Product Guides

Introducing the Innovative Technology Portfolio If you believe in the power of tech to blaze new trails, you can now tailor your investing to track the companies leading the way. The most valuable companies of today aren’t the same bunch as 20 years ago. With each generation comes new challengers and new categories (Hello, Big Tech). And while we can’t predict the next class of top performers exactly, innovation will likely come from parts of the economy that use technology in new and exciting applications, industries like: semiconductors clean energy virtual reality artificial intelligence nanotechnology This dynamic led us to create and add the Innovative Technology portfolio to our group of low-cost, diversified, and managed portfolios. What is the Innovative Technology Portfolio? The portfolio increases your exposure to companies pioneering the technology mentioned above and more. These innovations carry the potential to reshape the way we work and play, and in the process shape the market’s next generation of high-performing companies. Using the Core portfolio as its foundation, the Innovative Technology portfolio is built to generate long-term returns with a diversified, low-cost approach, but with increased exposure to risk. It contains many of the same investments as Core, but swaps specific exposures to value stocks with an allocation to the SPDR S&P Kensho New Economies Composite ETF (Ticker: KOMP). For a more in-depth look at the portfolio’s methodology, skip over to its disclosure. How are pioneering companies selected? The Kensho index that KOMP tracks uses a special branch of artificial intelligence called Natural Language Processing to screen regulatory data and identify companies helping drive the Fourth Industrial Revolution. After picking companies across 22 categories, each is combined into the overall index and weighted according to their risk and return profiles. Why choose this portfolio over Betterment’s Core portfolio? We built the Innovative Technology portfolio to perform more or less the same as an equivalent stock/bond allocation of the Core portfolio. It may, however, outperform or underperform depending on the return experience of KOMP and the companies this fund tracks. So, if you believe the emerging tech of today will drive the returns of tomorrow—and are willing to take on some additional risk to make that bet— this is a portfolio made with you in mind. Risk and early adoption go hand-in-hand, after all. Why invest in innovation with Betterment? Full disclosure: we’re a little biased when it comes to making bets on new frontiers and the plucky companies exploring them. We may be the largest independent digital investment advisor now, but the category barely existed when we opened shop in 2008. Innovative tech is in our DNA, so when you invest in it with Betterment, you not only get our professional portfolio management tools, you get an advisor with first-hand experience in the field of first movers.

