will first examine how we created Betterment’s Broad Impact portfolio. Further information on the Social Impact and the Climate Impact portfolios’ construction can be found in Section VI and VII. In order to maintain geographic and asset class diversification and to meet our requirements for lower cost and higher liquidity in all SRI portfolios, we continue to allocate to some funds that do not have SRI mandates, particularly in bond asset classes. How does the Broad Impact portfolio compare to Betterment’s Core portfolio? When compared to Betterment’s Core portfolio, there are three main changes. First, in both taxable and tax-deferred portfolios we replace the Core portfolio’s current US stock market exposure with an allocation to a broad ESG US stock market ETF (ESGU) and an allocation to a broad US stock market ETF focused on shareholder engagement (VOTE). Two other broad ESG US stock market ETFs (ESGV and SUSA) serve as the alternative tickers for ESGU, which are utilized by Tax-Loss Harvesting+ (TLH+). Currently, there are not any comparable alternative tickers for VOTE so this component of the portfolio will not be tax-loss harvested. Second, in both taxable and tax-deferred portfolios we replace the Core portfolio’s current Emerging Market stock exposure and Developed Market stock exposure with a broad ESG Emerging Market ETF (ESGE) and a broad ESG Developed Market ETF (ESGD), respectively. Because of limited liquidity among other Emerging Market and Developed Market SRI funds, non-SRI market-capitalization based ETFs, which are not screened for ESG criteria, are used as alternative tickers for TLH+. Third, in tax-deferred portfolios we replace the Core portfolio’s current US High Quality Bond and US Investment Grade Corporate Bond exposure with an ESG US High Quality Bond fund (EAGG) and an ESG US Investment Grade Corporate Bond fund (SUSC), respectively. A more subtle difference is that ESG funds tend to tilt away from small-cap stocks when compared to the broader market, as small-cap stocks often score poorly from an ESG perspective. As a result, the SRI portfolio may have limited investments in small cap stocks. Additionally, the Core portfolio has a tilt towards small cap and value, which is removed from all of the SRI portfolios in favor of using more funds screened for socially responsible criteria. ESGU, ESGV, SUSA, ESGD, ESGE, SUSC, and EAGG each track a benchmark index that screens out companies involved in specific activities and selectively includes companies that score relatively highly across a broad set of ESG metrics. ESGU, ESGD, ESGE, SUSC, and EAGG exclude tobacco companies, thermal coal companies, oil sands companies, certain weapons companies (such as those producing landmines and bioweapons), and companies undergoing severe business controversies. The benchmark index for ESGV explicitly filters out companies involved in adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power. SUSA benchmark index screens out tobacco companies and companies that have run into recent ESG controversies (a few examples were mentioned earlier). VOTE tracks a benchmark index that invests in 500 of the largest companies in the U.S. weighted according to their size, or market capitalization. This is different from the other indexes tracked by SRI funds in the Broad Impact portfolio, because the index does not take into account a company’s ESG factors when weighting different companies. Rather than invest more in good companies and less in bad companies, VOTE invests in the broader market and focuses on improving these companies’ social and environmental impact through shareholder engagement. Some of our allocations to bonds continue to be expressed using non-SRI focused ETFs since either the corresponding SRI alternatives do not exist or may lack sufficient liquidity. These non-SRI funds continue to be part of the portfolios for diversification purposes. An example of how a Betterment Broad Impact portfolio for IRA accounts at a 70% stock allocation, with its primary tickers, is shown in Figure 4. Taxable portfolios are similar but with the replacement of US High Quality SRI Bond exposure (EAGG primary) by US Municipal bonds (MUB primary) as is implemented currently for Betterment Core portfolios. Figure 4. Betterment Broad Impact Portfolio for IRA – 70% Stock Allocation Based on the primary ticker holdings, the following are the main differences between Betterment’s Broad Impact portfolio and Core portfolio: Replacement of market cap-based US stock exposure and value style US stock exposure in the Core portfolio, with SRI-focused US stock market funds, ESGU and VOTE, in the Broad Impact portfolio. Replacement of market cap-based developed market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGD, in the Broad Impact portfolio. Replacement of market cap-based emerging market stock fund exposure in the Core portfolio, with SRI-focused emerging market stock fund, ESGE, in the Broad Impact portfolio. Replacement of market cap-based US high quality bond fund exposure in the Core portfolio, with SRI-focused US high quality bond funds, EAGG and SUSC, in the Broad Impact portfolio. SRI portfolios can also support our core products for increasing after-tax returns, Tax-loss Harvesting+ (TLH) and Tax-coordinated portfolios (TCP). In the Broad Impact portfolio, because of limited fund availability in the developed and emerging market SRI spaces, we use non-SRI market cap-based funds, like VWO, SPEM, VEA, and IEFA as secondary and tertiary funds for ESGE and ESGD when TLH is enabled. How does the legacy SRI portfolio compare to the current SRI portfolios? There are certain differences between the legacy SRI portfolio and the current SRI portfolios. If you invested in the legacy SRI portfolio prior to October 2020 and chose not to update to one of the SRI portfolios, your legacy SRI portfolio does not include the above described enhancements to the Broad Impact portfolio. The legacy SRI portfolio may have different portfolio weights, meaning as we introduce new asset classes and adjust the percentage any one particular asset class contributes to a current SRI portfolio, the percentage an asset class contributes to the legacy SRI portfolio will deviate from the makeup of the current SRI portfolios and Betterment Core portfolio. The legacy SRI portfolio may also have different funds, ETFs, as compared to both the current versions of the SRI portfolios and the Betterment Core portfolio. Lastly, the legacy SRI portfolio may also have higher exposure to broad market ETFs that do not currently use social responsibility screens or engagement based tools and retain exposure to companies and industries based on previous socially responsible benchmark measures that have since been changed. Future updates to the Broad, Climate, and Social Impact portfolios will not be reflected in the legacy SRI portfolio. IV. How socially responsible is the Broad Impact portfolio? As mentioned earlier, we first use the ESG data and analytics from MSCI to quantify how SRI-oriented our portfolios are. For each company that they cover, MSCI calculates a large number of ESG metrics across multiple environmental (E), social (S), and governance (G) pillars and themes (recall Table 1 above). All these metrics are first aggregated at the company level to calculate individual company scores. At the fund level, an overall MSCI ESG Quality score is calculated based on an aggregation of the relevant company scores. As defined by MSCI, this fund level ESG Quality score reflects “the ability of the underlying holdings to manage key medium- to long‐term risks and opportunities arising from environmental, social, and governance factors”. These fund scores can be better understood given the MSCI ESG Quality Score scale shown below. See MSCI's ESG Fund Ratings for more detail. Table 2. The MSCI ESG Quality Score Scale The ESG Quality Score measures the ability of underlying holdings to manage key medium- to long-term risks and opportunities arising from environmental, social, and governance factors. Scale 0-10 Score 8-10 Very high ESG quality — underlying holdings largely rank best in class globally based on their exposure to and management of key ESG risks and opportunities 6-8 High ESG quality — underlying holdings largely rank above average globally based on their exposure to and management of key ESG risks and opportunities 4-6 Average ESG quality — underlying holdings rank near the global peer average, or ESG quality of underlying holdings is mixed 2-4 Low ESG quality< — underlying holdings largely rank below average globally based on their exposure to and management of key risks and opportunities 0-2 Very low ESG quality — underlying holdings largely rank worst in class globally based on their exposure to and management of key ESG risks and opportunities Source: MSCI Based on data from MSCI, which the organization has made publicly available for funds to drive greater ESG transparency, and sourced by fund courtesy of etf.com, Betterment’s 100% stock Broad Impact portfolio has a weighted MSCI ESG Quality score that is approximately 21% greater than Betterment’s 100% stock Core portfolio. The data shown in Table 3 and the scale presented in Table 2 show that, on average, while current Betterment Core portfolios hold US, Developed and Emerging Market stocks that are of Average to High ESG quality, the funds that follow indexes based on ESG criteria in the Broad Impact portfolio invest in US, Developed and Emerging Market stocks that are of High to Very High ESG quality. MSCI ESG Quality Scores U.S. Stocks Betterment Core Portfolio: 5.72 Betterment Broad Impact Portfolio: 6.30 Emerging Markets Stocks Betterment Core Portfolio: 4.72 Betterment Broad Impact Portfolio: 7.35 Developed Markets Stocks Betterment Core Portfolio: 7.26 Betterment Broad Impact Portfolio: 8.35 US High Quality Bonds Betterment Core Portfolio: 6.28 Betterment Broad Impact Portfolio: 6.84 Table 3. Sources: MSCI ESG Quality Scores courtesy of etf.com, values accurate as of June 3, 2021and are subject to change. In order to present the most broadly applicable comparison, scores are with respect to each portfolio’s primary tickers exposure, and exclude any secondary or tertiary tickers that may be purchased in connection with tax loss harvesting. Because VOTE has yet to be evaluated by MSCI, we use the MSCI ESG score of SPY to derive the above values as it has a very similar investment nature to VOTE. Another way we can measure how socially responsible a fund is by monitoring their shareholder engagement with companies on environmental, social and governance issues. Engagement-based socially responsible ETFs use shareholder proposals and proxy voting strategies to advocate for ESG change. We can review the votes of particular shareholder campaigns and evaluate whether those campaigns are successful. That review however does not capture the impact that the presence of engagement-based socially responsible ETFs may have on corporate behavior simply by existing in the market. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly. These aspects of sustainable investing are more challenging to measure in a catch-all metric, however that does not diminish their importance. We believe as this field of sustainable investing expands, investors will demand increased transparency in fund sponsor’s corporate engagements. A Note On ESG Risks And Opportunities An ESG risk captures the negative externalities that a company in a given industry generates that may become unanticipated costs for that company in the medium- to long-term. An example of such a risk is the possible need to reformulate a company’s product due to a regulatory ban on a key chemical input. An ESG opportunity for a given industry is considered to be material if companies will capitalize over a medium- to long-term time horizon. Examples of ESG opportunities include the use of clean technology for the LED lighting industry. See MSCI ESG Ratings Methodology (April 2020) for more detail. For a company to score well on a key ESG issue (see Table 1 above), both the exposure to and management of ESG risks are taken into account. The extent to which an ESG risk exposure is managed needs to be commensurate with the level of the exposure. If a company has high exposure to an ESG risk, it must also have strong ESG risk management in order to score well on the relevant ESG key issue. A company that has limited exposure to the same ESG risk, only needs to have moderate risk management practices in order to score as highly. The converse is true as well. If a company that is highly exposed to an ESG risk also has poor risk management, it will score more poorly in terms of ESG quality than a company with the same risk management practices, but lower risk exposure. For example, water stress is a key ESG issue. Electric utility companies are highly dependent on water with each company more or less exposed depending on the location of its plants. Plants located in the desert are highly exposed to water stress risk while those located in areas with more plentiful water supplies present lower risk. If a company is operating in a location where water is scarce, it needs to take much more extensive measures to manage this risk than a company that has access to abundant water supply. V. Should we expect any difference in an SRI portfolio’s performance? One might expect that a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio. The notion behind this reasoning is that somehow there is a premium to be paid for investing based on your social ideals and values. A white paper by the Morgan Stanley Institute for Sustainable Investing, however, shows that this claim is questionable at best. This paper summarized the results from a study that analyzes the performance of nearly 11,000 funds from 2004 to 2018 and compares traditional funds to sustainable funds. The primary takeaway of the study revealed that there was no trade-off in performance when comparing sustainable to traditional funds. The study suggests they were only able to find sporadic and inconsistent differences in returns, which suggests that while there can be differences in performance over shorter time periods, over the long term there is likely no meaningful difference. The second significant finding from the study was that sustainable funds exhibited 20% lower downside risk, as measured by downside deviation. When considering the possible performance of Betterment’s SRI portfolios (excluding the legacy SRI portfolio), we examined evidence based on both historical and forward-looking analyses described below. When adjusting for the stock allocation level, the data indicates that the performance of Betterment’s Broad Impact portfolio versus our Core portfolio is not significantly different. Backtests Based On Historical Returns Past performance does not guarantee future results. Nonetheless, our analysis of historical returns is consistent with our assertion that the performance of SRI portfolios should track the performance of the Core portfolios very closely. An analysis of the historical total gross returns over the past four years shows that SRI portfolios and Core portfolios have been very highly correlated. In Figure 5 we illustrate this high correlation using Broad Impact IRA portfolios at a 70% stock allocation as an example. Both Taxable and IRA portfolios exhibit similar properties given other stock allocation levels. Figure 5. Betterment Core Portfolio vs Broad Impact Portfolio Monthly Returns Figure 5. Based on historical returns of a 70% stock allocation portfolio gross of all fees for the period starting May 31, 2017 and ending May 28, 2021.* But how do the net returns compare? In Figure 6 we show that the weighted expense ratios of the Broad Impact portfolio is higher than those of Core portfolios at non-zero stock allocation levels (and the spread increases as you add more stocks to the mix). You might expect that the higher expense ratios would drag down the net performance of Broad Impact portfolios relative to Core portfolios. Figure 6. Weighted Expense Ratios For All IRA Portfolio Allocations Figure 6. Sources: Xignite. Calculations by Betterment as of June 3, 2021. Weighted expense ratios for each portfolio are calculated using the expense ratios of the primary ETFs used for IRA allocations of Betterment’s portfolios as of June, 2021. As it turns out, after reducing returns both by weighted expense ratios and a 0.25% annual Betterment fee, the performance of the Broad Impact portfolio ended up being similar to that of Core portfolio for the period starting May 31, 2017 and ending May 28, 2021, with the Broad Impact portfolio outperforming over this specific period. Table 3 provides an example of this claim for IRA portfolios at a 70% stock allocation. Performance summaries for other stock allocation levels as well as for taxable portfolios look similar. Table 4. Comparing Net Performance 70% Stock Allocation Portfolios for Period starting August 1, 2016 and ending February 28, 2021 Betterment Portfolio Betterment Broad Impact Annualized Return (net) 10.41% 12.14% Annualized Standard Deviation 11.02% 11.46% *Performance information for Table 4 ‘Comparing Net Performance’ and for Figure 5 ‘Betterment Core Portfolio vs Broad Impact Portfolio Monthly Returns’ for the Betterment allocations are based on a backtest of the ETFs or indices tracked by each asset class in Betterment’s portfolios as of June, 2021. Though we have made an effort to closely match performance results shown to that of the Betterment Portfolio over time, these results are entirely the product of a model. Actual client experience could have varied materially. Performance figures assume dividends are reinvested and daily portfolio rebalancing at market closing prices. The returns are net of a 0.25% annual management fee and fund level expenses. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time and the effect on performance results could be either favorable or unfavorable. The returns of SPY were used as a proxy for the returns of VOTE for the purposes of this calculation due to their similar investment natures. See additional disclosure https://www.betterment.com/returns-calculation/. Source: Price data from Xignite. Calculations by Betterment. Forward-looking Analysis In Figure 7, we graph expected net total returns at each risk (stock allocation) level for both Betterment Core and Broad Impact portfolios. All expected total returns are expressed in annual terms and are net of the portfolio weighted ETF annual expense ratios and a 0.25% annual Betterment fee. Based on the application of Black-Litterman and mean-variance portfolio optimization methods, they are our best estimates of the actual returns, net of known fees, that you might expect to achieve on average annually. The expected net total returns of Betterment’s Broad Impact portfolio are only slightly below those of the Betterment Core portfolio. The higher weighted expense ratios of Broad Impact portfolios account for a large component of their expected underperformance. Figure 7. Comparison of Broad Impact and Core IRA Efficient Frontiers Assumes a risk-free rate of 2.77% Sources: Market capitalization data collected from S&P Dow Jones Indices, SIFMA, and Bank for International Settlements. Price data are from Xignite. A risk-free rate assumption of 2.77% is for a 10-year horizon and is derived using our methods for estimating the forward curve as of June 3, 2021. The forward looking returns are shown net of known fund fees and Betterment’s 0.25% management fee. Calculations by Betterment. Dividend Yields Could Be Lower Dividend yields calculated over the past year (ending June 3, 2020) indicate that income returns coming from Broad Impact portfolios have been lower than those of Core portfolios recently (see Figure 8). Oil and gas companies like BP, Chevron, and Exxon, for example, currently have relatively high dividend yields and excluding them from a given portfolio can cause its income return to be lower. Of course, future dividend yields are random variables and past data may not provide accurate forecasts. Nevertheless, lower dividend yields can be a factor in driving total returns for SRI portfolios to be lower than those of Core portfolios. Figure 8. Comparison of Dividend Yields Source: Xignite, Calculations by Betterment for one year period ending June 3, 2021. Dividend yields for each portfolio are calculated using the dividend yields of the primary ETFs used for IRA allocations of Betterment’s portfolios as of June, 2021. The dividend yield of SPY was used as a proxy for the dividend yield of VOTE for the purposes of this calculation due to their similar investment natures. VI. Climate Impact Portfolio Betterment offers a Climate Impact portfolio for investors that want to invest in an SRI strategy more focused on being climate-conscious rather than focusing on all ESG dimensions equally. The Climate Impact portfolio was designed to give investors exposure to climate-conscious investments, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio, as we seek to incorporate broad based climate-focused ETFs with sufficient liquidity relative to their size in the portfolio. How does the Climate Impact portfolio more positively affect climate change? Half of the stocks in the Climate Impact portfolio are allocated to iShares MSCI ACWI Low Carbon Target ETF (CRBN), an ETF which seeks to track the global stock market, but with a bias towards companies with a lower carbon footprint. By investing in CRBN, investors are actively supporting companies with a lower carbon footprint, because CRBN overweights these stocks relative to their high-carbon emitting peers. One way we can measure the carbon impact a fund has is by looking at its weighted average carbon intensity, which measures the weighted average of tons of CO2 emissions per million dollars in sales, based on the fund's underlying holdings. Based on weighted average carbon intensity data from MSCI (courtesy of etf.com), Betterment’s 100% stock Climate Impact portfolio has carbon emissions per unit sales more than 50% lower than Betterment’s 100% stock Core portfolio as of June 3, 2020. Because VOTE has yet to be evaluated by MSCI, we use the carbon intensity of SPY for this calculation as it has a very similar investment nature to VOTE. The remaining half of the International Developed and Emerging Markets stocks in the Climate Impact portfolio are allocated to fossil fuel reserve free funds, EFAX and EEMX. 40% of the U.S. stocks in the Climate Impact portfolio are allocated to a fossil fuel reserve free fund, SPYX, while the remaining 10% is allocated to the engagement-based ESG fund, VOTE. Rather than ranking and weighting funds based on a certain climate metric like CRBN, fossil fuel reserve free funds instead exclude companies that own fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in fossil fuel reserve free funds investors are actively divesting from companies with some of the most negative impact on climate change, including oil producers, refineries, and coal miners such as Chevron, ExxonMobile, BP, and Peabody Energy. Another way that the Climate Impact portfolio promotes a positive environmental impact is by investing in bonds that fund green projects. The Climate Impact portfolio invests in iShares Global Green Bond ETF (BGRN), which tracks the global market of investment-grade bonds linked to environmentally beneficial projects, as determined by MSCI. These bonds are called “green bonds”. The green bonds held by BGRN fund projects in a number of environmental categories defined by MSCI including alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation. How does the Climate Impact portfolio compare to Betterment’s Core portfolio? When compared to the Betterment Core portfolio allocation, there are three main changes. First, in both taxable and tax-deferred portfolios, replace 50% of our Core portfolio’s Total Stock exposure with an allocation to a broad global low-carbon stock ETF (CRBN) in the Climate Impact portfolio. Currently, there are not any viable alternative tickers for the global low-carbon stock asset class so this component of the portfolio cannot be tax-loss harvested. Second, we allocate the remaining 50% of our Core portfolio’s International Stock exposure, and 40% of our Core portfolio’s US Total Stock Market exposure to three broad region-specific stock ETFs that screen out companies that hold fossil-fuel reserves in the Climate Impact portfolio. US Total Stock Market exposure is replaced with an allocation to SPYX, International Developed Stock Market exposure is replaced by EFAX, and Emerging Markets Stock Market exposure is replaced by EEMX. In the Climate Impact portfolio, SPYX, EFAX, and EEMX will use ESG secondary tickers ESGU, ESGD, and ESGE respectively for tax loss harvesting. Third, we allocate the remaining 10% of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any comparable alternative tickers for VOTE so this component of the portfolio will not be tax-loss harvested. Lastly, for both taxable and tax-deferred portfolios we replace both our Core portfolio’s US High Quality Bond and International Developed Market Bond exposure with an allocation to a global green bond ETF (BGRN) in the Climate Impact portfolio. Some of our allocations to bonds continue to be expressed using non-climate focused ETFs since either the corresponding alternatives do not exist or may lack sufficient liquidity. These non-climate-conscious funds continue to be part of the portfolios for diversification purposes. How do performance expectations compare to the Core portfolio? When some first consider ESG investing, they assume that they must pay a heavy premium in order to have their investments aligned with their values. However, as previously noted in Section V, the data suggests that the performance between sustainable funds versus traditional funds is not significantly different, although there can be differences over shorter periods. We also compared Betterment’s Broad Impact portfolio’s returns versus our Core portfolio’s and show the two are highly correlated. This holds true for the Climate Impact portfolio as well. BGRN, the global green bond ETF, was created in November of 2018, so backtests on historical returns are limited. However, we can still examine the Climate Impact portfolio’s return versus Betterment’s Core portfolio to get an idea as to whether they’ve been similar since BGRN’s inception. In Figure 9, comparing an IRA portfolio with a 70% stock allocation, we show that the returns of the portfolios are certainly directionally aligned, while the Climate Impact portfolio actually outperformed (+43.27% vs +39.45%) over the shorter time horizon. Betterment Core 70% Stock Returns vs. Betterment Climate Impact 70% Stock Returns Figure 9. This plot shows the cumulative return of the IRA 70% stock allocation for both the Betterment Core portfolio as well as the Climate Impact portfolio from November 28, 2018 to May 31, 2020. The returns of SPY were used as a proxy for the returns of VOTE for the purposes of this calculation due to their similar investment natures. Performance information for the Betterment allocations is based on the time-weighted returns of Betterment IRA portfolios with primary tickers that are at the target allocation every market day (this assumes portfolios are rebalanced daily at market closing prices). Dividends are assumed to be reinvested in the fund from which the dividend was distributed. Betterment allocations reflect portfolio holdings as of June 2021 and include an annual 0.25% management fee. This does not include deposits or withdrawals over the performance period. These allocations are not representative of the performance of any actual Betterment account and actual client experience may vary because of factors including, individual deposits and withdrawals, secondary tickers associated with tax loss harvesting, allowed portfolio drift, transactions that do not occur at close of day prices, and differences in holdings between IRA and taxable portfolios. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Market conditions can and will impact performance. Past performance is not indicative of future results. Source: Returns data from Xignite. Calculations by Betterment. Now that we have examined how the Climate Impact portfolio has performed historically since inception, we next focus on forward-looking analysis. In Figure 10, we show that the weighted expense ratios of Climate Impact portfolios are higher than those of Core portfolios at non-zero stock allocation levels (and the spread increases as you add more stocks to the mix). However in Figure 11, when we examine this difference within the context of our best estimates of future returns, net of known fees, the expected net total returns of Climate Impact portfolios are only slightly below those of Betterment Core portfolios. The higher weighted expense ratios of Climate Impact portfolios primarily account for their future expected underperformance. Figure 10. Weighted Expense Ratios for IRA Portfolio Allocations Figure 10. Sources: Xignite. Calculations by Betterment as of June 3, 2021. Weighted expense ratios for each portfolio are calculated using the expense ratios of the primary ETFs used for IRA allocations of Betterment’s portfolios as of June 2021. Figure 11. Comparison of Climate Impact SRI and Core IRA Efficient Frontiers Figure 11. Sources: Market capitalization data collected from S&P Dow Jones Indices, SIFMA, and Bank for International Settlements. Price data are from Xignite. A risk-free rate assumption of 2.77% is for a 10-year horizon and is derived using our methods for estimating the forward curve as of June 3, 2021. The forward looking returns are shown net of known fund fees and Betterment’s 0.25% management fee. Calculations by Betterment. VII. Social Impact Portfolio Betterment offers a Social Impact portfolio for investors that want to invest in a strategy more focused on the social pillar of ESG investing (the S in ESG). The Social Impact portfolio was designed to give investors exposure to investments which promote social equity, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio discussed above, as we seek to incorporate broad based ETFs that focus on social equity with sufficient liquidity relative to their size in the portfolio. How does the Social Impact portfolio promote social equity? The Social Impact portfolio shares many of the same holdings as Betterment’s Broad Impact portfolio, which means the portfolio holds funds which rank strongly with respect to broad ESG factors. The Social Impact portfolio looks to further promote the social pillar of ESG investing, by also allocating to two ETFs that specifically focus on diversity and inclusion -- Impact Shares NAACP Minority Empowerment ETF (NACP) and SPDR SSGA Gender Diversity Index ETF (SHE). NACP is a US stock ETF offered by Impact Shares that tracks the Morningstar Minority Empowerment Index. The National Association for the Advancement of Colored People (NAACP) has developed a methodology for scoring companies based on a number of minority empowerment criteria. These scores are used to create the Morningstar Minority Empowerment Index, an index which seeks to maximize the minority empowerment score while maintaining market-like risk and strong diversification. The end result is an index which provides greater exposure to US companies with strong diversity policies that empower employees irrespective of race or nationality. By investing in NACP, investors are allocating more of their money to companies with a better track record of social equity as defined by the NAACP. SHE is a US Stock ETF that allows investors to invest in more female-led companies compared to the broader market. In order to achieve this objective, companies are ranked within each sector according to their ratio of women in senior leadership positions. Only companies that rank highly within each sector are eligible for inclusion in the fund. By investing in SHE, investors are allocating more of their money to companies that have demonstrated greater gender diversity within senior leadership than other firms in their sector. For more information about these social impact ETFs, including any associated risks, please see our disclosures. How does the Social Impact portfolio compare to Betterment’s Core portfolio? The Social Impact portfolio builds off of the ESG exposure from funds used in the Broad Impact portfolio and makes the following additional changes. First, we replace 10% of our US Total Stock Market exposure with an allocation to a US Stock ETF, NACP, which provides exposure to US companies with strong racial and ethnic diversity policies in place. Second, we replace an additional 10% of our US Total Stock Market exposure with an allocation to a US Stock ETF, SHE, which provides exposure to companies with a relatively high proportion of women in high-level positions. As with the Broad Impact and Climate Impact portfolios, we allocate the remaining 10% of our Core portfolio’s US Total Stock Market exposure to a fund focused on engaging with companies to improve their corporate decision-making on sustainability and social issues, VOTE. Currently, there are not any viable alternative tickers for NACP, SHE, or VOTE, so these components of the portfolio will not be tax-loss harvested. How do performance expectations compare to the Core portfolio? When some first consider ESG investing, they assume that they must pay a heavy premium in order to have their investments aligned with their values. However, as previously noted in Section V, the data suggests that the performance between sustainable funds versus traditional funds is not significantly different, although there can be differences over shorter periods. We also compared Betterment’s Broad Impact portfolio’s returns to our Core portfolio’s and show the two are highly correlated. This holds true for the Social Impact portfolio as well. NACP, the minority empowerment ETF, was created in July of 2018, so backtests on historical returns are limited. However, we can still examine the Social Impact portfolio’s return versus the Betterment Core portfolio’s return to get an idea as to whether they’ve been similar since NACP’s inception. In Figure 12, comparing an IRA portfolio with a 70% stock allocation, we show that the portfolios are directionally aligned, while the Social Impact portfolio actually outperformed (+47.37% vs +43.90%) over the shorter time period. Figure 12. Betterment Core 70% Stock Returns vs. Betterment Social Impact 70% Stock Returns Figure 12. This plot shows the cumulative return of the IRA 70% stock allocation for both the Betterment Core portfolio as well as the Social Impact portfolio from October 24, 2018 to May 31, 2021. The returns of SPY were used as a proxy for the returns of VOTE for the purposes of this calculation due to their similar investment natures. Performance information for the Betterment allocations is based on the time-weighted returns of Betterment IRA portfolios with primary tickers that are at the target allocation every market day (this assumes portfolios are rebalanced daily at market closing prices). Dividends are assumed to be reinvested in the fund from which the dividend was distributed. Betterment allocations reflect portfolio holdings as of June 2021 and include an annual 0.25% management fee. This does not include deposits or withdrawals over the performance period. These allocations are not representative of the performance of any actual Betterment account and actual client experience may vary because of factors including, individual deposits and withdrawals, secondary tickers associated with tax loss harvesting, allowed portfolio drift, transactions that do not occur at close of day prices, and differences in holdings between IRA and taxable portfolios. Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Market conditions can and will impact performance. Past performance is not indicative of future results. Source: Returns data from Xignite. Calculations by Betterment. Now that we have examined how the portfolio has performed historically since inception, we next focus on forward-looking analysis. In Figure 13 we show that the weighted expense ratios of Social Impact portfolios are higher than those of core portfolios at non-zero stock allocation levels (and the spread increases as you add more stocks to the mix). However in Figure 14, when we examine this difference within the context of our best estimates of future returns, net of known fees, the expected net total returns of Social Impact portfolios are only slightly below those of Betterment core portfolios. The higher weighted expense ratios of Social Impact portfolios primarily account for their future expected underperformance. Figure 13. Weighted Expense Ratios for IRA Portfolio Allocations Figure 13. Sources: Xignite. Calculations by Betterment as of June 3, 2021. Weighted expense ratios for each portfolio are calculated using the expense ratios of the primary ETFs used for IRA allocations of Betterment’s portfolios as of June 2021. Figure 14. Comparison of Social Impact SRI and Core IRA Efficient Frontier Figure 14. Sources: Market capitalization data collected from S&P Dow Jones Indices, SIFMA, and Bank for International Settlements. Price data are from Xignite. A risk-free rate assumption of 2.77% is for a 10-year horizon and is derived using our methods for estimating the forward curve as of June 3, 2021. The forward looking returns are shown net of known fund fees and Betterment’s 0.25% management fee. Calculations by Betterment. Conclusion SRI portfolios are designed to help you express your values and social ideals through your investments. Despite the various limitations that all SRI implementations face today, Betterment will continue to support its customers in further aligning their values to their investments. Betterment may add additional socially responsible funds to the SRI portfolios and replace other ETFs as more socially responsible products become available. We are now able to provide you with multiple globally diversified SRI portfolios, at relatively low cost that are expected to track the performance of the long-standing Betterment Core portfolio closely. We also now are able to provide you with an avenue to influence corporate decision making. We believe shareholder engagement is a key component of evaluating sustainable investing products. We released our first SRI offering in 2017, with the stated intent to incrementally improve it over time, and we’ve done just that. You can think of these iterations as the latest, and certainly not the last step in that journey. By indicating what matters to you, as an investor, you are sending a signal to the financial services industry, which we will amplify, by bundling it with those of our other customers. As demand grows, and assets flow into funds that best reflect your values, those funds will become bigger, cheaper, and more liquid, continuing to erase whatever accessibility gaps remain between standard market-cap based index funds, and those that track a values-based index or actively engage with the companies they’re invested in. As a result, the SRI portfolio you opt for today will only keep getting better at expressing your values.
3 Ways To Pay Your Bills With Checking3 Ways To Pay Your Bills With Checking There are three different ways you can use Betterment Checking to pay your bills. Our mobile-first checking account can help make any tedious financial task easy. Paying your bills online with a checking account is an essential feature for most modern banking customers. For nearly everyone, being able to organize all of your monthly payments from a single funding account, selecting the details of the automatic payments, and then seeing a successful transaction are crucial checking components that may factor into choosing your financial institution. With a Betterment Checking account, you can easily pay your bills using your account information or your Betterment Visa debit card. Set up automatic payments for your monthly bills. Here are two ways you can set up automatic payments directly through vendors by providing them with your debit card information or your checking account and routing numbers. 1. Use your Betterment Visa debit card. You can simply enter your Betterment Visa debit card information on the merchant’s bill paying portal and it will pull directly from your Betterment Checking account. This can include the 16-digit card number, expiration date, and security code found on the back of your debit card. Your debit card is available for use anywhere Visa is accepted. 2. Use your account and routing number. You can use your account and routing numbers to pay your rent, student loans, credit card, phone bill, and more. Easily find your Checking account and routing numbers in your Betterment account by logging in on either a web browser or on your mobile app. When asked to choose the account type during payment, make sure to choose “checking.” Make an instant debit card transfer. Another way to pay your bills is by using your Betterment Visa debit card for instant transfers. For example, if your landlord uses third-party apps like Venmo, Cash App, and Zelle for rent payment, you can send an instant debit card transfer from your Checking account via your Betterment Visa debit card. However, not all landlords or property managers accept this, so make sure to confirm with them directly if they accept this method of payment. Betterment Checking: a financial experience made easy. With no overdraft fees or minimum balances, paying your bills with a funded Checking account can be stress-free: Rest easy knowing that your money is yours to spend how you see fit.