Addressing Tax Impact with Our Improved Cost Basis Accounting Method Selecting tax lots efficiently can address and reduce the tax impact of your investments.  We use advanced tax accounting methods to help make your transactions more tax-efficient. When choosing which lots of a security to sell, our sophisticated method factors in both cost basis as well as duration held. When you make a withdrawal for a certain dollar amount from an investment account, your broker converts that amount into shares, and sells that number of shares. Assuming you are not liquidating your entire portfolio, there's a choice to be made as to which of the available shares were sold. Every broker has a default method for choosing those shares, and that method can have massive implications for how the sale is taxed. Betterment's default method seeks to reduce your tax impact when you need to sell shares. In the chart below, you can see the tax impact of an actual $150,000 withdrawal made by a Betterment customer with New Jersey listed as their state of residence. The withdrawal sold some of several ETF positions in a $1,000,000+ portfolio. Assuming tax rates consistent with their input income, Betterment saved this customer $11,122 in state and federal taxes, just by having a better default selling method. Betterment saves a customer $11,122   Typical FIFO selling Betterment's TaxMin selling Ticker Gain/Loss Short or Long Term Gain/Loss Short or Long Term VTI $23,639 Long $11,771 Long VEA $10,378 Long $4,410 Long VWO $7,472 Long $2,628 Long MUB $7 Long -$3 Short EMB -$10 Long -$20 Short VTV $6,193 Long $2,130 Long VOE $5,571 Long $2,714 Long VBR $6,704 Long $4,144 Long Total ST Gain/Loss $0   -$22   LT Gain/Loss $59,955   $27,797   Tax Owed: $20,714 $9,592 *Actual customer withdrawal of $150k in April 2021 as a resident of New Jersey, with input annual income of $220,000 and single tax-filing status with no dependents. This calculation assumes that this customer takes the standard deduction when filing taxes, a state capital gains rate of 10.75%, and federal tax rates on short and long term gains of 40.8% and 23.8%, respectively, both inclusive of the net investment income tax of 3.8%. State of residence and other client information may materially affect the outcome or projection of tax minimization technology. The real life scenario listed in this example may not apply to all clients and is not a guarantee of similar results. Tax savings are net of Betterment’s fee of 25 BPS. Basis reporting 101 What's going on here? How can internal accounting result in such a drastic difference? First, some background. The way investment cost basis is reported to the IRS was changed as a result of legislation that followed the financial crisis in 2008. In the simplest terms, your cost basis is what you paid for a security. It’s a key attribute of a so-called “tax lot”—a new one of which is created every time you buy into a security. For example, if you buy $450 of Vanguard Total Stock Market ETF (VTI), and it’s trading at $100, your purchase is recorded as a tax lot of 4.5 shares, with a cost basis of $450 (along with date of purchase.) The cost basis is then used to determine how much gain you’ve realized when you sell (and the date is used to determine whether that gain is short or long term). However, there is more than one way to report cost basis, and it’s worthwhile for the individual investor to know what method your broker is using—as it will impact your taxes. Brokers report your cost basis on Form 1099-B, which Betterment makes available electronically to customers each tax season. Better tax outcomes through advanced accounting When you buy the same security at different prices over a period of time, and then choose to sell some (but not all) of your position, your tax result will depend on which of the shares in your possession you are deemed to be selling. The default method stipulated by the IRS and typically used by brokers is FIFO (“first in, first out”). With this method, the oldest shares are always sold first. This method is the easiest for brokers to manage, since it allows them to go through your transactions at the end of the year and only then make determinations on which shares you sold (which they must then report to the IRS.) FIFO may get somewhat better results than picking lots at random because it avoids triggering short-term gains if you hold a sufficient number of older shares. As long as shares held for more than 12 months are available, those will be sold first. Since short-term tax rates are typically higher than long-term rates, this method can avoid the worst tax outcomes. However, FIFO's weakness is that it completely ignores whether selling a particular lot will generate a gain or loss. In fact, it's likely to inadvertently favor gains over losses; the longer you've held a share, the more likely it's up overall from when you bought it, whereas a recent purchase might be down from a temporary market dip. Clearly, the ability to identify specific lots to sell regardless of when they were purchased could get you a better result, and the rules allow an investor to do so. Yet having to identify specific shares every time you sell is tedious at best, and incomprehensible at worst. Fortunately, the IRS allows brokers to offer investors a different default method in place of FIFO, which selects specific shares by applying a set of rules to whatever lots are available whenever they sell. The problem is that many investors are not even aware there's something they should be overriding, much less which alternative to choose. Upgrading the default method can be a multi-step process through a clunky and confusing interface. While Betterment was initially built to use FIFO as the default method, specific share identification can have such a positive impact on your tax bill that we’ve doubled down to improve our methods. We upgraded our algorithms to support a more sophisticated method of basis reporting, which aims to result in better tax treatment for securities sales in the majority of circumstances. Most importantly, we’ve structured it to replace FIFO as the new default—Betterment customers don’t need to do a thing to benefit from it. Betterment’s TaxMin method When a sale is initiated in a taxable account for part of a particular position, a choice needs to be made about which specific tax lots of that holding will be sold. Our algorithms select which specific tax lots to sell, following a set of rules which we call TaxMin. This method is more granular in its approach, and will improve the tax impact for most transactions, as compared to FIFO. How does this method work? As a general principle, realizing taxable losses instead of gains and allowing short-term gains to mature into long-term gains (which are generally taxed at a lower rate) whenever possible should result in a lower tax liability in the long run. Instead of looking solely at the purchase date of each lot, TaxMin also considers the cost basis of the lot, with the goal of realizing losses before any gains, regardless of when the shares were bought. Lots are evaluated to be sold in the following order: Short-term losses Long-term losses Long-term gains Short-term gains Generally, we sell shares in a way that is intended to prioritize generating short term capital losses, then long term capital losses, followed by long term capital gains and then lastly, short term capital gains. The algorithm looks through each category before moving to the next, but within each category, lots with the highest cost basis are targeted first. With a gain, the higher the basis, the smaller the gain, which results in a lower tax burden. In the case of a loss, the opposite is true: the higher the basis, the bigger the loss (which can be beneficial, since losses can be used to offset gains).1 A simple example If you owned the following lots of the same security, one share each, and wanted to sell one share on July 1, 2021 at the price of $105 per share, you would realize $10 of long term capital gains if you used FIFO. With TaxMin, the same trade would instead realize a $16 short term loss. If you had to sell two shares, FIFO would get you a net $5 long term gain, while TaxMin would result in a $31 short term loss. To be clear, you pay taxes on gains, while losses can help reduce your bill. Purchase Price ($) Purchase Date Gain or Loss ($) FIFO Selling order TaxMin Selling order $95 1/1/20 +10 1 4 $110 6/1/20 -5 2 3 $120 1/1/21 -15 3 2 $100 2/1/21 +5 4 5 $121 3/1/21 -16 5 1 What can you expect? TaxMin automatically works to reduce the tax impact of your investment transactions in a variety of circumstances. Depending on the transaction, the tax-efficiency of various tax-lot selection approaches may vary based on the individual’s specific circumstances (including, but not limited to, tax bracket and presence of other gains or losses.) However, we feel that TaxMin serves the typical Betterment customer far better than FIFO, the default used by most brokers. Note that Betterment is not a tax advisor and your actual tax outcome will depend on your specific tax circumstances—consult a tax advisor for licensed advice specific to your financial situation. This is just one more way we continue to innovate under the hood to maximize your investor returns: net of transaction costs, net of behavior, and net of tax. Footnote 1 Note that when a customer makes a change resulting in the sale of the entirety of a particular holding in a taxable account (such as a full withdrawal or certain portfolio strategy changes), tax minimization may not apply because all lots will be sold in the transaction.