Welcome to the Betterment 401(k)Welcome to the Betterment 401(k) Find out how to make the most of your plan and start saving for your future. We’re excited that your company has chosen to help you prioritize your financial wellness with us, starting with your 401(k) plan. Betterment’s goal-based investing approach is designed to help you feel confident that the money you need will be there when you’re ready. Let’s get started. TABLE OF CONTENTS Importance of saving for retirement now How much to save How Betterment makes saving easy Getting started with your Betterment 401(k) Set up or update how much you save Traditional and Roth contributions Customize your retirement plan Your investments with Betterment Rolling over an old 401(k) to Betterment Access to your 401(k) funds Importance of saving for retirement now Retirement is a significant, long-term goal. That’s why, no matter where you are in your career, it’s never too soon to start saving in your 401(k). The sooner you start, the more you’re likely to have when you do retire, whenever that may be. And, of course, it’s never too late to start saving either. There are several advantages to saving for retirement through a 401(k): You can save on taxes Contributions (also called deferrals) made through payroll deduction are convenient and automatic You can legally save more than you can in other retirement vehicles, like an individual retirement account (IRA) In addition, your employer may make contributions to your 401(k) account on a matching (or other) basis. To find out if your employer makes contributions to your account, log into your account, click on “Documents” in the left-hand menu and choose “401(k) documents” to download your “Summary Plan Description” and read about “Contributions to your Plan.” How much to save Whether you decide to contribute to your 401(k) as a percentage of your paycheck or a flat dollar amount, the amount you put aside now is a big factor in how much you’ll have at retirement. Most experts recommend saving 10%–15% of your annual income. We can help you figure out how much you should be saving depending on when and where you want to retire. And, even if you can’t save that much now, save as much as you can every pay period, and commit to revisiting your contribution amount in the future. IRS rules determine how much you’re able to save in your 401(k). For 2020, you can save as much as $19,500 in your 401(k). Those aged 50 and older can save an additional $6,500. How Betterment makes saving easy Our approach uses low-cost exchange-traded funds (ETFs) so more of your money stays invested in your account. Betterment makes saving easy in other ways as well, all at no additional cost to you: Your Betterment dashboard allows you to see all of your financial goals—not just retirement—in one place We automatically incorporate sophisticated investment features that make your money work harder. For example, portfolios are automatically rebalanced, are automatically adjusted over time, and can benefit from tax coordination strategies We offer personalized advice that takes into consideration everything you tell us about you and your situation, including any other accounts you may have Getting started with your Betterment 401(k) Once you become eligible to save in your 401(k) plan, Betterment will create an account and send you a welcome email inviting you to start contributing and to establish your retirement goal. Were you automatically enrolled into your plan? By now, you’ve been notified that your employer is going to help get you started by automatically enrolling you into your 401(k) plan with a specific percentage of pay going toward your 401(k) account. Keep in mind that this default amount, which you see when you first enter your account, is just a starting point. You can increase or decrease this amount at any time. Set up or update how much you save You determine how much to contribute to your 401(k) account each pay period, either as a percentage of your paycheck or flat dollar amount. To set or update how much you’re contributing: Log into your account and choose your Retirement goal from the left-hand menu. Under “Accounts”, locate the contribution type (Roth or traditional) you’d like to update, and click on “edit” within the “Automatic Deposit” column On the next screen, toggle between “% Percent” and “$ Amount” to input the new desired rate or amount you’d like to save. Here, you’ll also see how much you have contributed to your account year-to-date and how much you have remaining before you reach the maximum allowable contribution amount Click on “Update setting” and your new contribution amount will be reflected in your next paycheck (or the next paycheck, if your change was made too close to deadline for payroll changes) Traditional and Roth contributions Since they are part of your compensation, 401(k) contributions are taxable, but the IRS provides flexibility in letting you choose when to pay those taxes: now (Roth) or later (traditional). Roth 401(k): Taxes are paid up front before contributions to the plan are made. The advantage of making Roth contributions is that withdrawals—both the contributions and earnings—are tax-free once you hit age 59½, as long as you’ve held the Roth account for at least 5 taxable years. Traditional 401(k): Contributions are deducted from your paycheck before any taxes are withheld and will therefore lower your taxable income. Both the contributions and associated earnings are “tax-deferred” until you withdraw the funds, when taxes will be due. You can choose to make Roth contributions, traditional contributions, or both. Read more about how to decide what’s right for you. Customize your retirement plan Planning for retirement may seem overwhelming, but Betterment makes it easy. When you create a personalized retirement plan: You’ll get our recommendations on how much to save, and in which accounts You can see whether or not you’re on track to meet your goal every time you log into your account (and take steps to get on track if needed) You can input personal information like income and retirement age so that the advice is customized to your needs You can sync other accounts so our advice takes your entire financial picture into consideration To set up your personalized retirement plan: Log into your account and choose your Retirement goal from the left-hand menu From the “Plan” tab, click on “Get started” Follow the prompts and click “Finish setup” at the bottom of the “Review Allocation” screen. Don’t worry, you can always change your inputs! Next, track your current savings and sync any outside accounts you’re using to save for retirement Finally, click on “see your plan” to receive Betterment’s recommendations for how much you should be saving (and in which accounts) this year From the left-hand menu, you can also add other financial goals, like building an emergency fund or a vacation fund, and you can even open a cash or checking account. Your investments with Betterment Your retirement account is designed as a long-term investment. Market ups and downs along the way are a normal part of the process. We encourage you to maintain a long-term perspective and to avoid making rash decisions, like removing investments, based on events in the market. Read more about our investment approach. To get started, you’ll be defaulted into our Core Strategy, with a globally-diversified portfolio that’s built based on how long you have until retirement. Betterment will automatically rebalance and adjust your portfolio over time. As an alternative to your default portfolio, you may customize your investments at any time with our Flexible Portfolio option or by choosing one of our Socially Responsible Investing Portfolio strategies, the Goldman Sachs Smart Beta Strategy, or the BlackRock Target Income Portfolio for those in retirement. To learn about these options or to change your portfolio, go to the “Holdings” tab of your Retirement account, and click “Edit” underneath “Portfolio Strategy”. Rolling over an old 401(k) to Betterment When you roll over (or move) other accounts to Betterment, you could lower your investment fees and get personalized advice. Having your retirement accounts in one place can make it easier for you to keep track of your savings. Plus, you’ll be invested in a diversified portfolio and can take advantage of our tax-smart features, which could mean more money in retirement. Start your rollover now to move your 401(k) over from another provider. Questions about whether you should roll over to your 401(k) plan or a Betterment IRA? We’ve got answers. Access to your 401(k) funds Your 401(k) account is designed for retirement, so access to your funds is limited. Keeping your retirement savings invested, even when you change jobs, means that it can continue to grow for the benefit of your future. Generally, you cannot withdraw your 401(k) savings before turning 59½, unless you leave your employer (or become disabled or pass away). If you are still working for your employer, your plan may include provisions that allow you to access funds in a couple of ways: Loans may enable you to borrow a portion of your 401(k) account and repay it over time with accrued interest. This does not impact your credit score because you are borrowing from your own account. Hardship distributions. According to IRS rules, this type of distribution must: be due to an immediate and heavy financial need be necessary to satisfy that need not exceed the amount you needed A hardship distribution to an employee younger than 59½ often includes a 10% early withdrawal penalty. The money you withdraw may also be taxable. In addition, if you were impacted by COVID-19 and your plan adopted certain provisions, you may qualify for special distributions and/or loans in 2020. If you have left your employer, learn about your options with respect to your 401(k) account. Information on the withdrawal and loan provisions can be found in the “Summary Plan Description” (SPD), available within your Retirement account by clicking “Documents” on the left-hand menu and navigating to “401(k) documents”, or within your 401(k) account as part of the withdrawal menu. Didn’t find what you were looking for? Get answers to commonly asked questions and a variety of saving and investing topics via our FAQ or our educational articles. You can also start planning for the future with our free interactive tools. If you’re looking for more in-depth advice or to feel more confident about your financial decisions, consider our advice packages. Our Customer Support Team is available five days a week to help answer questions about your account. Reach out here. Want to educate yourself on retirement planning and financial wellness? Check out our employee resources for more articles and videos.
Your Guide to Betterment RolloversYour Guide to Betterment Rollovers Moving your money to a new financial institution can be tedious and complicated. At Betterment, our goal is to make it easy and automatic. Here, we break down each rollover method and explain which might be right for you. We’ve talked before about why we believe Betterment is the best place to put your money if you’re investing for the long term: our globally diversified portfolio, low fees, personalized advice, and tax-efficient services that can increase your after-tax returns by an estimated 15% over 30 years. Read about all the benefits. Once you’ve made the decision to move your money to Betterment, there are a few different ways you can do so. Based on your account type and provider, we will automatically select an appropriate transfer method for you. If you’re ready to get started now, click the “Transfer” button from the Summary tab of your account. From the Transfer tab, click “Roll over an IRA or 401(k)” to begin moving your money to Betterment. Or, if you'd first like to learn more about each method, read our guide below. A Guide to Moving Your Money to Betterment: 2 Transfer Methods Direct IRA Transfer or Direct 401(k) Rollover via Check Moving money through ACATS is usually ideal because it’s a more efficient process, but in some cases, it’s not an option. To start, both firms must support ACATS transfers. Second, you must move funds between matching account types (i.e., IRA to IRA). Therefore, moving retirement money from an employer-sponsored account, such as a 401(k) or 403(b), into an IRA is generally not an option via ACATS. It’s also worth noting that if you own a mutual fund IRA account and not a brokerage IRA account, you cannot use the ACATS system. There may be other reasons why ACATS is not available for your specific account. In that case, we will automatically provide you everything you need to do a direct transfer or rollover via check. While there are a few more steps required, this method maintains many of the advantages that are tied to direct transfers. Not only can you complete as many direct transfers or rollovers via check as you would like in any given year, it’s considered to be a direct exchange between providers, meaning there are no tax penalties involved and generally no withholding. Read about how to roll over a 401(k) to Betterment. Indirect Rollover As a last resort, completing an indirect rollover is another way to move retirement funds between institutions. However, the many IRS rules and restrictions attached typically make it a last-resort choice. Not only are you limited to one indirect rollover per 365 days, but you must also distribute all or part of your account, take possession of the funds, and then redeposit the cash proceeds into a new IRA within 60 days. What’s more, it’s potentially reportable on your federal tax return. In addition, generally, the original firm withholds on the distribution, meaning you must make up the difference from your own funds, or else it may count as a taxable distribution. This can leave a lot of room for error, not to mention it requires a lot of manual work for you. If you have any questions about moving your retirement money to Betterment, we have experts on hand to assist. Ready to make the move to Betterment? Get started today. Betterment is not a tax advisor, nor should any information contained in this article be considered tax advice. Please consult a tax professional. When deciding whether to roll over a 401(k) account or another retirement account, you should carefully consider your personal situation and preferences. Relevant factors may include that: (i) 401(k) accounts may offer greater protection from creditors than IRAs. (ii) In some cases, the ability to take penalty-free distributions at an earlier age or to defer minimum required distributions. (iii) Some 401(k) accounts may also allow for loans or distributions in a broader set of circumstances than IRAs. (iv) Some 401(k) plans may also offer specific educational and advisory services to participants that are unavailable to some IRAs. (v) Some 401(k) plans may have lower fees and expenses than some IRAs. (vi) Some IRAs may offer a broader range of investment options that some 401(k) plans. (vii) Special tax rules may apply to the rollover of employer securities. You should research the details of your 401(k) and speak to a tax and other advisors about whether the features of your 401(k) are relevant to your personal situation. The rollover process is currently automated for rollovers from select providers. If you have a provider that is not part of our automated process, you will receive an email with a checklist for completing your rollover to Betterment. In processing you rollover request, Betterment will be acting at your direction.
Optimizing Performance in Lower Risk Betterment PortfoliosOptimizing Performance in Lower Risk Betterment Portfolios In this methodology, we provide insight into how we optimize the performance of the lower risk bonds in Betterment's portfolios. TABLE OF CONTENTS The Role of Ultra Low-Risk Assets in a Bond Portfolio How we optimize ultra-low-risk bonds to target a higher yield Why Two Low-Volatility Funds Result in Our Ultra-Low-Risk Asset Allocation Using 30-day historical yields to inform future yields Continued bond portfolio research In this methodology, we provide insight into how we optimize the performance of the lower risk bonds in our 100% bond portfolio. Primarily, Betterment’s optimization method involves the inclusion of short-term, investment-grade bonds in lower-risk allocations of the Betterment Portfolio Strategy. Why are we exploring this part of how we manage the Betterment Portfolio Strategy? First, over time, we’ve improved the mix of bonds in our portfolios to control risk without compromising expected performance—the main focus of this methodology. Second, many investors may not yet know about the important role of ultra-low-risk bonds in the portfolio we recommend. When investors opt for a 100% bond, 0% stock allocation in their Betterment portfolio, the only assets in the portfolio are bonds with ultra-low-risk profiles. The Role of Ultra Low-Risk Assets in a Bond Portfolio We have constructed the Betterment Portfolio Strategy—our set of recommended portfolios—to fulfill our five investing principles that guide our advice for you. One of our key investing principles is maintaining diversification. Effective diversification means taking as little risk as possible to achieve your growth target. For portfolios with lower risk levels, adding in ultra-low-risk bonds can help reduce risk without adversely affecting returns. We consider U.S. short-term Treasuries and other US. short-term investment-grade bonds to be ultra-low-risk (although all investments carry some measure of risk). At every risk level, Betterment invests in a portfolio that we expect to have the highest rate of return relative to its risk. These portfolios are considered to be on the “efficient frontier,” or the boundary of highest returning portfolios at any given level of risk. By further diversifying bond holdings with ultra-low-risk assets, the Betterment Portfolio Strategy pursues higher expected returns with less risk than portfolios that do not include these low-risk assets. Graphically, you can see below that the highest returning portfolios for lower risk levels (i.e., levels of volatility) are portfolios that include ultra-low-risk bonds (the black line). Additionally, certain low risk portfolios could not be achieved at all without adding ultra-low-risk assets. As you can see below, portfolios constructed without ultra-low-risk bonds (the blue line) are unable to achieve a volatility lower than approximately 7%. Figure 1. Betterment’s efficient frontier including ultra-low-risk bonds Expected returns are computed by Betterment using the process outlined in our methodology optimizing the Betterment Portfolio Strategy. Volatilities are calculated by Betterment using monthly returns data provided by Xignite. At a certain point, including ultra-low-risk bonds in the portfolio no longer improves returns for the amount of risk taken. This point is called the ‘tangent portfolio.’ For the Betterment portfolio strategy, the tangent portfolio is our 43% stock portfolio. Portfolios with a stock allocation of 43% or more do not include ultra-low-risk bonds. When a portfolio includes no stocks—100% bonds—the allocation suggests an investor has no tolerance for market volatility, and thus, our recommendation is to put the investor’s money completely in ultra-low-risk bonds. How we optimize ultra-low-risk bonds to target a higher yield As you can see in the chart below, we include our U.S. Short-Term Investment-Grade Bond ETF and our U.S. Short-Term Treasury Bond ETF in the portfolio at stock allocations below 43% for both the IRA and taxable versions of the Betterment Portfolio Strategy. https://d1svladlv4b69d.cloudfront.net/src/d3/allocation-mountain-chart/aa-chart.html At 100% bonds and 0% stocks, a Betterment portfolio consists of 80% U.S. short-term treasury bonds and 20% U.S. short-term investment-grade bonds. If an investor were to increase the stock allocation in their portfolio, the allocation to ultra-low-risk bonds decreases, though the relative proportion of short-term U.S. treasuries to short-term investment-grade bonds remains the same. Above the 43% stock allocation threshold, these two assets are no longer included in the recommended portfolio because they decrease expected returns given the desired risk of the overall portfolio. Fund selection In line with our fund selection process, we currently select JPST – JPMorgan Ultra-Short Income ETF to gain exposure to the U.S. short-term investment-grade bonds and we’ve selected SHV – iShares Short Treasury Bond ETF to gain exposure to U.S. short-term treasury bonds. To summarize the fund selection process, we start with the universe of bond ETFs with average maturities of less than 3 years, given the relationship between maturity length and risk. We further reduce the set of candidates by ruling out ETFs with unfavorable risk characteristics, including those with excessive interest-rate risk or high overall volatility. We then filter for funds with sufficient liquidity, so that we can maintain low costs for investors. Finally, we select the fund with the lowest combination of expense ratio and expected trading costs: JPST. The same process led to our selection of SHV. Why Two Low-Volatility Funds Result in Our Ultra-Low-Risk Asset Allocation Short-term US treasuries and investment-grade bonds are both inherently low-risk assets. As can be seen from the chart below, short-term U.S. treasuries (SHV) have low volatility (any price swings are quite mild) and smaller drawdowns (the length and magnitude of periods of loss are muted). Though slightly more volatile than short-term treasuries, the same can be said for short-term investment grade bonds (JPST). Figure 2. SHV and JPST The above chart shows the historical growth of $1 invested in each investment option from 9/30/2013 (the first date both funds SHV and NEAR (which is used as a historical proxy for JPST) were in existence) to 5/23/2018. Performance is net of fund-level fees and does not include any management fees from Betterment. Dividends are assumed to be reinvested. The composite is assumed to be rebalanced daily at closing prices. JPST fund inception as in May, 2017. For returns data in May, 2017 and earlier, we use returns from a comparable fund, NEAR. JPST replaced NEAR as our U.S. short-term investment-grade bond fund in Dec, 2019. Data: xIgnite. It’s also worth noting that these two asset classes do not always go down at exactly the same time. By combining these two asset classes, we are able to produce a two-fund portfolio with a higher potential yield and the same low volatility. In fact, combining these asset classes resulted in smaller historical drawdowns in performance that lasted for fewer days than was the case for either asset class individually. As you can see from the chart below, the combination of U.S. short-term treasury bonds and U.S. short-term investment-grade bonds used for the Betterment 100% bond, 0% stock portfolio (blue) generally had shorter, less severe periods of down performance than either fund by itself. Figure 3. Drawdowns in performance The above chart shows the largest drawdowns in performance from Sept 30, 2013—the first date both funds SHV and NEAR, which is used as a historical proxy for JPST—were in existence) to 11/14/2019. Performance is net of fund-level fees and does not include any management fees from Betterment. Dividends are assumed to be reinvested. The composite portfolio (blue) is assumed to be rebalanced daily at closing prices to maintain a 80% SHV, 20% JPST weighting. JPST fund inception was in May, 2017. For returns data in May, 2017 and earlier, we use returns from a comparable fund, NEAR. JPST replaced NEAR as our U.S. short-term investment-grade bond fund in Dec, 2019. Data: xIgnite. Using 30-day historical yields to inform future yields A reasonable question about this methodology is how to interpret the potential returns of the composite looking forward. As with other assets, the returns for ultra-low-risk bonds include both the possibility of price returns and income yield. Generally, price returns are expected to be minimal, with the primary form of returns coming from the income yield. Below you can see that the prices for the composite of 80% SHV and 20% JPST tends to stay fairly constant, while the price with dividends grows through time. This shows that the yield (paid by the funds through monthly dividends) is responsible for almost all of the growth in these funds. Figure 4. Growth of $100 in the Betterment 0% stock portfolio The above chart shows the historical growth of $100 invested in a portfolio that consists of 80% SHV and 20% JPST. Data is from 6/1/2017 (the first full month both funds SHV and JPST were in existence) to Nov. 14, 2019. Performance is net of fund-level fees and does not include any management fees from Betterment. Dividends are assumed to be reinvested. The portfolio is assumed to be rebalanced daily at closing prices. Data: xIgnite. Looking at 30-day SEC yield—a standardized calculation of yield that includes fees charged by the fund—we can get a good sense of the expected performance for these low-volatility assets. Why can we believe this? First, performance is determined by both yield and price change, and because there is low price volatility in these assets, yield is the primary component of performance. We use the SEC 30-day historical yield as an expectation of annualized future yield because it’s the most recent 30 days of yield performance, and we generally expect future yield to be similar to the last 30 days, although past performance does not guarantee future results. We expect this to be the case because the monthly turnover in these funds is relatively low. However, the yield can be expected to change—either up or down—as market conditions, including interest rates, change. The yields you receive from the ETFs in Betterment’s 100% bond portfolio are the actual yields of the underlying assets after fees. Betterment does not adjust the yield you earn according to our discretion, as a bank savings account could. A bank may choose not to adjust its interest rate higher as prevailing rates rise, or may cut its interest rate. Because we are investing directly in funds that are paying prevailing market rates, you can feel confident that the yield you are receiving is fair and in line with prevailing rates. Below we can see that over the 30 days ending Nov. 14, 2019, SHV had an annualized yield of 1.59%, net of fund fees, which is dispersed to shareholders on a monthly basis. Over the same period, JPST yielded 2.12%. The 100% bond portfolio, composed of 80% SHV and 20% JPST, has yielded 1.70%. Table 1: Risk and Yield Ultra low-risk bond baseline (SHV) Additional candidate fund (JPST) SHV 80% + JPST 20% SEC 30-day yield (includes fund expense ratios) 1.59% 2.12% 1.69% Annual Volatility 0.30% 0.38% 0.30% Deepest drawdown return -0.12% -0.34% -0.12% Expense ratio 0.15% 0.18% 0.16% SEC 30-day yields are as of Nov. 14, 2019. Annual volatility and drawdown return are calculated from Sept. 30, 2013 —the first date both funds SHV and NEAR, which is used as a historical proxy for JPST—were in existence) to Nov 14, 2019. For returns data in May, 2017 and earlier, we use returns from a comparable fund, NEAR. JPST replaced NEAR as our U.S. short-term investment-grade bond fund in Dec, 2019.SEC 30-day yields, annual volatility and drawdown are net of fund fees and do not include Betterment’s management fee. Data from Xignite and Betterment calculations. Bond portfolio research never stops. By combining multiple low-risk assets, we seek to deliver higher expected returns, through higher yields, while keeping risk in check. The diversification benefits of U.S. short-term treasuries and investment-grade bonds allow us to construct low-risk portfolios with shorter and less severe downturns. As always, we iterate on our portfolio optimization methods. We update our changes in this overview of our financial advice as we develop improved ways of helping you reach your financial goals.
Cash Analysis MethodologyCash Analysis Methodology Betterment's cash analysis aims to provide smart feedback when we think you have extra cash that could be earning you more value if it were in a higher yield account. TABLE OF CONTENTS How We Analyze Your Checking Account Predicting Future Expenses Based on Past Expenses How We Define Extra Cash in Checking Accounts Evolving How We Help You Manage Cash Most American adults face some sort of cash management problem. Maybe you face a tight budget and need to control expenses; or maybe you have extra income and want to know the best use for that cash; or perhaps your income fluctuates from month to month and you’re looking to maintain a relatively constant amount of cash in your checking account. As a financial advisor, Betterment aims to help people better understand their cash flows to make more effective decisions for their money. It’s part of our core philosophy: Every person should have a personalized financial plan, and to get there, you often need a more solid understanding of your day-to-day money needs. At a high level, we offer two things to help Betterment customers manage their cash. We analyze the timing and amount of money flowing out of the checking account you’ve linked to your Betterment account. We identify whether you have extra cash in your linked bank account that might earn a higher yield in a different account, such as Cash Reserve. In this methodology, we’ll describe our process for analyzing how money flows out of your checking account, and how we arrive at our recommendation on whether you have any extra cash in your account. How We Analyze Your Checking Account At Betterment, we allow you to link one checking account to deposit and withdraw money from your Betterment accounts for several reasons. For starters, it helps us prevent fraud by giving customers just one door to move money through. It also allows us to start helping you manage your cashflow (without collecting information on all your possible accounts) by analyzing your checking transactions to make a recommendation on how much extra cash you may have. Betterment only analyzes expenses that are debited from your checking account, so expenses made through a credit card are analyzed as an aggregated credit card expense, not as individual expenses. For those with multiple checking accounts, it’s important to keep in mind that we only analyze the one checking account linked to Betterment. Predicting Future Expenses Based on Past Expenses We make a prediction about future expenses by looking at your last year of expenses. To get a better idea of your ongoing expenses, we filter out and remove very large, one-off expenses. We consider expenses to be large or one-off if they are over either the greater of $5,000 or the 99th percentile of all your expenses. If multiple expenses occur on the same day, we’ll add all of those expense totals together as if it was all one expense. To make the forecast, we averaged the last year of the combined, filtered expenses and scale by the upper and lower bounds of the forecast period (21 days and 35 days). Our predictions are updated on a regular basis as new expense data is available, which means that you may see them change from day to day. How We Define Extra Cash in Checking Accounts To estimate how much extra cash you may be holding in your checking account, we use the expense analysis and prediction process explained above to define a target balance for your checking account in the future. Because the goal of our analysis is to continually give you smart feedback on your balance, the target balance isn’t static advice; it evolves as our prediction about your cash needs evolve. To arrive at our target balance for determining how much extra cash you have, our technology simultaneously makes two predictions: How much cash we predict you’ll need for the next 21 days (three weeks). How much cash we predict you’ll need for the next 35 days (five weeks). The difference between the current balance in your checking account and your target balance (the balance we predict you’ll need for the next 35 days) is what we consider extra cash, which we recommend moving to an account where you could generate higher earnings. If your current balance falls between the 21-day prediction and 35-day prediction, then we provide you with a message to use your own judgment as to whether you have extra cash based on your knowledge of your cashflow expectations. If your balance falls below the 21-day prediction, then we suggest that you may want to check in on your balance to see if you can cover your expenses, given what we know about you. This analysis will be updated regularly, as long as your checking account remains linked to Betterment. So, our advice on your extra cash will refresh regularly. It is important to note that this information is not gathered or adjusted in real time. We aim to provide current checking account balance that is no more than 24 hours old, so you should be aware that deposits and withdrawals won’t be reflected immediately in your cash analysis. While there are an array of cash savings solutions to choose from, we tie this analysis to Cash Reserve. It is important to note that we assume a cash solution is the appropriate use for any extra cash in your checking account and do not consider whether that money might better be used for investing, or for another purpose, such as paying down debt. Cash Analysis is not available for goals that can be held in Betterment cash or an Investing portfolio strategy. These features can only be accessed through a Cash Reserve goal. Evolving How We Help You Manage Cash As described in this methodology, we aim to provide smart feedback when we think you have extra cash that could be earning you more value if it were in a higher yield cash account. You can think of this methodology as a starting point for helping you manage your cashflow. By adding to our analysis and refining our prediction capabilities, we’re working to help you manage your cash more effectively over time.
The Betterment Portfolio StrategyThe Betterment Portfolio Strategy Betterment’s core portfolio strategy is based on Nobel Prize-winning research. We continually improve the portfolio strategy over time in line with our research-focused investment philosophy. TABLE OF CONTENTS I. Prerequisites for a Betterment Portfolio Strategy II. Achieving Global Diversification with a Nobel Prize-Winning Approach to Asset Allocation III. Increasing Value with Evidence-based Portfolio Optimization IV. Manage Taxes Using Municipal Bonds Conclusion Citations Betterment has a singular objective: to help you make the most of your money, so that you can live better. Our investment philosophy forms the basis for how we pursue that objective: Betterment uses real-world evidence and systematic decision-making to help increase our customers’ wealth. In building our platform and offering individualized advice, Betterment’s philosophy is actualized by our five investing principles. Regardless of one’s assets or specific situation, Betterment believes all investors should: Make a personalized plan. Build in discipline. Maintain diversification. Balance cost and value. Manage taxes. In this in-depth guide to the Betterment Portfolio Strategy, our goal is to demonstrate how the Betterment Portfolio Strategy, in both its application and development, contributes to how Betterment carries out its investing principles. How we select funds to implement the Strategy is also guided by our investing principles, and is covered separately in our Investment Selection Methodology paper. Within this paper, you will find that our portfolio construction process strives to define a strategy that is diversified, increases value by managing costs, and enables good tax management—three key investing principles. Of these, portfolio strategy construction is most particularly concerned with diversification. And that’s where most investment managers stop—diversifying a portfolio across asset classes. We don’t. As you’ll see in this paper, our prerequisites and iterative portfolio optimization process enable us to construct the portfolio strategy as one piece of a larger holistic investing approach where personalized planning, cost management, tax optimization, and discipline each are achieved through different methodologies. At the end of this paper, we will touch on the complementary processes we use in our investment process and how they work together to help our customers maximize their wealth. I. Prerequisites for a Betterment Portfolio Strategy When developing a portfolio strategy, any investment manager faces two main tasks: asset class selection and portfolio optimization. We’ll provide a guided tour of how we pursue each of Betterment’s investing principles and, in effect, accomplish each task along the way in crafting the Betterment Portfolio Strategy. Laying a Foundation for Personalized Planning & Discipline To align with Betterment’s investing principles, a portfolio strategy must enable personalized planning and built-in discipline for investors. If the Betterment Portfolio Strategy—when standing alone—cannot reasonably be applied to an investor’s specific goal and situation, then it fails to help Betterment achieve its principle of helping customers formulate a personalized plan. If a portfolio strategy seems unintuitive or causes poor investor behavior, then we have failed to build in discipline. The Betterment Portfolio Strategy is comprised of 101 individualized portfolios, in part, because that level of granularity in allocation management provides the flexibility to align to multiple goals with different timelines and circumstances. This helps to lay a foundation for the principles of personalized planning and built-in discipline. While Betterment solves for these principles in other ways as well, their manifestation starts with portfolio strategy itself. II. Achieving Global Diversification with a Nobel Prize-Winning Approach to Asset Allocation An optimal asset allocation is one that lies on the efficient frontier, which is a set of portfolios that seek to achieve the maximum objective for the lowest amount of risk. The objective of most long-term portfolio strategies is to maximize return, while the associated risk is measured in terms of volatility—the dispersion of those returns. In line with our investment philosophy of making systematic decisions backed by research, Betterment’s asset allocation is based on a theory by economist Harry Markowitz called Modern Portfolio Theory, as well as subsequent advancements based on that theory.1 Introduced in 1952, Markowitz’ work was awarded the Nobel Prize in 1990 after his theoretical framework and mathematical modeling informed decades of improvements in portfolio strategy construction. While there remains enormous debate (and entire sectors of financial services) devoted to portfolio construction and optimization, many practitioners rely on Markowitz’ theoretical framework to evaluate returns and measure risk for asset allocation. It’s also a very intuitive framework for constructing a portfolio strategy. The major insight posited by Markowitz is that any asset included in a portfolio should not be assessed by itself, but rather, its potential risk and return should be analyzed as a contribution to the whole portfolio. This is mathematically expressed as an optimization of maximizing expected returns while penalizing those returns for risk. Using this insight as the objective of portfolio construction is just one way of building portfolios; other forms of portfolio construction may legitimately pursue other objectives, such as optimizing for income, or minimizing loss of principal. However, our portfolio construction goes beyond traditional Modern Portfolio Theory in five important ways: Estimating forward looking returns Estimating covariance Tilting specific factors in the portfolio Accounting for estimation error in the inputs Accounting for taxes in taxable accounts Each of these additions to basic Modern Portfolio Theory will be explained in full later in this paper. Asset Classes Selected for the Betterment Portfolio Strategy Any asset allocation strategy starts with the universe of investable assets. Leaning on the work of Black-Litterman, the universe of investable assets for us is the global market portfolio.2 However, the global market portfolio is, in some sense, not well-defined, and, often, definitions depend on the context of the application. Below we describe the assets that compose our global market portfolio and, hence, the Betterment Portfolio Strategy. To capture the exposures of the asset classes for the global market portfolio, we rely on the exchange-traded funds (ETFs) available that represent each class in the theoretical market portfolio. We base our asset class selection on ETFs because this aligns the portfolio construction with our subsequent process, our investment selection methodology. Equities Developed Market Equities We select U.S. and international developed market equities as a core part of the portfolio. Historically, equities exhibit a high degree of volatility, but provide some degree of inflation protection.3 Even though significant historical drawdowns, such as the global financial crisis of 2008, demonstrate the possible risk of investing in equities, longer-term historical data and our forward expected returns calculations suggests that developed market equities remain a core part of any asset allocation aimed at achieving positive returns.4 This is because, over the long term, developed market equities have outperformed bonds on a risk-adjusted basis. Within developed market equities, the following sub-asset classes are included in the Betterment Portfolio Strategy: Equities representing the total market of the United States Equities representing the total international developed market Emerging Market Equities To achieve a global market portfolio, we also include equities from less developed economies, called emerging markets. Generally, consistent with the research of others, our analysis shows that emerging market equities tend to be more volatile than U.S. and international developed equities. And while our research shows high correlation between this asset class and developed market equities, their inclusion on a risk-adjusted basis is important for global diversification. Note that we exclude frontier markets, which are even smaller than emerging markets, due to their widely varying definition, extreme volatility, small contribution to global market capitalization, and cost to access. Bonds Bonds have a low correlation with equities historically. Because of this, they remain an important way to dial down the overall risk of a portfolio. To leverage various risk and reward tradeoffs associated with different kinds of bonds, we include the following sub-asset classes of bonds in the Betterment Portfolio Strategy. Short-term treasury bonds Inflation protected bonds Investment grade bonds International bonds Municipal bonds - read more here Emerging market bonds Figure 1. Correlation between Asset Classes in the Betterment Portfolio Strategy Figure 1. This figure demonstrates the correlation of each asset class relative to each other, using historical data from April 2007 to December 2016. A sample covariance matrix was calculated and then modified by the shrinkage method explained in this paper. The source of data for each asset class is Yahoo! Finance (a specific ETF represents each asset class). Asset Classes Excluded from the Betterment Portfolio Strategy While Modern Portfolio Theory would have us craft the Betterment Portfolio Strategy to represent the total market, including all available asset classes, we exclude some asset classes whose cost and/or lack of data outweighs the potential benefit gained from their inclusion in the portfolio strategy. For this reason, we have excluded private equity, commodities, and natural resources, since estimates of their market capitalization are unreliable, and there is a lack of data to support their historical performance. Our chosen model for assessing the rate of return for a given asset also suggests that asset classes such as these may not show sensitivity to total portfolio returns.5 While commodities represent an investable asset class in the global financial market, we have excluded the class of ETFs from the Betterment Portfolio Strategy for several reasons—most importantly, their low contribution to a global stock/bond portfolio's risk-adjusted return. In addition, real estate investment trusts (REITs), which tend to be well marketed as a separate asset class, are not explicitly included in the portfolio strategy. We include exposure to real estate, but as a sector within equities. Adding additional real estate exposure by including a REIT asset class would overweight the portfolio strategy’s exposure to real estate relative to the overall market. III. Increasing Value with Evidence-based Portfolio Optimization While asset selection sets the stage for a globally diversified portfolio strategy, to increase performance value at a reasonable cost (without sacrificing diversification) we must further optimize the portfolio strategy. This process requires tilting the portfolio strategy in ways that our analysis shows could lead to higher returns. While most asset managers offer a limited set of model portfolios at a defined risk scale, the Betterment Portfolio Strategy is designed to give customers more granularity and control over how much risk they want to take on. Instead of offering a conventional set of three portfolio choices—aggressive, moderate, and conservative—our portfolio optimization methods enable the Betterment Portfolio Strategy to contain 101 different portfolios. Optimizing Portfolios to Help Increase Returns Modern Portfolio Theory requires estimating returns and covariances to optimize for portfolios that sit along an efficient frontier. While we could use historical averages to estimate future returns, this is inherently unreliable because historical returns do not necessarily represent future expectations. A better way is to utilize the Capital Asset Pricing Model along with a utility function which allows us to optimize for the portfolio with the greatest return for the risk that the investor is willing to accept. Computing Forward-Looking Return Inputs To compute forward-looking returns for the Betterment Portfolio, we instead turn to the Capital Asset Pricing Model (CAPM), which assumes all investors aim to maximize their expected return and minimize volatility while holding the same information.6 Under CAPM assumptions, the global market portfolio is the optimal portfolio. Since we know the weights of the global market portfolio and can reasonably estimate the covariance of those assets, we can recover the returns implied by the market.7 This relationship gives rise to the equation for reverse optimization: μ = λ Σ ωmarket Where μ is the return vector, λ is the risk aversion parameter, Σ is the covariance matrix, and ωmarket is the weights of the assets in the global market portfolio.8 By using CAPM, the expected return is essentially determined to be proportional to the asset’s contribution to the overall portfolio risk. It’s called a reverse optimization because the weights are taken as a given and this implies the returns that investors are expecting. While CAPM is an elegant theory, it does rely on a number of limiting assumptions: e.g., a one period model, a frictionless and efficient market, and the assumption that all investors are rational mean-variance optimizers.9 In order to complete the equation above and compute the expected returns using reverse optimization, we need the covariance matrix as an input. Let’s walk through how we arrive at an estimated covariance matrix. The covariance matrix mathematically describes the relationships of every asset with each other as well as the volatility risk of the asset themselves. Our process for estimating the covariance matrix aims to avoid skewed analysis of the conventional historical sample covariance matrix and instead employs Ledoit and Wolf’s shrinkage methodology, which uses a linear combination of a target matrix with the sample covariance to pull the most extreme coefficients toward the center, which helps reduce estimation error.10 Tilting the Betterment Portfolios based on the Fama-French Model Decades of academic research have pointed to certain persistent drivers of returns that the market portfolio doesn’t fully capture.9 A framework known as the Fama-French Model demonstrated how the returns of equity security are driven by three factors: market, value, and size.11 The underlying asset allocation of the Betterment Portfolio Strategy ensures the market factor is incorporated, but to gain higher returns from value and size, we must tilt the portfolios. For the actual mechanism of tilting, we turn to the Black-Litterman model. Black-Litterman starts with our global market portfolio as the asset allocation that an investor should take in the absence of views on the underlying assets. Then, using the Idzorek implementation of Black-Litterman, the Betterment Portfolio Strategy is tilted based on the level of confidence we have for our views on size and value.12 These views are computed from historical data analysis, and our confidence level is a free parameter of the implementation. However, in both cases, the tilts are additionally expressed, taking into account the constraints imposed by the liquidity of the underlying funds. Using Monte Carlo to Add Robustness to Our Tilted Asset Class Weights Despite using reverse optimization to estimate the forward expected returns of our assets, we know that no one can predict the future. Therefore, we use Monte Carlo simulations to predict alternative market scenarios. By doing an optimization of the portfolio strategy under these simulated market scenarios, we can then average the weights of asset classes in each scenario, which leads to a more robust estimate of the optimal weights. This secondary optimization analysis alleviates the portfolio construction’s sensitivity to returns estimates and leads to more diversification and expected performance over a broader range of potential market outcomes. Thus, through our method of portfolio optimization, the Betterment Portfolio Strategy is weighted based on the tilted market portfolio, based on Fama-French, averaged by the weights produced by our Monte Carlo simulations. This highly methodical process gives us a robust portfolio strategy designed to be optimal at any risk level for not just diversification and expected future value, but also ideal for good financial planning and for managing investor behavior. Figure 2. Portfolio Allocations in the Betterment Portfolio Strategy Figure 2. This figure shows the Betterment Portfolio Strategy’s various weighted asset allocations for each stock allocation level. An easy way to see the value-add of our portfolio strategies is to look at the difference between our efficient frontier and that of a so-called “naïve” portfolio, one that is made up of only a U.S. equity index (SPY) and a U.S. bonds index (AGG). The expected returns of Betterment’s portfolio significantly outperform a basic two-fund portfolio for every level of risk (see Figure 4). Figure 3. Optimizing the Portfolio Strategy to Align to the Efficient Frontier Figure 3. The expected excess return hypothetical illustrated in this figure was calculated by reverse optimization using two inputs: market capitalization weight and asset covariance. The grey line can be considered a naïve portfolio of just two asset classes—U.S. Stocks (represented by SPY) and U.S. Bonds (represented by AGG). The blue line represents the Betterment Portfolio Strategy across the entire risk spectrum. At each level of risk, the Betterment Portfolio Strategy has a higher expected excess return. This analysis is theoretical and it does not represent actual or hypothetical performance of a Betterment portfolio. IV. Manage Taxes Using Municipal Bonds For investors with taxable accounts, portfolio returns can be further improved on an after-tax basis by utilizing municipal bonds. This is because the interest from municipal bonds is exempt from federal income tax. To take advantage of this, the Betterment Portfolio Strategy in taxable accounts is tilted toward municipal bonds. Other types of bonds remain for diversification reasons, but the overall bond tax profile is improved. For investors in states with the highest tax rates—New York and California—Betterment can optionally replace the municipal bond allocation with a more narrow set of bonds for that specific state, further saving the investor on state taxes. Betterment customers who live in NY or CA can contact customer support to take advantage of state specific municipal bonds. Conclusion With every element of Betterment’s investing strategy, we hold to the same investment philosophy and the fundamental principles we believe lead to investing success. Our philosophy is simple: We use real-world evidence and systematic decision-making to help increase the value of our customers’ assets. As explained throughout this paper, our portfolio construction process is built on years of research that point to three main areas of focus: diversification through asset allocation, improved value through portfolio optimization, and managing taxes. In the grander scheme of Betterment’s offering, these steps are just the beginning. After setting the strategic weight of assets in the Betterment Portfolio Strategy, the next step in implementing the strategy is Betterment’s investment selection process, which selects the appropriate ETFs for the respective asset exposure in a low-cost, tax-efficient way. In keeping with our philosophy, that process, like the portfolio construction process, is executed in a systematic, rules-based way, taking into account the cost of the fund and the liquidity of the fund. Beyond ticker selection is our established process for allocation management—how we advise downgrading risk over time—and our methodology for automatic asset location, which we call Tax Coordination. Finally, our overlay strategies of automated rebalancing and tax-loss harvesting can be used to help further maximize individualized, after-tax returns. Together these processes put our principles into action, helping each and every Betterment customer maximize value while invested at Betterment and when they take their money home. Citations 1 Markowitz, H., "Portfolio Selection".The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91. 2 Black F. and Litterman R., Asset Allocation Combining Investor Views with Market Equilibrium, Journal of Fixed Income, Vol. 1, No. 2. (Sep., 1991), pp. 7-18. Black F. and Litterman R., Global Portfolio Optimization, Financial Analysts Journal, Vol. 48, No. 5 (Sep. - Oct., 1992), pp. 28-43. 3 Boudoukh, J and Matthew R., “Stock Returns and Inflation: A Long-Horizon Perspective.” The American Economic Review, (Dec., 1993). 4 Siegel J., Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies. 5 Stambaugh, Robert, “On the exclusion of assets from tests of the two-parameter model: A sensitivity analysis.” (1982) 6 Sharpe, W. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk, Journal of Finance, 19 (3), 425–442, Treynor, J. (1961). Market Value, Time, and Risk. Treynor, J. (1962). Toward a Theory of Market Value of Risky Assets. Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics, 47 (1), 13–37. Mossin, Jan. (1966). Equilibrium in a Capital Asset Market, Econometrica, Vol. 34, No. 4, pp. 768–783. 7 Litterman, B. (2004) Modern Investment Management: An Equilibrium Approach. 8 Note that that the risk aversion parameter is a essentially a free parameter. 9 Ilmnen, A., Expected Returns. 10 Ledoit, O. and Wolf, M., Honey, I Shrunk the Sample Covariance Matrix, Olivier Ledoit & Michael Wolf. 11 Fama, E. and French, K., (1992). "The Cross-Section of Expected Stock Returns". The Journal of Finance.47 (2): 427. 12 Idzorek, T., A step-by-step guide to the Black-Litterman Model.