4 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 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.

Tax 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, 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 See visual of No Tax Loss Harvesting 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 See TLH with 30-day Switchbacks visual 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 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 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 0.075%. If each asset class consisted of a 50/50 split between primary and alternate, that cost would be 0.090%—a difference of less than two basis points. Of the 13 asset classes in Betterment’s core taxable portfolio, nine were assigned alternate tickers. Short-term Treasuries (GBIL),Inflation-protected Bonds (VTIP), U.S. Short-term Investment Grade Bonds (JPST), U.S. High Quality Bonds (AGG), and International Developed Bonds (BNDX)  are insufficiently volatile to be viable harvesting candidates. 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 See TLH Switchbacks visual Better wash sale management Managing cash flows across both taxable and IRA/401(k) accounts without needlessly washing realized losses is a complex problem. 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. 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 may create more harvesting opportunities over time. (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? In a full liquidation of a long-standing portfolio, the additional gains due to harvesting could push the taxpayer into a higher LTCG 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.

Portfolio Optimization: Our Secret to Driving Better Performance We optimally blend funds to pursue higher expected investor returns for each asset class. Many investors use a combination of tactics to try 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 Harry Markowitz's Nobel prize-winning research1 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. 1Markowitz, H., "Portfolio Selection".The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91.

Betterment’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.

ETF 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 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 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 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 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 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 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 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 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 cash account that helps you earn a competitive rate—0.75%*. 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 competitive 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 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 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 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 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 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.

Optimizing 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 a higher rate of return relative to its risk. These portfolios seek the “efficient frontier,” otherwise known as the theoretical 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 among 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.

Acceptable 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.

Cash Reserve Has A Variable APY: What That Means For You Interest rates change over time, but at Betterment, we are always working hard to give you competitive rates so you can make the most of your money. Our objectives are aligned with yours: we want to grow your money. Cash Reserve is an 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 competitive interest rates, no matter what the current rate environment may be. See what the current variable interest rate is for Cash Reserve. How does Betterment provide competitive rates? Similar to how select the ETFs in each asset class for your portfolio, we work with a number of program banks to provide you competitive rates. 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.

How 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 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+ 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 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. 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 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. 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.

How 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.