Acceptable Reasons For Using Flexible PortfoliosAcceptable Reasons For Using Flexible Portfolios If you have reasons not to follow our exact portfolio recommendation, small deviations are likely okay in moderation, although they are not advised. TABLE OF CONTENTS I. Following Advice vs. Adjusting a Portfolio II. Adjusting Portfolios to Express Your Views III. Personalizing a Portfolio Based on Your Circumstances Questions about Developing a Flexible Portfolio Personalizing your overall investment strategy is critical to maximizing your money and achieving your financial goals. At Betterment, we aim to give you sound financial advice that we’ve personalized to how you plan to use your money. Then, we let you further personalize your portfolio by allowing you to adjust the risk level (your allocation) to suit your personal risk tolerance. As with our entire approach to personalization, our portfolio recommendations are meant to be personalized for the aspects of your life we can accurately understand based on the information you give us. But for a variety of reasons, some investors—especially those with a large pool of assets—may want or need further personalized control over their portfolio. There may be personal nuances to your life that only you know, or perhaps you disagree with certain aspects of Betterment’s evidence-based approach to portfolio construction. Betterment will now enable you to modify your portfolio by adjusting the weights for each of the individual asset classes available in the Betterment Portfolio Strategy. In this paper, we’ll explain which scenarios may lead to a valid of use of a Flexible Portfolio. I. Following Betterment’s Advice vs. Adjusting a Portfolio Adjusting your portfolio allows you to express your views or circumstances, but it also means that you may be taking on additional risks. Betterment’s recommended portfolio strategy is exactly what it sounds like—our professional recommendation based on a great deal of evidence and testing. When you use a Flexible Portfolio, our role becomes similar to a personal fitness trainer who lets you decide your diet, while only supporting you in matters related to your exercise. We know that if you want to take control in an area of your plan, we can still help prevent bad behavior and keep you motivated to reach your goal. We want investors to take advantage of the broader elements of Betterment’s financial advice, even if you have reasons not to follow our exact portfolio recommendation. Small deviations from our recommended portfolio weights, although not advised, are likely okay in moderation. That said, Betterment’s default recommendation is right for most customers in most circumstances. But there may be some parts of your life that we don’t know enough about, or that you simply have not told us that we cannot reasonably know without you telling us. Generally, we think of these conditions as either an: Investor view: a personal opinion or preference towards a particular way of investing. Investor circumstance: a concrete fact about your life. Let’s review some of these views and circumstances in more detail. II. Adjusting Portfolios to Express Your Views You may enjoy some Betterment features, like smart rebalancing and tax-loss harvesting, but you come to us with your own investment views you’d like to put into action. These views should be ones for which you have a strong conviction and are committed to for the long haul. There are a number of reasons you may have investment views that differ from ours. For example, you may have a different methodology for estimating future asset returns and volatilities. Some views have more merit than others. That’s why we provide live feedback within the app while you build your portfolio. This feedback comes in two main forms. Overall Risk Assessment This measure shows you how the overall volatility of the portfolio you designed compares to the overall volatility of the recommended Betterment portfolio. The recommended risk level is based on your stated goal and time horizon. Taking too much or too little risk can decrease the likelihood of achieving your goal. goes a step further and provides guidance on not only how diversified you are, but also on whether you are positioned to seek high expected returns over time. These two important measures will update as you adjust your portfolio to help you make good investment decisions. The figure above shows Betterment's application experience for providing overall risk and diversification feedback ratings. Regardless of how you express your views, Betterment recommends any investor focus on following the fundamental investing principles of controlling your overall risk and being properly diversified. III. Personalizing a Portfolio Based on Your Circumstances Unlike investor views—which are subjective—circumstances tend to be fairly stable, objective reasons for modifying our recommended portfolio. The most common circumstance we see that warrants using a Flexible Portfolio is to factor in outside accounts and their holdings. By adjusting your Betterment portfolio to reflect the fact that you have holdings, you can make sure that your overall risk across all your investments is properly aligned to your goals. How to Factor in Outside Accounts It’s not uncommon to have investment accounts at multiple companies. Remember that no portfolio is an island. Even if one portfolio looks good on its own, it may have overlapping investments with your other accounts. This may lead to you taking too much or too little risk. The easiest way to fix this problem is to consolidate accounts, or at least make sure they are all invested similarly. But sometimes, this isn’t possible. If you’re still working, rolling over your current 401(k) isn’t an option. And adjusting some accounts may cause unnecessary tax consequences. When situations like this arise, your best option may be to compensate within your Betterment account. Let’s say you own some U.S. stock investments that have greatly increased in value since the 2008 recession. Selling them will likely cause a huge tax bill, so instead you can reduce the U.S. stock exposure within your Betterment account. Or maybe you have a ladder of individual US bonds that makes up the majority of your fixed income portfolio. You can reduce the US bond exposure within your Betterment account, while keeping international bonds to stay diversified. A more advanced use case might be “asset location” or determining which assets to hold in which accounts based on the expected returns of the assets and the tax status of the accounts. We use this tax strategy across your long-term Betterment accounts, but you may want to also factor in your current 401(k). In these situations, adjusting your Betterment portfolio based on your non-Betterment accounts can lead to a more personalized investment strategy. Questions about Developing a Flexible Portfolio? Investors have a variety of reasons for using a Flexible Portfolio. It may help to ensure you have an appropriate level of risk. It also may help you feel comfortable with your portfolio, which can help you stay committed to your investment strategy during times of market volatility. In general, we recommend following Betterment’s default advice. But making slight adjustments to reflect your views or circumstances is sometimes appropriate as long as you keep in mind the overall risk and diversification of your portfolio. That is why we give you feedback on those two measures when you design a Flexible Portfolio. Flexible portfolios is available for new or existing accounts. However, making any allocation changes to existing taxable accounts may have tax consequences. As with any allocation change for any portfolio strategy, our Tax Impact Preview can help you to evaluate the consequences of making the change.
Assessing a Portfolio’s DiversificationAssessing a Portfolio’s Diversification Guidance on diversification to help you make portfolio changes, knowing the potential impact to the future performance of your investments. TABLE OF CONTENTS Why does diversification matter? Understand the Efficient Frontier How We Measure Diversification Offering Feedback in Flexible Portfolios Higher levels of diversification allow you to take less risk to help achieve your desired level of return. At Betterment, we have carefully constructed our recommended portfolio strategy to achieve optimal diversification; it’s one of the core principles of our investment philosophy. We also allow investors to use our customization feature, Flexible Portfolios, to meet their individual needs. To help investors maintain diversification while adjusting their portfolios’ individual asset classes, we give real-time feedback about the level of portfolio diversification as they construct a Flexible Portfolio. Why does diversification matter? It’s worth taking a moment to review why diversification matters. An objective of almost any portfolio is to seek growth with as little volatility as possible. Most assets will have price swings along the way; however, not all asset prices change at the same time or in the same way. In other words, price volatility is unavoidable, but if we choose the right set of investments, we may be able to lower the overall volatility of the portfolio. This is possible when the prices of individual parts of the portfolio move in different directions. As illustrated below, the less that prices move in tandem, the smoother the returns of the overall portfolio are expected to be. The value across time of the two-asset portfolio is likely to be somewhat smoother while any drawdown in value is less severe. You can see more research on diversification here. Illustration of Diversification Figure 1. The less that prices move in tandem, the smoother the returns of the overall portfolio are expected to be. A simple example below shows that as you add to a portfolio uncorrelated assets—i.e., assets whose prices move independently of one another—the overall portfolio becomes less volatile, even when each asset has the same individual level of volatility. Volatility of a portfolio with N uncorrelated assets, all with 12% assumed volatility Figure 2. This figure is hypothetical in nature and simply shows six portfolios of imaginary uncorrelated asset classes with an assumed volatility of 12%. The example demonstrates the mathematical reality that a portfolio of assets that do not perfectly correlate is less volatile than any single asset in the portfolio. Understand the Efficient Frontier Mathematically, as long as assets not perfectly correlated, we can combine them into a portfolio to lower the overall volatility. Below, you can see the result of various portfolios that combine global stock and bond assets. Because of diversification, we can see that the combinations of assets are expected to perform better than the individual assets themselves. Efficient Frontier for the Betterment Portfolio Strategy Figure 3. This figure illustrates hypothetical annual expected excess returns—i.e. returns that exceed the risk free rate—projected for portfolios of the Betterment Portfolio Strategy. The calculation uses our asset class return assumptions using the Capital Asset Pricing Model. The blue points represents the Betterment Portfolio Strategy across the entire risk spectrum. The grey points represent other portfolio combinations using the fund components of the Betterment Portfolio Strategy. At each level of risk, the set of Betterment-recommended portfolios have higher hypothetical expected excess returns. These returns do not include a Betterment management fee or fees charged by issuers of particular securities. These returns include reinvestment of dividends and are in excess of the risk free rate. This calculation is hypothetical in nature, does not represent actual returns attained, and does not take into account any future economic or market conditions. The impact of trading, and other income is not considered. Actual results may differ significantly from the values shown. You can also see that there is a boundary at which we can no longer create a portfolio that has a higher expected return, given its level of risk (points no longer go higher or further to the left). The set of portfolios that comprise the outer boundary is called the efficient frontier. The efficient frontier is the set of hypothetical optimal portfolios that seek to provide the best possible risk-adjusted return, which is an input in determining the specific portfolio that Betterment recommends to a customer. Ideally, investors want to invest in portfolios on or very close to the efficient frontier. When a portfolio moves further from the efficient frontier, it may be taking additional risk that you are not being fully compensated for. Risk and returns are fundamentally linked. When you take more risk in your portfolio, you should aim for expected compensation via a higher return; it doesn’t make financial sense to take on more risk for less or the same returns. Investors should avoid portfolios that take unnecessary and uncompensated risk. The efficient frontier acts as a kind of north star, illustrating the best returns an investor could expect for a given level or risk. How We Measure Diversification When investors use Betterment Flexible Portfolios, we measure the amount of uncompensated risk they are taking in their portfolio. In other words, we measure how far the portfolio is straying from the efficient frontier. Using our portfolio optimization process, we have worked to make sure any recommended portfolio in the Betterment Portfolio Strategy is optimally diversified and sits on or very close to the efficient frontier. Because our recommended portfolios are optimally diversified, these serve as the starting point for any comparison. This is also why we recommend that investors choose the Betterment Portfolio Strategy. To measure diversification in a Flexible Portfolio, we calculate the expected return and volatility of the customized portfolio and compare it to an appropriate comparison portfolio in the Betterment Portfolio Strategy. Put simply, a Flexible Portfolio is well diversified if it has the same risk-adjusted return as the comparison Betterment portfolio. So, we define our diversification rating as the difference between the volatility of the Flexible Portfolio and the rescaled volatility of a comparison portfolio in the Betterment Portfolio Strategy. This process has two steps. First, we identify the portfolio in the Betterment Portfolio Strategy that has the closest expected return to use as our comparison portfolio. For example, if a Flexible Portfolio has an expected excess return of 5%, then we compare it to the 76% stocks, 24% bonds allocation of the Betterment Portfolio Strategy. Then, we assess how much additional risk the Flexible Portfolio may be taking on by scaling the Betterment-recommended portfolio to have the exact same expected return as the Flexible Portfolio. Now that we have two portfolios with comparable expected annual returns, we evaluate how much additional risk (expected volatility) a custom portfolio may be taking. That extra risk is the result of under-diversification—either from not holding enough assets or holding too much of one asset or a number of similar assets. Shown graphically, you can see that a portfolio consisting of 80% US stocks and 20% US bonds is expected to achieve the same annual return as the Betterment 63% stock portfolio, but has almost 10% more risk. Uncompensated Risk from Poor Diversification Figure 4. See Figure 3 for more information on the analysis behind this chart. Here we visualize the uncompensated risk—same hypothetical expected excess return but different expected volatility. Offering Feedback in Flexible Portfolios As we see above, diversification (or lack thereof) can be measured by the amount of uncompensated risk a portfolio is taking when compared to an optimal Betterment portfolio. When an investor is adjusting a portfolio using Flexible Portfolios, we provide real-time feedback on the amount of uncompensated risk. If a portfolio’s uncompensated risk is too high, we will highlight it and recommend increasing diversification across assets. There are a number of reasons investors may want to adjust the holdings in their portfolios. Our feedback on the diversification helps these investors make changes while highlighting the potential impact to the future performance of their investments.
Two-Way Sweep MethodologyTwo-Way Sweep Methodology Two-Way Sweep helps make everyday cash management easier to handle by seamlessly moving your extra cash from your linked checking account—and back when you need it. TABLE OF CONTENTS A Recurring Analysis Sweeping in to Betterment Sweeping Out of Betterment An Automated Solution for Extra Cash Betterment aims to help its customers manage their cash and investments more effectively by analyzing external accounts and making smart suggestions about how they could potentially be earning more or saving on fees. In this methodology, we’ll describe how Two-Way Sweep helps make everyday cash management easier to handle. Here’s how it works: Our recurring analysis determines whether your checking account holds enough cash to meet expected cash expenses for the next 21 to 35 days. If extra cash is found, Two-Way Sweep will automatically transfer money from your checking account to Cash Reserve. If your checking account balance falls below the balance we predict you’ll need in the next 21 days, we will automatically move money back into your checking account. A Recurring Analysis The goal of Two-Way Sweep is to seamlessly move your extra cash from your linked checking account to our high-yield cash account—and back when you need it. Two-Way Sweep combines a daily recurrent cash analysis with an automated cash transfer. We believe that a checking account must have enough cash reserves at all times to meet expected future cash expenses, yet this cash amount should not be excessive. Ideally, excess cash should be put to work to earn a yield that’s safe, yet higher than what’s typical in an average savings account. Two-Way Sweep monitors your linked checking account daily and aims to keep the account balance between the lower and upper bounds. How are these bounds defined? The lower bound is computed as an aggregate of 21 days of projected cash expense and recurring account transfers, while the upper bound is computed as an aggregate of 35 days of expense and recurring account transfers. You may also add additional padding to these bounds, which we discuss later in more detail. The range of 21 and 35 days is chosen to minimize the amount of extra cash in your checking account while also providing enough cash to meet expected cash expenses in the near future. You may also set your own target balance range for your checking account if you wish to do so. Each day, Two-Way Sweep will estimate the lower and upper bounds. By balancing what we predict you’ll need in your checking account in the next 35 days with the objective of not holding too much extra cash, Two-Way Sweep helps you earn more on your extra cash by shifting it to our high-yield cash account. No cash transfer takes place if your checking account balance already falls between the lower and upper bounds. Sweeping Into Betterment Two-Way Sweep’s movement of cash into Betterment is essentially automating our cash analysis and using Cash Reserve, our high-yield cash account, as the default destination for your extra cash. As we’ve articulated in this comparison, there may be other products you might also consider for earning a high yield on extra cash, but our cash account’s advantages in terms of yield and liquidity make it an ideal spot for your extra cash within Betterment. Betterment uses cash analysis to repeatedly analyze how much extra cash you may have in your checking account. The decision to sweep money into Cash Reserve is based on whether your linked checking account balance is greater than the upper bound, calculated as the amount of cash needed for the next 35 days of cash expenses. When Two-Way Sweep is activated and extra cash is found, we will move your extra cash, up to $5,000 per sweep, into Cash Reserve. After the sweep is complete, another sweep in will not occur again for at least seven days, as a rule. If you initiate a manual withdrawal from your cash account to your checking account, Two-Way Sweep will be automatically paused for two weeks, with the assumption that you plan to use the funds and don’t want them to be swept back to Cash Reserve right away. We will notify you via email before a sweep takes place. You have until 12 PM EST the following day to cancel the sweep, either through the link in the email, or in your account. Sweeping Out of Betterment Although our automated sweep to put your extra cash to work in your cash account is innovative, the true innovation of Two-Way Sweep is its ability to also sweep cash back into your checking account when you need your extra cash. Identifying When You May Have Too Little Cash If, on any given day, your linked checking account balance falls below the cash amount we estimate you‘ll need in the next 21 days (the lower bound), Two-Way Sweep will transfer cash back to your checking account. The sweep will transfer back enough cash to restore your checking account balance to the midpoint between your lower and upper bounds (as calculated on the day of the transfer). The maximum that we will transfer to your checking account is the total balance in your cash account. If your savings are less than the amount needed to bring your checking account balance back to the midpoint between your lower and upper bounds, we will transfer your full Cash Reserve balance back to your checking account. However, after the transfer, your checking account balance will still be below the midpoint. Moving Cash to Your Checking Account If our daily cash analysis finds that you have less than 21 days of expected cash expenses in your checking account, Two-Way Sweep will start the process of automatically moving cash into your checking account from Cash Reserve. If, during the transfer period, our cash analysis finds that your checking account balance is now sufficient (or if extra cash is now detected), the transaction will still continue to process. While a transfer is in progress, we will not initiate any additional sweeps, either to or from your cash account. If, on the day after a sweep into your checking account completes, our cash analysis again shows that your balance is low, Two-Way Sweep will initiate another sweep from your Cash Reserve account to your checking account. We will notify you via email before a sweep takes place. You have until 12 PM EST the following day to cancel the sweep, either through the link in the email, or in your account. Setting a Custom Target Balance Range If your bank requires you to hold a minimum balance, or you are aware of expenses that are not accounted for in our prediction of your lower and upper bounds, you can set your own target balance range for your checking account. This gives you additional control and flexibility to set a range that works for you and that you are comfortable with. Note that Two-Way sweep does not guarantee that your checking account balance will not drop below the lower bound. An Automated Solution for Extra Cash Two-Way Sweep is an automated solution for reducing cash drag in your checking account. It monitors your checking account and estimates future cash expenses on a daily basis with the goal of maintaining a checking account balance that’s within an optimal range while also putting any excess cash to work. Two-Way Sweep takes advantage of Cash Reserve to earn a yield that’s above the usual rate offered by an average savings account.