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 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 seeks to select the lowest tax impact lots, and stops before selling any lots that would realize short-term capital gains when possible. Since short-term capital gains are taxed at a higher rate than long-term capital gains, we can achieve higher after-tax outcomes 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 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 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 possible returns on the table. It’s during the countdown of an investment’s time horizon when many investors begin to feel less certain of what their allocation should be. This is when professionally managed allocation advice can help you reach your desired outcome. In this article, we will: Describe how portfolio allocation advice works Demonstrate how automation enables advisors—like Betterment—to implement more precise allocation advice Illustrate how Betterment customers can stay on track by enabling us to auto-adjust their allocation as their investment approaches the date they wish to use the money. The Essentials of Understanding Allocation Advice Every account you hold has a portfolio, and that portfolio is defined by its asset allocation. That’s your specific weighting of stocks and bonds in your portfolio strategy, usually calibrated to control risk. One of the most important roles an investment advisor can play is helping you tailor your allocation based on your investment goals. In a conventional advisory setting, changes to your allocation might occur periodically—perhaps once per year—leading to a stairstep-like fall of your allocation’s risk (i.e., more bonds and less stock over time). At Betterment, adjusting an allocation is one area of advice where automation can play a particularly important role for investors. As long as you choose to follow Betterment’s advice, we will automatically adjust your allocation through time to control risk as you near the end of your goal’s investing timeline. Rather than downshifting risk every so often, leading to a series of stairsteps, Betterment’s automation makes incremental changes to your risk level, rendering a smoother path from a higher risk level to a lower one. The smoother the path, the closer you stay to your optimal allocation. The below chart is an example that shows the target allocation for a Major Purchase goal that an investor would have if she updated her target allocation annually compared to more frequent monthly updates. As you can see, the size of any individual portfolio change is smaller when allocation is updated monthly. Major Purchase Target Allocation through Time The quality of the allocation advice an advisor offers depends heavily on how effectively they enable you to execute on that advice. Betterment provides full transparency on how we’ve designed our allocation advice to work here, but more importantly, we help you execute the advice through automation. Automation enables more precise allocations. For most accounts, the ideal allocation is one that changes to reduce risk as you near your goal. While some investors prefer to make every allocation change themselves, automation can help adjust an allocation with as much efficiency as possible. Think of it like a plane’s automatic landing system; in weather conditions that can be hard for a pilot to navigate, the automatic landing system helps put a plane in position to land safely. Similarly, automatic adjustment of your allocation helps keep you on track to meet your goal. Allocation advice should be personal. The key with allocation advice is to base the advice on well-researched evidence for appropriate risk levels. At Betterment, for every account you open, we automatically provide allocation advice based on the type of goal assigned to an account and your investment horizon. Different investment goals are used in very different ways. For example, a retirement goal generally has a long time horizon, and, once you reach retirement, you will potentially spend that money for the next 30 years or more. This requires a very different portfolio allocation than if you are saving for a major purchase, like a house, where the investment horizon is generally shorter and you will spend the full amount at once on your down payment. Appropriate allocation advice will consider these factors for each goal and frequently reassess them to ensure risk remains in control. Allocation advice should be executed tax-efficiently. The problem with some forms of allocation advice is that they are not executed tax-efficiently. Any change to an allocation can involve selling investments, which may cause taxes. The ideal allocation advice adjusts the allocation in a manner that causes an investor to realize the fewest possible capital gains taxes. For Betterment customers, we use the cash coming in and out of your account, as well as market changes, to help avoid sales that might cause taxes. Deposits, withdrawals, and dividends help us guide your portfolio toward the target allocation while minimizing the need to sell assets—which may result in taxes—to reach the right balance. Similarly, because our allocation advice allows a degree of drift from your target allocation, we can use changes in the market to help you balance your portfolio tax-efficiently and without unnecessary trading. If selling some investments is necessary to adjust your allocation, we use our TaxMin algorithm to minimize any potential tax impact. When we sell an investment that is overweight, we first look for shares that have losses, which may be used to offset other taxes, then we sell shares with long-term capital gains, and lastly short-term capital gains. To learn more about how Betterment approaches tax-efficient investing, please visit this resource. By auto-adjusting allocations, Betterment helps save you time—and much more. As explained before, your allocation advice is only as good as its capacity for implementation. If you plan to follow our allocation advice but adjust your allocation yourself, it can be time-consuming and a challenge to make the necessary changes as tax-efficiently as you might want to. By allowing Betterment to auto-adjust your allocation based on our advice, you not only save time but also gain the tax-efficiency of a smoother path from higher risk to lower risk. Near the end of an investment’s term, when account balances are often at their highest, most investors want to feel certain about what their final balance will be. A market downturn at the end of your investment period will usually cause a worse dollar loss than a similar-sized downturn earlier on, when your balance was likely smaller. Auto-adjusting an allocation helps you gain greater certainty without having to worry about making major changes. It saves time and adds efficiency, but more importantly helps you gain peace of mind. And even as you automate your allocation, you can always know exactly how your allocation will change because Betterment provides full transparency on how our allocation advice varies by goal, and your account will always detail what your current allocation is. At Betterment, our goal is to help you feel confident that you are taking an appropriate amount of risk through the life of your investment and that, as allocations change in your account to control risk, they are being managed efficiently.