Cash Reserve Has A Variable APY: What That Means For YouCash Reserve Has A Variable APY: What That Means For You Interest rates change over time, but at Betterment, we are always working hard to help give you one of the best rates possible so you can make the most of your money. Our objectives are aligned with yours: we want to grow your money. Cash Reserve is a high-yield account that is different from the savings accounts that you might find at traditional banks. We’re not tied to one specific bank, so we have the opportunity to obtain attractive rates in the marketplace. We use our size and scale to access a network of program banks, and then we use our technology and efficiency to pass rates on directly on to you. Is that rate guaranteed? No, it’s variable, and that’s by design. The Federal Funds Rate influences interest rates across all banks. As rates change, so will the Cash Reserve rate. You can feel confident that Betterment is always working to offer you one of the best interest rates we can find, no matter what the current rate environment may be. See what the current variable interest rate is for Cash Reserve. How does Betterment get one of the highest possible rates? Similar to how we aim to select the best ETFs in each asset class for your portfolio, we work with a number of program banks to provide you with one of the best possible rates we can find and then pass them on to you. Often, these rates are more competitive than what you could get as an individual depositor. When you deposit with Betterment, you become part of a larger community of savers. Banks can more efficiently support our customer base as a group, rather than as individuals. What causes interest rates to change? No matter where you bank, the prevailing interest rate environment will have an impact on your interest rate. The amount banks are willing to pay on deposits is heavily influenced by the Federal Reserve, which sets the rate at which banks can loan money to each other. This is known as the Federal Funds Rate. It’s the rising tide that raises all rates, and the receding tide that can also bring them all down. The Federal Reserve sets a target range for the Federal Funds Rate, rather than aiming for a specific number. Because of this, the Federal Funds Rate can change by a small amount from day to day. However, larger changes to the Federal Funds Rate can occur when the Federal Reserve changes its target range or when the Federal Reserve changes policies. The interest rate you receive on Cash Reserve typically will change as a result of these more significant shifts in the Federal Funds Rate. How do interest rate changes affect me? Let’s take a look at just how the Federal Funds Rate affects rates at traditional banks. The chart below shows the relationship between what happens to the rates at traditional banks when the Federal Funds Rate goes up or down. Historical Comparison of the Federal Funds Rate and the Average Bank Rate This chart shows the historical Federal Funds Rate in comparison to the historical national average savings rate. Source data: Federal Reserve and FDIC. The average rate at banks has been nearly flat throughout the period shown above. The wide spread between the two lines on the graph represents the additional amount of interest we’re able to pass on to you because of the way our Cash Reserve product is set up. What will future rates look like? If the Federal Reserve lowers its target range, the interest rate on Cash Reserve will generally change by a similar amount. You can expect this to impact rates at other banks as well. Below, we’ve extended the previous comparison chart to include a forecast for how the Federal Funds Rate might change in the future. Potential Future Rates With Forecasted Interest Rate Changes Source data: Federal Reserve and FDIC. This chart shows the hypothetical future Federal Funds Rate in comparison to the hypothetical future national average savings rate, based on one possible path of future changes in the Federal Funds Rate. The forecasted Federal Funds Rate is based on yield curve data as of 10/10/2019. This chart is hypothetical in nature and based on forecasts. Actual interest earned may differ. As you can see in the hypothetical chart above, the announcement of a rate change by the Federal Reserve would cause changes in the interest rate environment. Because Cash Reserve tracks closely with the Federal Funds Rate, you can expect that, in the future, our Cash Reserve rate will continue to track alongside the Federal Funds Rate as it changes. We Do What We Believe Is Best For You As your advisor and as a smart money manager, it’s in our DNA to do what we believe is best for you. We’ve spent the past decade working to optimize your investments and provide you with advice that helps you reach your long-term financial goals, and we are excited to partner with you to make the most of your money with our newest cash management solution—Cash Reserve.
Manage Your Cash the Modern Way With Two-Way SweepManage Your Cash the Modern Way With Two-Way Sweep Manage your cash the modern way—effortlessly. Try out Two-Way Sweep, our latest in cash management technology. Most of us organize our day-to-day financial lives using three different accounts: a checking account, a savings account, and a credit card. The Headaches Of Cash Management After paying bills and paying down credit card balances each month, you may accumulate extra cash in your checking account. Over time, if you leave this extra cash in your checking account, it will likely lose value to inflation, and you may wish to move that extra cash to an account that earns a higher yield over time. On the other hand, if you find that you end up spending more than your income in a given month, you may need to move cash back from your savings account (or from another type of account) to your checking account. If you choose to manage your cash manually, not only would you have to take time to move money back and forth, but to get the most out of your hard earned money, you may also end up spending your time comparing banks to find the best yield for your savings account. Does all this sound like the perfect job for a computer? It is. Two-Way Sweep Provides A Solution The next evolution of cash management for Betterment customers is here. By working alongside our cash analysis recommendations and Cash Reserve, Two-Way Sweep minimizes the need for tedious manual cash management practices. Two-Way Sweep automates transfers between your checking account and our Cash Reserve account so that idle cash you might have in your checking account is moved to help earn a higher yield. Conversely, if we detect insufficient funds in your checking account for your expected future spending needs, Two-Way Sweep will move cash back to your checking account from Cash Reserve. Now you can have a personal cash management tool that helps you earn a high yield on money that may otherwise be sitting in cash, and also aims to keep enough cash in your checking account to cover expected future cash needs. Ready To Try The Latest Technology? We have automated cash management by addressing two competing objectives: increasing returns on idle cash while sufficiently funding your checking account to cover expected future cash needs. Get started or log in to access Two-Way Sweep in your Betterment account. We’ve also got all your Two-Way Sweep questions covered in our methodology and our comprehensive overview.
How Account Security Works at BettermentHow Account Security Works at Betterment Here are some of the ways we are keeping you and your data safe. The Internet can be a scary place: websites can get hacked and private data can get stolen. We understand that personal safety on the Internet is more important now than ever, especially when it comes to managing your investments online. To help keep your investments safe, we have a dedicated security team of experts who think about things like passwords and encryption so that you don’t have to. Here are just a few of the ways that we work to help keep your information safe. Password Safety In our digital age, passwords can sometimes feel like the bane of our existence. We’re expected to have different passwords for different websites and have them all be complex but still easy to remember. This often leads to bad habits, like reusing the same password for multiple websites because it feels easier. This makes passwords a valuable target for hackers. When they hack into a website, this is usually the first thing they go for. We make this more difficult for hackers by storing your password in a format called a “bcrypt hash.” In short, this format is used to store your password in a scrambled state so that any potential hackers can’t read your password. This scrambled state also makes guessing difficult, so an attacker would still need to spend a lot of time and energy to decipher the original password. We also offer app-specific passwords. For example, tax preparation software will often need access to your accounts to build an accurate understanding of your finances. The risk is that these third-party services have to save a copy of your password. They could use it do anything with your accounts that you could do yourself, including taking actions such as withdrawing all your money or changing your bank account information. Our app-specific passwords were designed to prevent this scenario. These special passwords grant read-only access to third parties, meaning they can only be used to read information but not change it. If an attacker were to get this password, they would not be able to withdraw any money or make any other changes. Two-Factor Authentication Typically when you log in to a website, you just need your password. Your password is acting as the first factor in place in order to access your account. With two-factor authentication, you not only need your password to log in, but you also need your trusted device. We’ll text you or call you with a code, and you’ll have to enter that code in order to finish logging in. The code is now the second factor in place for account access. Two-factor authentication strengthens the security of your account. Even if an attacker knows your password, they still would not be able to log in unless they also had access to your trusted device. While this adds little friction for legitimate customers, it frustrates attackers. We’ll even remember which trusted devices you’ve logged in with in the past, so that you don’t have to keep entering codes when you log in repeatedly with the same device. Limited Data Access At many companies, external network security is taken very seriously, but the internal network can be a data free-for-all. At Betterment, we make sure that this is not the case. Most of our employees do not have access to any customer account information at all. Access to customer data is only given to those who need it. Engineers who work on our software and administrative tools use a sanitized copy of the necessary data. This means the data is structurally similar enough to real data to get their work done, but does not contain any personally identifiable information. Limiting access to customer data has two benefits to user safety. In the unlikely event that there is an employee with bad intentions, the amount of data they could access is kept at an absolute minimum. If an outside attacker found their way inside our network, they would still have a hard time gaining access to customer data. Encryption Even before you log in to your account, encryption has already kicked in via Transport Layer Security (TLS). TLS helps to ensure privacy for all communications between your computer and our servers. Without it, anything you send us—such as your password or bank account information—would be sent out in the open web, making it easy for attackers to access your information. Because of TLS, you can feel confident that any information sent between you and us is kept private as it makes its way through the internet. We also use encryption when storing your personal information. The information we encrypt includes your financial information, such as bank account and tax identification numbers, to your personal information, like social security number and secret questions. Our dedicated security team is always working for you. We understand that when you open an account with us, you’re placing a lot of trust in our services. This is why we have a dedicated in-house security team that works full-time to keep you safe. The team regularly reviews new code to minimize the potential for security issues, they monitor our various tools and systems, and they stay on top of industry trends and events. Keeping your account safe is our top priority, and we hope that gives you peace of mind.
How Betterment Works During Volatile MarketsHow Betterment Works During Volatile Markets It can be difficult to ride out a market downturn when you can see it affecting your investment portfolio. We have automated features in place to address volatile markets when they occur. Volatile markets can make even the most experienced investor worry about their investment accounts. A sharp drop in your portfolio’s value is never fun. It might leave some investors wanting to take immediate action. Because we passively invest here at Betterment, taking action based on market movements is not required on your part, and doing so can actually lower your returns. An internal study found that customers who change their allocation as a result of market changes are often likely to underperform customers who don’t make such unnecessary changes. When volatility does hit—and it will—we have several automated features that can help keep you on track towards your financial goals even in times of uncertainty. Automatic Allocation Adjustments Many financial advisors, including Betterment, will help you choose an asset allocation that is suitable for each of your financial goals. When you initially set up a goal with us, we will ask you how long you’ll be investing for and what amount of money you’re aiming towards. This information helps us choose the appropriate asset allocation for you not only for right now, but for the future as well. For most goals, the asset allocation will automatically get less risky as you get closer to your goal’s end date, by following a “glide-path”. This reduction in risk as your goal’s end date gets closer is based on Betterment research into potential negative outcomes, or downside risk. If you’re only investing for a short time period, it’s a good idea to invest in low-risk assets, because you likely won’t have enough time to earn back value if a large market drop occurs. Over long time horizons, including stocks in your allocation is likely to lead to a higher final balance, even in poor market scenarios. Since 1871, the lowest average annual return over any 30-year period for the S&P 500 was still 5% from 1903 to 1933, a period that includes World War I and ends in the middle of the Great Depression (data from Robert Shiller; calculations by Betterment.) Even during one of the most tumultuous 30-year periods in American history, adding stocks to your allocation would have left you better off than leaving your money on the sidelines. Portfolio Rebalancing The allocation that we choose for you is our best estimate of the combination of assets that will help you reach your goal by the date you’re aiming for. But, unless each asset you invest in has the same exact returns, normal stock market fluctuations will cause your actual allocation to drift away from the allocation you started with. We call this process portfolio drift, and though a small amount of drift is perfectly normal—and a mathematical certainty—a large amount of drift could expose your portfolio to unwanted risks. Example: If you initially split your investment 50/50 between stocks and bonds, and in the subsequent month stocks return 10% while bonds stay at the same price, your actual allocation at the end of that month could be around 52% stocks and 48% bonds. A period of sustained volatility could be especially harmful to your portfolio if your portfolio drift is left unchecked. To help minimize this risk, we automatically rebalance your portfolio whenever your portfolio drift exceeds a certain threshold. We generally use any cash inflows, like deposits or dividends, and outflows, like withdrawals, to help rebalance your portfolio. When money comes in, we can buy assets from asset classes your portfolio is underweight in. When money is going out, we can sell assets from asset classes your portfolio is overweight in. This cash flow based rebalancing method helps keep your portfolio risk in check while reducing the need to sell investments, and potentially realize capital gains, to rebalance. If rebalancing does require selling investments in a taxable account, the specific shares to be sold are selected tax-efficiently, using our TaxMin method, ensuring that no short-term gains will be realized in your account during the rebalance, as these are particularly tax-inefficient. Tax Loss Harvesting Tax loss harvesting is the practice of selling an investment that has experienced a loss. By realizing, or "harvesting" a loss, you are able to offset taxes on both gains and income. The sold investment is replaced by a similar one, maintaining an optimal asset allocation and expected returns. Tax loss harvesting is a feature that may benefit you most when the market is volatile. After all, if there are no losses in your account, we cannot harvest any losses. In fact, we found that the periods where tax loss harvesting would have provided the most hypothetical value was in the period following the dot-com bubble as well as the financial crisis of 2008. You can use any harvested losses to reduce capital gains you’ve realized through other investments in the same tax year. This can reduce your tax bill, especially if you have a lot of short-term capital gains, which are taxed at a higher rate than long-term capital gains. If you’ve harvested more losses than you have in realized capital gains, you can use up to $3,000 in losses to reduce your taxable income. Any unused losses from the current tax year can be carried over indefinitely and used in subsequent years. Updated Advice When you set up your goals, we’ll offer advice on how much you should be depositing in order to reach your goal. Large swings in the market can change our deposit advice, because different deposit amounts are now needed. Fortunately, if your account drops in value due to large market swings, our recommended monthly deposit advice will increase to help keep you on track. Likewise, a large increase in your account value caused by strong market performance will mean you can decrease your monthly deposits and still reach your goal, though an added margin of safety doesn’t hurt. We’ll Be Right There With You Hopefully you’re no longer worried about the next market downturn. You know that Betterment is working for you through all the ups and downs, because we have built-in features that help you ride out inevitable volatile markets. Set up your account today and let us ride out the next market downturn with you.
The Benefits of Tax Loss Harvesting+The Benefits of Tax Loss Harvesting+ We’ve automated tax loss harvesting which can help you save on taxes over time. Learn about the benefits of TLH+. Tax loss harvesting is the practice of selling an asset that has experienced a loss. The sold asset is replaced by a similar one, helping to maintain your risk level and your expected returns. By realizing, or "harvesting" a loss, you can: Offset taxes on realized capital gains. Reduce tax liability by reducing your income. Realized losses on investments can offset gains and reduce ordinary taxable income by as much as $3,000 per year. We do this all for you—at no additional cost—with our automated Tax Loss Harvesting+ feature. You could benefit from Tax Loss Harvesting+ if... You are investing in a taxable investment account. You plan to donate to charity or leave your assets to your heirs. The IRS allows you to offset your realized capital gains with realized capital losses. The IRS allows you to reduce up to $3,000 from your ordinary income. We don’t recommend Tax Loss Harvesting+ if... Your future tax bracket will be higher than your current tax bracket. You can currently realize capital gains at a 0% tax rate. Under current law, this may be the case if your taxable income is below $39,375 as a single filer or $78,750 if you are married filing jointly. You are planning to withdraw a large portion of your taxable assets in the next 12 months. You risk causing wash sales due to having substantially identical investments elsewhere.