Introducing Income Portfolios from BlackRock Partnering with BlackRock, you and your clients can access an income portfolio strategy that delivers cash income while preserving capital. Betterment for Advisors has selected an income portfolio strategy from BlackRock to help advisors offer their clients the opportunity to generate cash income while preserving capital. Nearly a decade of historically low interest rates has forced advisors to take extraordinary measures to help clients reach their investing goals. Meanwhile, one of the longest stock market rallies in history leaves some investors fearing that we’re near a market top, making them too nervous to invest at all. To help you better serve your clients with a preference for a low risk investment strategy, we’re adding a new income portfolio strategy sourced from BlackRock to add to your arsenal of portfolio strategy options. If you’re familiar with BlackRock’s income ETFs, you know that the income portfolio strategy is a diversified 100% bond basket that seeks to provide a steady stream of cash income while minimizing potential loss of capital or stock market volatility. In our portfolio strategy arrangement with BlackRock, we offer four risk levels to choose from, each with different expected levels of income yield. This portfolio strategy will be available to Betterment’s direct retail customers in addition to Betterment for Advisors’ clients. An income portfolio strategy is part of Betterment’s objective for offering customers’ greater personalization to meet their needs and preferences. We see Betterment for Advisors as a critical part of this focus on personalization. You understand your clients’ inclinations and motivations, their beliefs and personal preferences. In order for some investors to use this new income portfolio strategy successfully, they may need guidance from an advisor who understands their situation, and in many cases, we expect Betterment for Advisors to play that role. We are firm in our belief that offering personalized portfolio strategies like this one is a way to grow your business as well as Betterment’s business. Keep reading to explore two scenarios we see this portfolio being potentially useful for your clients. Generating Retirement Income As advisors know well, many retirees value stable income and principal preservation during the later stages of their lives. They also tend to hold most of their wealth in tax-advantaged accounts such as IRAs and 401(k)s. The income portfolio strategy is one way to meet retirees’ preferences. Like with any account you manage through Betterment for Advisors, you can invest a retirees’ entire savings into an income portfolio, or you can use a “bucket approach,” investing a portion of the savings to prioritize income generation, while leaving the rest in stocks for long-term growth. The chart below shows the expected income yields for each of the four risk levels in the income portfolio strategy and how those levels compare to Betterment’s core portfolio strategy with similar levels of risk. Expected Income Yields Betterment Portfolios vs. BlackRock Target Income Portfolios Disclosure: This chart compares the four BlackRock income portfolios available to Betterment against four allocations of Betterment’s core portfolio strategy with similar relative risk levels. All four of the comparison allocations include both stocks and bonds, while BlackRock’s income portfolios are comprised completely of bonds. The Betterment Portfolio’s income yield is comprised of dividends from equities and coupon income from the underlying bonds in the fixed income ETF. The BlackRock Target Income Portfolios’ income yield is comprised solely of coupon income from the underlying bonds in the fixed income ETF. The expected income yields are expressed in annual terms and are based on the historical dividend yields over the past 1-year period ending August 30, 2017 for the individual funds in each of the portfolios, as reported by Yahoo Finance. These expected yields correspond to the time period referenced above for the funds in the relevant portfolios and will change over time as economic and market conditions change. When an economy is expanding (contracting), for example, interest rates will tend to rise (fall) and credit markets will tend to strengthen (weaken) as companies become less (more) vulnerable to defaulting on their debt. These figures do not include the Betterment fee or fund level expenses. The Betterment stock allocations shown here correspond to the Betterment portfolios that have expected volatilities that are closest to the expected volatilities of the four BlackRock income portfolios. The stock-to-bond allocations used for Betterment are: 9% stock to 91% bond, 22% stock to 78% bond, 37% stock to 63% bond and 40% stock to 60% bond. Expected volatilities are estimated based on the historical total returns data for the relevant funds over the past 10 years using the methods of Ledoit and Wolf (2003). This chart is hypothetical and used to illustrate the points discussed in this article. Past performance is not indicative of future results and does not guarantee that any particular result will be achieved. As you can see in the chart above, Betterment’s income portfolios have a higher expected income yield than allocations in Betterment’s core portfolio strategy with comparable risk levels. For example, if a client had a $1,000,000 retirement portfolio, you could invest it in the 40% stock Betterment Portfolio, and the income portion of your client's return would be about $24,000 per year in gross investment income. (Note that the income portion composes only part of the total potential return generated by a Betterment portfolio allocation.) However, if the client invested in the income portfolio strategy with the same level of expected risk, your client could potentially receive an expected $43,000 per year in investment income. It’s also important to note that any income-focused strategy will be inherently less tax-efficient than a strategy that balances income and growth because bond interest is taxed at a higher rate than long-term capital gains. Low Risk Investment Alternative In addition to the retirement use case, we believe the income portfolio strategy could also be useful for clients who show considerable anxiety about the stock market. If your client strongly prefers not to invest in stocks, the income portfolio strategy can be an effective, personalized approach. It’s one way to make sure their money doesn’t sit idly in cash without taking on more risk than they are comfortable with. According to Gallup, 48% of Americans have no money invested in the stock market. And with the best savings accounts paying only slightly above 1% in interest, choosing bonds over cash products can be a nice middle ground that better balances risk and return. The chart below shows the risk (as measured by standard deviation) for various types of bonds over the past 15 years, compared to stocks in large US companies. Comparing Risk The chart shows the risk (as measured by standard deviation) for various types of bonds over the past 15 years, compared to stocks in large U.S. companies. Click respective categories for data on short-term bonds, intermediate-term bonds, long-term bonds, high-yield bonds and large cap stocks. Short-term bonds were almost six times less risky than US large company stocks. Even high-yield bonds, the most risky type of bonds, were almost two times less risky than stocks. It’s worth noting that investing in bonds is generally more costly than investing in stocks, so your clients will pay a higher expense ratio on income portfolio funds compared to funds invested in the core Betterment portfolio. The Betterment portfolio strategy, which contains a mix of stocks and bonds, has annual ETF fees of only 0.07% - 0.16%, depending on the portfolio’s allocation. The income portfolio strategy, while still far lower cost than the industry average, has slightly higher ETF fees of 0.21% - 0.38%, depending on the portfolio’s target income level. Different Income Targets to Meet Clients’ Needs As with the other portfolio strategies we’ve made available to Betterment for Advisors, all of our portfolio strategies can adjust to your clients’ risk tolerance. The income portfolio strategy is no different. The income portfolio strategy includes four different risk levels to choose from, each with different targeted levels of income. The income portfolio strategy is actively managed, so the exact allocations of the underlying bonds is subject to change approximately once per quarter (and up to 6 times per year depending on market volatility). With each rebalance, we allocate to the asset classes that are designed to help your clients maximize their income return while limiting overall volatility. The income portfolio increases projected income by taking on more risk in two main ways: Investing in longer-term bonds: Long-term bonds are more sensitive to changes in interest rates, and thus carry more risk. To compensate for this risk, long-term bonds pay more interest. Investing in lower-quality bonds: When you lend money from less-established companies, the chances of the company defaulting and not paying you back are higher. To compensate for this risk, low quality bonds pay more interest. With this additional strategy to offer your clients, you can personalize your financial planning to match a client’s specific goals, risk tolerances, and viewpoints. Whether you have a retiree who wants to focus on income rather than growth or a nervous investor who would feel better with bonds rather than stocks, we hope this new portfolio offering will help every advisor further personalize their services and offer investors more added value. You can explore the new income portfolio strategy by BlackRock alongside the other portfolio strategies within your advisor portal. Please contact our team with in-depth questions about this new offering and any other features of Betterment for Advisors.