How We Use Your Dividends To Keep Your Tax Bill LowHow We Use Your Dividends To Keep Your Tax Bill Low Every penny that comes into your account is used to rebalance dynamically—and in a tax-savvy way. There is no doubt that dividends always feel good. It’s not just well-deserved returns from the companies you are funding; it’s also a sweet reminder that investing works while you do other things, like spend time with family or hit the beach. “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” John D. Rockefeller. Here at Betterment, we also use your dividends to keep your tax bill as small as possible. Dividends Boost Your Total Returns There are two opportunities for profit when you buy a share: when the value of the share appreciates, and when the share generates income in the form of dividends. Dividends are your portion of a company’s earnings. Not all companies pay dividends, but as a Betterment investor, you almost always receive some because your money is invested across more than 3,000 companies in the world. Dividends make up a significant proportion of the total return you can expect from investing in those companies. Performance of S&P 500 With Dividends Reinvested Source: Bloomberg More Opportunities to Rebalance Your Portfolio Your dividends are also an essential ingredient in our tax-efficient rebalancing process. When you receive a dividend into your Betterment account, you are not only making money as an investor—your portfolio is also getting a quick micro-rebalance that helps keep your tax bill down at the end of the year. This is especially crucial after coming through a period of market volatility. Big market changes have a tendency to cause your asset allocation to veer off course. However, in order to better control risk, you want to get back to your correct asset allocation as quickly as possible. Reinvesting dividends helps to get you back on track by allowing us to buy assets that you are underweight in, rather than sell assets you are overweight in. Dividends + Deposits = Tax-Efficient Rebalancing When your account receives any cash—whether through a dividend or deposit—we automatically identify which investments need to be topped up. When market movements cause your portfolio’s actual allocation to drift away from your target allocation, we automatically use any incoming dividends or deposits to buy more shares of the lagging part of your portfolio. This helps to get the portfolio back to its target asset allocation without having to sell off shares. This is a sophisticated financial planning technique that traditionally has only been available to big accounts, but our automation makes it possible to do it with any size account. The Final Puzzle Piece: Fractional Shares The secret is that we can do this because we handle fractional shares. That means every penny that enters your account reinforces full diversification. This contrasts with how many individual investors handle dividends on their own. Some online brokers offer an automatic option, and may reinvest dividends into whatever fund the cash came from. However, this blind reinvesting is often not the most efficient use of dividends, and can very easily lead to a poorly allocated portfolio that requires a sell-off of assets at a gain—with the accompanying capital gains taxes—to rebalance it over time. Instead, our tax-efficient rebalancing helps you avoid such a “hard” rebalance which would require a major sale and expose you to capital gains. For the DIY investor, this automated tax-efficiency is virtually impossible to achieve. At Betterment, it’s included on every dividend and every deposit, every time, for every client. And you do not need to do a thing.
The Benefits of Tax CoordinationThe Benefits of Tax Coordination Once you’ve set up Tax Coordination for your Retirement goal, we will manage your assets as a single portfolio across all included legal accounts, using every dividend and deposit to optimize the location of the assets. Betterment’s Tax Coordination service is our fully automated version of an investment strategy known as asset location—and it comes at no extra cost to you. Our research shows that this strategy can boost after-tax returns by an average of 0.48% each year, which approximately amounts to an extra 15% over 30 years. Once you’ve set up Tax Coordination for your Retirement goal, we will manage your assets as a single portfolio across all included legal accounts, using every dividend and deposit to optimize the location of the assets. We’ll also rebalance in order to improve your asset location when we see opportunities to do so—without causing taxes. We’ll generally place assets that we expect to be taxed at higher rates in your tax-advantaged accounts (IRAs and 401(k)s), which have big tax breaks. We’ll generally place assets that we expect to be taxed at lower rates in your taxable account, since you’ll owe taxes on dividends and any realized capital gains each year. You could benefit from Tax Coordination if... You are investing in at least two of the following types of Betterment accounts for retirement: Individual Taxable account (Retirement or General Investing) Tax-deferred account (Traditional IRA, SEP IRA, or Betterment for Business 401(k) plan) Tax-exempt account (Roth IRA or Betterment for Business Roth 401(k) plan) You are investing for the long term and your coordinated goals have the same time horizon. We don’t recommend Tax Coordination if... Your federal marginal tax bracket is 12% or below. The accounts you plan to coordinate have different time horizons. You plan to make a significant withdrawal in the near future from only one of the accounts you are considering including in the goal using Tax Coordination.
The Betterment Rollover: A Fast Track to a Better Financial FutureThe Betterment Rollover: A Fast Track to a Better Financial Future Roll over a Traditional, Roth, or SEP IRA—and start yourself on the path to a better financial future. At Betterment, we’ll manage your account for you, without the hidden fees that you may be used to from other providers. We invest your money in a low-cost, globally diversified portfolio, and we offer personalized advice with your best interests in mind. Before us, there wasn’t an easy, automatic way for people to get advice and invest their money. We built our platform from the ground up to give customers an intuitive interface, designed to lead to better behavior and better expected returns. Take advantage of the benefits we offer by rolling over your old 401(k)s and other retirement accounts into an Individual Retirement Account (IRA) here at Betterment. Our Mission: Low-Cost Investing and Personalized Advice for Everyone We believe that everyone has the right to both low-cost investing as well as advice that is tailored to their situation. We offer services that we believe will help make everyone a smarter investor—and help them ultimately reach their goals. Personalized advice keeps you on track. Our retirement advice shows you how much to save for retirement based on your current age, your desired retirement age, where you plan to retire, and how much you’re saving across all of your retirement accounts—even those that are held somewhere other than Betterment. You can even include your spouse’s accounts in order to plan more accurately. Our globally-diversified portfolio balances risk and reward. Rollovers and deposits into IRAs at Betterment are instantly diversified across our global portfolio. We carefully select Exchange Traded Funds (ETFs) across 12 types of asset classes, which are invested in more than 36,000 stocks and bonds, which represent companies and governments in over 100 countries. Because no one can predict how each asset class, country, or company will perform in a given month or year, it’s often best to diversify across them all. This helps to balance out your returns over time. Tax-smart automation boosts your returns. While IRAs already offer many great tax benefits, our Tax Coordination feature helps take it a step further. TCP optimizes and automates a strategy called asset location. It starts by placing your assets that will be taxed highly in your IRAs, which have big tax breaks. Then, it places assets taxed at lower rates into your taxable retirement account. Our research shows that this strategy can boost after-tax returns by an average of 0.48% each year, which approximately amounts to an extra 15% over 30 years. Save money with our low fees. Our fees are a fraction of the cost of other services because of our cutting-edge technology. We are vertically integrated, meaning we are the registered investment advisor (RIA) and the broker-dealer through our affiliated entity, Betterment Securities. That means we handle the investment process from beginning to end, which allows us to charge lower fees than other investment services, which have to work with and pay third-party custodians. Additionally, all of our fees are completely transparent—we have no hidden costs. Fast track your 401(k) rollover. Ready to get on the path to a better financial future? When deciding whether to roll over a 401(k) account or other retirement accounts, you should carefully consider your personal situation and preferences. Relevant factors may include that: (i) 401(k) accounts may offer greater protection from creditors than IRAs. (ii) In some cases, the ability to take penalty-free distributions at an earlier age or to defer minimum required distributions. (iii) Some 401(k) accounts may also allow for loans or distributions in a broader set of circumstances than IRAs. (iv) Some 401(k) plans may also offer specific educational and advisory services to participants that are unavailable to some IRAs. (v) Some 401(k) plans may have lower fees and expenses than some IRAs. (vi) Some IRAs may offer a broader range of investment options that some 401(k) plans. (vii) Special tax rules may apply to the rollover of employer securities. You should research the details of your 401(k) and speak to a tax and other advisors about whether the features of your 401(k) are relevant to your personal situation. The rollover process is currently automated for rollovers from select providers. If you have a provider that is not part of our automated process, you will receive an email with a checklist for completing your rollover to Betterment. In processing you rollover request, Betterment will be acting at your direction.
How Much to Save: Our Advice Guides You Towards Your GoalsHow Much to Save: Our Advice Guides You Towards Your Goals A good financial plan has to adapt over time to be successful. Here’s how Betterment helps you do that. Voyager 1 and Rosetta were two very different space probes that achieved their missions in my lifetime. How they accomplished their missions is a lesson in planning. Voyager 1 was a bullet. Aim. Adjust for wind, gravity, friction. Fire. Pray. When Voyager was launched in 1977, we needed to get everything exactly right. Once it left Earth, it’s fate was sealed. Whatever path it would take… was set. A lot of unexpected events can happen across the millions of miles it was set to journey. Rosetta’s mission was magnitudes harder: it had to catch a comet. Launched March 2, 2004, Rosetta took 14 years to accelerate and catch it’s target. It used a lot of the same methods as Voyager, but finding the right path to take with so many moving bodies in the inner solar system is orders of magnitude harder than the bullet shot that was Voyager 1. Rosetta needed the ability to adjust as time went on and to deal with unforeseen changes. Rosetta was a guided missile: over half of its launch weight was taken up by fuel. That cost a lot at launch time, but it gave it the ability to adjust along the way, to make course corrections, and to opportunistically change its future position. It could avoid obstacles that would have ended Voyager. "Voyager 1 and Rosetta were two very different space probes... How they accomplished their missions is a lesson in planning." How Voyager and Rosetta were managed reflect different approaches to planning, including financial plans. My life now is so different than what it was five years ago. I have a dog, a mortgage, and a child. I work for a startup. I can’t imagine what my life will be like 5 years from now. I can’t plan like Voyager, I have to plan like Rosetta. So, when I plan, I need to expect some future flexibility: Some ability to opportunistically make the most of circumstances when they come up. The humility to let go of some ambitions when my priorities change. How Betterment Guides Your Investment Deposits One of the questions Betterment helps customers answer is “How much do I need to save?” We could provide you with a simple number, say $750 per month. That number is a bullet calculation. It will likely never be perfectly right in hindsight. For any given goal you set up at Betterment, our own advice and projections forecast that there is roughly a 20% chance you’ll be within ± 5% of your target balance if you took our initial advice and never refreshed it. But, since there’s a 60% likelihood of reaching your target based on our initial deposit recommendation, our saving behavior needs to be future-flexible—to account for how the future actually pans out. So what does being future-flexible look like? How much extra fuel might you need? In this article, we describe how our deposit recommendations really work. We make deposit recommendations by simulating possible futures. The analysis we’ll describe in this article—the analysis that informs how much we recommend you deposit—is based on our hypothetical simulations of Betterment’s recommended portfolios’ expected investment returns, because that assumed rate of growth informs how much we recommend you deposit. We do simulations to be highly realistic about our deposit advice. Not only that, we simulate the portfolios’ returns using our standard projection methodology taking into account our advice for portfolio allocations based on your goal, and assumptions about an individual’s savings behavior. In this article, to make our examples easier to understand, let’s assume your goal is for a major purchase with a target of $100,000 in 10 years. To be clear, our simulations, which are month by month, will assume that your portfolio follows our recommended portfolio strategy and target allocation. They also assume that the hypothetical returns include immediate dividend reinvestment, which is built into how Betterment operates—and a flat 1% risk-free rate of return. Further, we assume performance is net of the 0.25% annual management fee. The different scenarios you’ll see come from the distribution of possible expected returns. We generate 100 such portfolio return paths, and then for each path simulate the behavior of an individual using either a ‘regular’ deposit strategy or a ‘ratchet’ deposit strategy. In the ‘regular’ case, the individual saves the amount we recommend every month. In the ‘ratchet’ case, she saves the greater of our recommended amount, or their previous months amount. The recommended amounts vary based on the simulated portfolio performance. Since this is an illustration of how deposit recommendations should work—not actual portfolio performance—we’ve simplified for your convenience. Remember that these simulations should be considered illustrative and hypothetical. It’s better to be precisely right than approximately wrong. Let’s start by looking at how our savings advice might change over time. We’ve done a single backtest before that examines a possible poor market scenario, but a more thorough analysis, like a Monte Carlo simulation, offers a much richer view of how advice should change in response to future scenarios. The charts below show how we’ve put this kind of analysis into action at Betterment in our advice on saving. Our recommendation changes over time in response to positive or negative market movements. Underlying our simulation is an investment goal ten years away with a target stock-to-bond allocation that follows our recommended moderate glidepath. You can see that there is a wide spread of recommended monthly deposits over time and that most paths involve changing how much you save. In general, that’s not a bad recommendation because most of us are likely to make more money over time. Gentle increases to how much we recommend depositing makes for fairly acceptable advice. Yet, notice the far right side of the figure. If you were to experience poor performance leading up to the date of your goal, the only thing we can do is recommend to increase your deposit abruptly. The figure above shows Betterment’s recommended deposit amounts for a sample goal following our glidepath. The figure is based on the hypothetical simulations mentioned above, and is meant to show how our auto-deposit recommendations are likely to vary over time due to realized returns being higher or lower than planned for (based on our own projections). The graph is in no way meant to guarantee any type of investment performance. When we analyze such problematic possibilities in these unfriendly scenarios, we can start to find ways of making the smart pivots of a Rosetta-like journey. For instance, let’s assume any increases of >2% per year more than our starting recommended deposit amount are unacceptable (i.e., too much acceleration), and any increase of more than 6% over a 12 month period is also unacceptable (i.e. too much jerk—read more). Using these assumptions, we see unacceptable change at some point in time in 55% of the possible scenarios. Let’s be honest: that is a high rate for having to change your savings amount up by an unexpected and unacceptable amount. As an advisor, we don’t like making that kind of recommendation, and as an investor, you’re not likely to be able to follow it. Instead of settling for such a high hit rate, we should expect to have to change over time and let those expectations shape our advice on how much you should save and invest. Making More Rosetta-like Savings Recommendations What can we do to help reduce the need for these bumps up and down? How about a simple behavioral strategy, called a savings ratchet. A savings ratchet means you increase how much you save when you have to, but never decrease it afterwards. Below we show the month-to-month changes from a regular (downward adjusting) strategy versus a ratchet (only adjust upward) strategy. The figure above shows Betterment’s current recommended auto-deposit amounts for the hypothetical sample goal used in the simulations. It shows how our recommendations are likely to vary over time due to differences in projected and actual returns. The “ratchet” is a variant of Betterment’s savings advice, which will only increase over time, as explained below (versus regular goal savings advice that might decrease auto-deposits for a variety of reasons). The “ratchet” figure is hypothetical in nature, and not meant to guarantee any type of investment performance. Rather, it is meant to indicate how a “ratchet” strategy recommends only increasing deposits over time. As shown in the graph, ratcheting savings rates can produce greater final portfolio values, with only slightly more in total deposits. The ratchet uses market downturns as catalysts to help save more, but it doesn’t use performance above expectations as a reason to save less. As a result, future market drops can have a much smaller effect, and we don’t need to save more. The hypothetical ratchet strategy above sees unacceptable increases in only 24% of the simulations we ran, or less than half the original strategy. This chart shows final portfolio values for the simulations described above. You can see that for the total deposits made using a ratchet strategy, the range of final portfolio values has a broader possible range, compared to the regular strategy. However, please note that these are only simulations, and do not fully reflect the chance for loss or gain. Actual results of applying these strategies can vary from the results above. A missile like Rosetta makes the most of ongoing optionality. So does Betterment. Optionality is when you reserve the right to do something in the future, like when you pay for just the option to buy a certain security at a certain price in the future. Financial plans shouldn’t be bullets like Voyager 1: we’re likely to miss if we actually set it and forget it. Plans should be guided. But we need to strategically use fuel—our deposits—in a way that maximizes optionality in the future. Optionality isn’t free. A ratchet savings strategy does require more in deposits over time. But the optionality has value in that the other choice is to stick with the relatively high possibility of needing to deposit more than you have to reach your goal too close to its date. In the case of Betterment’s deposit recommendations and our advice for saving in general, we try to guide toward greater optionality: Maximizing your ability to adjust your goals as they change and re-prioritize where your savings are going. Sometimes that means realizing you won’t achieve certain goals you care about. But often it means purchasing some future optionality you’re not sure you’ll need. This post was inspired by The Constant Reminder and Hurricanes and Retirement.
Use App-Specific Passwords to Sync Accounts More SecurelyUse App-Specific Passwords to Sync Accounts More Securely It’s easy to set up app-specific passwords so that you can help safely share your Betterment data with your other financial providers. In the days before everyone’s financial accounts were available online—and even still—you might bring a shoebox full of financial statements to an advisor, who would pore over them and manually input your data into a computer system. Any big changes in your financial life would require hauling in a new shoebox full of statements, and a whole new round of manual inputs. If this sounds inefficient, it is. But like many things in our lives, technology now makes this much, much easier and better. Data aggregation is the general term for the process of streamlining, sharing, and storing financial information among financial institutions and financial applications, as well as the technology that facilitates it. This can be an incredibly powerful tool, allowing you to better organize a financial life that spans multiple accounts at multiple institutions: in addition to your Betterment account, you might have 401(k) accounts at your job, checking and savings accounts at large national banks, as well as student loans and credit card balances. But, sharing data also raises concerns about security, and you may wonder steps you can take to help protect your financial information while taking advantage of all of the benefits of aggregation. This article encourages you to consider using a technology to help protect your data that is widely available but less widely used than it should be: the application-specific password (or “app-specific password” for short). Tools that help sync external accounts offer a more holistic view of your finances but can lead to potential security risks. To help you understand what the app-specific password is, and why we recommend that you use them, it will be helpful to talk briefly about how companies typically use and share financial data within the data aggregation ecosystem. Sharing data between applications raises the competing concerns of 1) making sure that you have the ability to authorize the applications you use to access the information you need while 2) also making sure that your sensitive financial information—for example, the value of your financial accounts, or transaction data about how and where you spend your money—is secure. Betterment takes the security of your information incredibly seriously, both when we receive your data from an aggregator, and when we provide your data to third-party applications. Generally speaking, companies can be classified into three buckets in the data aggregation ecosystem. First, there are financial institutions, such as banks or brokerages, which are sources of financial account data. Next, there are “third-party applications,” which use financial information to provide other services. And third, there are data aggregators, which are the intermediaries that connect financial institutions with third-party applications. In different contexts, Betterment is both a consumer and a producer of financial data. On the data consumer side, Betterment gives you the option of syncing your external accounts to your Betterment goals. Betterment also is a source of account data for other third-party applications. For example, you may use tax preparation software and want to export transactional data from your Betterment account to the tax software. Or, you may use budgeting software and want to sync your Betterment account to it. App-specific passwords offer a middle ground between complete security and complete visibility of your accounts. App-specific passwords offer a middle ground between the highest levels of security and the maximum ease of data sharing. An app-specific password is generated by the financial institution that produces data that you, as a financial consumer, might want to share with a data aggregator or a third-party application. For example, you can generate a Betterment app-specific password for Mint, go to Mint, and enter that password, rather than your actual login credentials. Importantly, this means that third parties won’t have the ability to make changes to your account or withdraw money from your account. Since an app-specific password provides read-only access to your data, if a third-party application is subject to a hack or data breach, you can sleep easily knowing that a hacker who obtained your app-specific password would not be able to gain full access to your account as a result of that breach. App-specific passwords compare favorably with other types of data aggregation technologies. One of these is “screen scraping,” which allows an aggregator or third-party application to log in to a financial account and capture the information that appears on the screen. There are serious downsides to this approach. Every time you share your user credentials, it increases the opportunities for a bad actor to obtain them; a hacker could compromise your account if it breaches the data aggregator or third-party application. And, because screen scraping requires sharing credentials that provide complete access to the underlying account, anyone who obtains those credentials has the potential to steal not only your data, but possibly to transfer money out of your account as well. An alternative is an application-programming interface, or “API.” An API is a protocol or link between two applications that facilitates the exchange of data. There are many different approaches to creating APIs, but they typically allow the customer to exercise control over the data that is shared, including the ability to turn off access to the data whenever the customer wants. APIs have their drawbacks as well. Because they can be technically complex, APIs can be expensive to build. APIs also don’t follow any set technical standard, and unfortunately, many large financial require that data aggregators and third-party applications build to particular technical specifications that apply only to that one institution’s data. The end result is that APIs make sharing data more complex and, as a result, more expensive for you. Although Betterment is certainly supportive of the data aggregation industry moving toward a shared open architecture framework for APIs (meaning that everybody uses the same technical specifications), we’re not there yet. It will take time, money, and coordination between financial institutions, data aggregators, third-party applications, and regulators to ultimately make that vision a reality. In the meantime, we highly recommend that you take advantage of app-specific passwords, where available, to help protect the data that you share through aggregation. When you use Betterment, we make it easy for you to set up app-specific passwords. Here is a step-by-step guide for setting up an app-specific password to use when sharing your Betterment data. First, go to "Security" within Settings when you log in; scroll down to the section called “App passwords.” This is what you’ll see: When you are asked to generate a new app password, Betterment’s interface will then generate credentials for you to use to input into the third-party application, such as Mint or TurboTax. By entering this password, the application will get access to the data it needs in a read-only format, without providing full access to your Betterment account. And, just like with an API, you have total control over how long the third-party application has access to your data. To end that access at any time, all you need to do is navigate back to the “App passwords” section on "Security" and click “Revoke,” which will terminate the permission associated with the app-specific password to access your data. Use Betterment’s app-specific passwords, and encourage your other providers to adopt them. We hope that you will consider using app-specific passwords where they are available, and that you will push your other financial service providers to make them available if they aren’t already. Using them may be a very small hassle now, but could save you major headaches down the road.
How Does Betterment Calculate Investment Returns?How Does Betterment Calculate Investment Returns? Understanding and using time-weighted and money-weighted returns within your Betterment dashboard. Investors often want a simple answer to a seemingly simple question: how is my money doing? While it’s relatively easy to calculate any one performance figure, understanding it and knowing how to use it can be more of a challenge. When you log in to Betterment, we calculate the following return metrics under “Performance” for each of your goals: A time-weighted return Two money-weighted returns: simple return and internal rate of return Here, we try to help you better understand each way of looking at returns, when you should use each measure, how to compare them, and the dangers of misunderstanding them. We even provide an interactive calculator (see below) that you can use to test with the different calculations. Time-Weighted Return Time weighted returns are the most common way investors will see a return communicated. A time-weighted return can be thought of as the return on the initial balance of an investment over a certain period. For example, investing $1 in the S&P 500 for one year. Common indices, such as the S&P 500, are reported in time-weighted returns. Time weighted returns can refer to a price-only return, or a total return (price and income/dividends). Price returns reflect only the change in price of the asset, while total returns reflect both price and reinvested income. By default, Betterment displays total returns. If you have an investment account in which you, the investor, control the cash flows into and out of the portfolio, and you want to judge the performance of the investments without the distortion introduced by your cash flow timing, you should use a time-weighted return. For that reason, it is the only method you should use to compare the performance of different investments or of a single investment against a benchmark, making it the industry standard return methodology for financial advisors. Money-Weighted Returns: Two Measures 1. Internal rate of return If you want to judge the overall performance of an investment including both investment returns and timing of cashflows, then you should use a money-weighted return. This is true if you use an investment manager who controls when cash is invested, or if you are managing cash flows yourself and wanted to check your performance. The math gets more complicated here, but the concept is simple: When there is more money in the account, its performance is given more weight than when there is less. That way, an investment that has a lot of your money invested when your portfolio is appreciating, and then only a little when it is depreciating, will have that good timing (or good luck!) reflected in a money-weighted return. It almost never makes sense to compare internal rates of return across accounts or managers, since it includes differences resulting from both your cashflows and differences in investment performance. 2. Simple Return The return on an investment is most simply defined as the amount you gained as a percentage of the amount you invested. The simple return is a good back-of-the-envelope calculation that can work perfectly when you’ve only made a single investment, but in most common circumstances will not be a good judge of the growth of your portfolio. If you invested $100,000, and after a year you have $110,000, you can safely describe your return as 10%. But, consider what happens if you were to invest an additional $400,000 at the end of that year. Using the same calculation, you’d now find your simple return to be 2%. Did your investment performance suddenly drop by 8%? Thankfully, no. That is the major limitation of a simple return—it treats all of the deposits into an investment account as having happened at the same time as the first deposit. For more information on Betterment's approach to designing how your investment returns appear in our digital advice, read about our principled display approach.
How Portfolio Rebalancing Works to Manage RiskHow Portfolio Rebalancing Works to Manage Risk Portfolio rebalancing, when done effectively, can help manage risk and keep you on track to pursue the expected returns you want to reach your goals. What is rebalancing? Over time, the value of individual ETFs in a diversified portfolio move up and down, drifting away from the target weights that help achieve proper diversification. Over the long term, stocks generally rise faster than bonds, so the stock portion of your portfolio will likely go up relative to the bond portion—except when you rebalance the portfolio to target the original allocation. The difference between the target allocation for your portfolio and the actual weights in your current portfolio (e.g. your actual allocation) is called portfolio drift. Measuring Portfolio Drift At Betterment, we define portfolio drift as the total deviation of each asset class (put in positive terms) from its target allocation weight, divided by two. Here’s a simplified example, with only four assets: Target Current Deviation (±) U.S. Bonds 25% 30% 5% International Bonds 25% 20% 5% U.S. Stocks 25% 30% 5% International Stocks 25% 20% 5% Total 20% Total ÷ 2 10% A high drift may expose you to more (or less) risk than you intended when you set the target allocation, and much of that risk may be uncompensated—meaning that the portfolio isn’t targeted higher expected returns by taking on the additional risk. Taking actions to reduce this drift is called rebalancing, which Betterment automatically does for you in several ways, depending on the circumstances, and always with an eye on tax efficiency. Cash Flow Rebalancing This method involves either buying or selling, but not both, and generally occurs when cash flows into or out of the portfolio are happening anyway. Cash flows (deposit, dividend reinvestment or withdrawal) can be used to rebalance your portfolio. Fractional shares allow us to allocate these cash flows with precision to the penny. Inflows: You may be rebalanced if you make a deposit, including when you auto-deposit or receive dividends in your account. We use the inflow to buy the asset classes you are currently under-weight, reducing your drift. The result is that the need to sell in order to rebalance is reduced (and with sufficient inflows, eliminated completely). No sales means no capital gains, which means no taxes will be owed. This method is so desirable that we’ve built it directly into our application. Whenever your drift is higher than normal (approximately 2% or higher), we calculate the deposit required to reduce your drift to zero, and make it easy for you to make the deposit. Although we show the deposit amount needed to bring drift back to 0%, smaller deposits also help reduce drift. In fact, the first dollars deposited have the largest impact on reducing drift. This means, for example, that depositing half the amount recommended to reduce drift to 0% will generally reduce drift by more than half. Portfolio Drift vs. Deposit Size The chart above is a hypothetical, illustrative example of the relationship between portfolio drift and deposits needed to rebalance without selling any assets. The blue line in the chart demonstrates the general relationship between deposit size and drift. As you can see, the first dollars of a deposit reduce drift by more than the last dollars. The dotted grey line shows what a linear relationship between drift and deposits would look like. Withdrawals (and other outflows) are likewise used to rebalance, by first selling asset classes that are overweight. (Once that is achieved, we sell all asset classes equally to keep you in balance.) We employ a sophisticated ‘lot selection’ algorithm called TaxMin within asset classes to minimize the tax impact as much as possible in taxable accounts. Sell/Buy Rebalancing In the absence of cash flows, we rebalance by selling and buying, reshuffling assets that are already in the portfolio. When cash flows are not sufficient to keep your portfolio’s drift within a certain tolerance, we sell just enough of the overweight asset classes, and use the proceeds to buy into the underweight asset classes to reduce the drift to zero. Sell/Buy rebalancing is triggered whenever the portfolio drift reaches or exceeds 3%. Our algorithms check your drift approximately once per day, and rebalance if necessary. Note: In addition to the higher threshold, we built in another restriction into the rebalancing algorithm for taxable accounts. As with any sell trade, our tax minimization algorithm selects the lowest tax impact lots, but stops before selling any lots that would realize short-term capital gains. Since short-term capital gains are taxed at a higher rate than long-term capital gains, we can achieve higher after-tax outcome by simply waiting for those lots to become long-term before rebalancing, if it’s still necessary at that point. As a result, it’s possible for your portfolio to stay above the 3% drift if we have no long-term lots to sell. Almost always, it’s because the account is less than a year old. In this case, we recommend rebalancing via a deposit to avoid taxes. The Portfolio Tab will let you know how much to deposit, as described above. Please note that for advised clients on our Betterment For Advisors platform, the drift threshold is 5% for portfolios that contain mutual funds. Allocation Change Rebalancing Changing your target allocation by moving the allocation slider and confirming the change will also cause a rebalance. Because you have chosen a new target allocation, Betterment will rebalance to the new target with 0% drift. This sells securities and could possibly realize capital gains. Moreover, if you change your allocation even by 1%, you will be rebalanced entirely to match your new desired target allocation, regardless of tax consequences. As with all sell trades, we will utilize our tax minimization algorithm to help reduce the tax impact. Additionally, before you confirm your allocation change we will let you know the potential tax impact of the change with Tax Impact Preview. Transaction Timelines If you’d like to turn off automated rebalancing so that Betterment only rebalances your portfolio in response to cash flows (i.e., deposits, withdrawals, or dividend reinvestments) and not by reshuffling assets already in the portfolio, please contact Customer Support. Our team will be happy to help you do this.
Take on More Control with Flexible PortfoliosTake on More Control with Flexible Portfolios You may be an experienced investor who enjoys Betterment but would like to change aspects of our recommended portfolios. Enter Flexible Portfolios. Do you ever find yourself thinking... “I like the Betterment Portfolio in general, but I wish I could make some adjustments.” “I hold a lot of large-cap stocks outside of Betterment. Can I adjust the weight of my small- and mid-cap holdings to accommodate this?” Some Betterment customers do. That’s why we’ve developed a new feature for adjusting any Betterment goal’s recommended portfolio. We call it Flexible Portfolios. A Flexible Portfolio enables experienced investors to adjust the individual asset class weights in the Betterment Portfolio Strategy. At Betterment, our investment philosophy says that any investor should be aligned to their investments through a personalized financial plan. If you have views on your investments that differ from Betterment’s advice, we know it will be challenging for you to pursue that plan effectively. Just as we give you personalized control to follow our allocation advice or not, Flexible Portfolios helps investors follow Betterment’s broad array of financial advice without being limited to the specific individual asset class weights we recommend. How do Betterment Flexible Portfolios work? Start with the Betterment Portfolio Strategy. Betterment’s financial advice has several layers, and the portfolio we recommend to you (specifically, our stock allocation advice) is just one of them. At the core is Betterment’s evidence-based approach to building a diversified, risk-efficient portfolio strategy and our cost-aware selection of ETFs. Flexible Portfolios lets you benefit from this evidence-rich approach to building portfolios, but turns the control over to you for the weight of each asset class. Adjust portfolios based on each of your investment goals. At Betterment, a portfolio’s allocation is recommended to pursue a specific goal. A Flexible Portfolio enables you to take control of the portfolio for any given goal. If you have two different investment goals, you can use a Flexible Portfolio for one, and Betterment’s recommended portfolio for the other. Or different Flexible Portfolios for each goal. Take advantage of automation and tax optimization recommendations. Although use of a Flexible Portfolio means you’re not following Betterment’s portfolio recommendation, you still enjoy the same automation and tax features that help you save time and taxes while reaching your financial goals. The features include Tax Loss Harvesting+™, Tax Coordination™, and Tax Impact Preview, as well as features that help you automate your financial planning: auto-deposit, automatic rebalancing, and no manual trading. Get principled feedback on your Flexible Portfolio. For those who want the control offered by Flexible Portfolios, Betterment still provides immediate feedback on your adjustments. If you review Betterment’s principles for investing success, you’ll see that we believe maintaining diversification to manage risk is paramount. That’s why for any Flexible Portfolio you create, we’ll rate the resulting diversification and your relative risk before you make any investment switches. We want any customer with a Flexible Portfolio to understand the risks of a portfolio that is outside our recommendation. You can get started using a Flexible Portfolio by editing the portfolio strategy on an existing goal—then choosing “Design a Flexible Portfolio.” Or, if you’re starting a new goal, choose “See other portfolios” when viewing our recommended portfolio to start a Flexible Portfolio. When does a Flexible Portfolio make sense? You can think of a Flexible Portfolio as a decision to take personalized control of your portfolio and deviate from Betterment’s recommendation. So, while small changes should not cause dramatic shifts in your expected investment outcomes, this feature is intended for experienced investors, and only those who have acceptable reasons for building a Flexible Portfolio. Our intention in offering Flexible Portfolios is to give you the option of control to tailor your portfolio while benefiting from the rest of Betterment’s advice. It’s part of our broader methodology of personalizing investment management: We offer guidance personalized to you for the aspects of your life we can reasonably help with, but we also give you a degree of control. Flexible Portfolios is one more way we offer you that control.
Managing Your Allocation As Your Goal ApproachesManaging Your Allocation As Your Goal Approaches Automatically adjusting your allocation is one area of advice where automation can play a particularly important role for investors. “Am I holding the right kind of investments in my portfolio?” “Am I taking on too much risk by staying invested in stocks?” “Am I being too conservative by holding bonds?” These are questions that are often on the top of an investor’s mind. And rightly so, especially when a major life goal, like retirement, starts to feel closer than it used to. Taking on too much market risk could lead to losses for investors who plan to use their money soon. But taking on too little risk may mean leaving returns on the table. It’s during the countdown of an investment’s time horizon when many investors begin to feel less certain of what their allocation should be. This is when professionally managed allocation advice can help you reach your desired outcome. In this article, we will: Describe how portfolio allocation advice works Demonstrate how automation enables advisors—like Betterment—to implement more precise allocation advice Illustrate how Betterment customers can stay on track by enabling us to auto-adjust their allocation as their investment approaches the date they wish to use the money. The Essentials of Understanding Allocation Advice Every account you hold has a portfolio, and that portfolio is defined by its asset allocation. That’s your specific weighting of stocks and bonds in your portfolio strategy, usually calibrated to control risk. One of the most important roles an investment advisor can play is helping you tailor your allocation based on your investment goals. In a conventional advisory setting, changes to your allocation might occur periodically—perhaps once per year—leading to a stairstep-like fall of your allocation’s risk (i.e., more bonds and less stock over time). At Betterment, adjusting an allocation is one area of advice where automation can play a particularly important role for investors. As long as you choose to follow Betterment’s advice, we will automatically adjust your allocation through time to control risk as you near the end of your goal’s investing timeline. Rather than downshifting risk every so often, leading to a series of stairsteps, Betterment’s automation makes incremental changes to your risk level, rendering a smoother path from a higher risk level to a lower one. The smoother the path, the closer you stay to your optimal allocation. The below chart is an example that shows the target allocation for a Major Purchase goal that an investor would have if she updated her target allocation annually compared to more frequent monthly updates. As you can see, the size of any individual portfolio change is smaller when allocation is updated monthly. Major Purchase Target Allocation through Time The quality of the allocation advice an advisor offers depends heavily on how effectively they enable you to execute on that advice. Betterment provides full transparency on how we’ve designed our allocation advice to work here, but more importantly, we help you execute the advice through automation. Automation enables more precise allocations. For most accounts, the ideal allocation is one that changes to reduce risk as you near your goal. While some investors prefer to make every allocation change themselves, automation can help adjust an allocation with as much efficiency as possible. Think of it like a plane’s automatic landing system; in weather conditions that can be hard for a pilot to navigate, the automatic landing system helps put a plane in position to land safely. Similarly, automatic adjustment of your allocation helps keep you on track to meet your goal. Allocation advice should be personal. The key with allocation advice is to base the advice on well-researched evidence for appropriate risk levels. At Betterment, for every account you open, we automatically provide allocation advice based on the type of goal assigned to an account and your investment horizon. Different investment goals are used in very different ways. For example, a retirement goal generally has a long time horizon, and, once you reach retirement, you will potentially spend that money for the next 30 years or more. This requires a very different portfolio allocation than if you are saving for a major purchase, like a house, where the investment horizon is generally shorter and you will spend the full amount at once on your down payment. Appropriate allocation advice will consider these factors for each goal and frequently reassess them to ensure risk remains in control. Allocation advice should be executed tax-efficiently. The problem with some forms of allocation advice is that they are not executed tax-efficiently. Any change to an allocation can involve selling investments, which may cause taxes. The ideal allocation advice adjusts the allocation in a manner that causes an investor to realize the fewest possible capital gains taxes. For Betterment customers, we use the cash coming in and out of your account, as well as market changes, to help avoid sales that might causes taxes. Deposits, withdrawals, and dividends help us guide your portfolio toward the target allocation without having to sell assets—which may result in taxes—to reach the right balance. Similarly, because our allocation advice allows a degree of drift from your target allocation, we can use changes in the market to help you balance your portfolio tax-efficiently and without unnecessary trading. If adjusting your allocation causes us to sell your investments, we use our TaxMin algorithm to minimize any potential tax impact. When we sell an investment, we first look for shares that have losses, which may be used to offset other taxes, then we sell shares with the smallest embedded gains (and smallest potential taxes). By auto-adjusting allocations, Betterment helps save you time—and much more. As explained before, your allocation advice is only as good its capacity for implementation. If you plan to follow our allocation advice but adjust your allocation yourself, it can be time-consuming and a challenge to make the necessary changes as tax-efficiently as you might want to. By allowing Betterment to auto-adjust your allocation based on our advice, you not only save time but also gain the tax-efficiency of a smoother path from higher risk to lower risk. Near the end of an investment’s term, when account balances are often at their highest, most investors want to feel certain about what their final balance will be. A market downturn at the end of your investment period will cause a worse dollar loss than a similar-sized downturn earlier on, when your balance was likely smaller. Auto-adjusting an allocation helps you gain greater certainty without having to worry about making major changes. It saves time and adds efficiency, but more importantly helps you gain peace of mind. And even as you automate your allocation, you can always know exactly how your allocation will change because Betterment provides full transparency on how our allocation advice varies by goal, and your account will always detail what your current allocation is. At Betterment, our goal is to help you feel confident that you are taking an appropriate amount of risk through the life of your investment and that, as allocations change in your account to control risk, they are being managed efficiently.