Introducing Our Smart Beta Portfolio Strategy by Goldman Sachs A smart beta portfolio strategy reflects the underlying principles of Betterment’s core portfolio strategy, while seeking higher returns by deviating away from market capitalization in and across asset classes. When it comes to investing in the market, a portfolio strategy should be well aligned with your personal goals and disposition to bear market risks. If you are seeking to outperform a conventional, market-cap portfolio strategy, despite the potential to experience underperformance, our analysis shows there may be a more effective strategy for you. Today, we’re introducing a smart beta portfolio, sourced from Goldman Sachs Asset Management, to help meet the preference of our customers who are willing to take on additional risks to potentially outperform a market capitalization strategy. This smart beta portfolio strategy reflects the same underlying principles that have always guided the core Betterment portfolio strategy—investing in a globally diversified portfolio of stocks and bonds. The difference is that the smart beta portfolio strategy seeks higher returns by moving away from market capitalization weightings in and across equity asset classes. What is a smart beta portfolio strategy? Industry insiders often describe portfolio strategies as either passive or active. Most index funds and exchange-traded funds (ETFs) are categorized as “passive” because they track the returns of the underlying market based on asset class. By contrast, many mutual funds or hedge fund strategies are considered “active” because an advisor or fund manager is actively buying and selling specific securities to attempt to beat their benchmark index. The result is a dichotomy in which a portfolio gets labeled as passive or active, and investors infer possible performance and risk based on that label. In reality, portfolio strategies reside within a plane where passive and active are just two cardinal directions. Smart beta funds, like the ones we’ve selected for this portfolio, seek to achieve their performance by falling somewhere in between extreme passive and active, using a set of characteristics, called “factors,” with an objective of outperformance while managing risk. The portfolio strategy also incorporates other passive funds to achieve appropriate diversification. This alternative approach is also the reason for the name “smart beta.” An analyst comparing conventional portfolio strategies usually operates by assessing beta, which measures the sensitivity of the security to the overall market. In developing a smart beta approach, the performance of the overall market is seen as just one of many factors that affects returns. By identifying a range of factors that persistently drive returns, we seek market-beating performance while managing reasonable risk. When we develop and select new portfolio strategies at Betterment, we operate using five core principles of investing: Personalized planning A balance of cost and value Diversification Tax optimization Behavioral discipline The Goldman Sachs Smart Beta portfolio strategy aligns with all five of these principles, but the strategy configures cost, value, and diversification in a different way than Betterment’s core portfolio. In order to pursue higher overall returns, the smart beta strategy adds additional systematic risk factors that are summarized in the next section. Additionally, the strategy seeks to achieve global diversification across stocks and bonds while overweighting specific exposures to securities included in Betterment’s core portfolio, such as real estate investment trusts (REITs). Meanwhile, with the smart beta portfolio, we’re able to continue delivering all of Betterment’s tax-efficiency features, such as tax loss harvesting and Tax Coordination. Investing in smart beta strategies has traditionally been more expensive than a pure market cap-weighted portfolio. The Goldman Sachs Smart Beta portfolio strategy has a far lower cost than the industry average, with aggregate annual ETF expense ratios ranging from 0.11% to 0.24%, depending on the portfolio’s allocation between stocks and bonds. This is slightly more expensive than the core Betterment portfolio strategy, which has aggregate annual ETF expense ratios of only 0.07% to 0.16%, depending on the portfolio’s allocation. Note: Expense ratios data are from Xignite as of August 30, 2017 Because a smart beta portfolio incorporates the use of additional systematic risk factors, we typically only recommend this portfolio for investors who have a high risk tolerance and plans to save for the long term. Which “factors” drive the Goldman Sachs Smart Beta portfolio strategy? Factors are the variables that drive performance and risk in a smart beta portfolio strategy. If you think of risk as the currency you spend to achieve potential returns, factors are what determine the underlying value of that currency. As analysts, we can dissect a portfolio’s return into a linear combination of factors. In academic literature and practitioner research (Vanguard, Research Affiliates, AQR), factors have been shown to drive historical returns. These analyses form the backbone of our advice for using the smart beta portfolio strategy. Factors reflect economically intuitive reasons and behavioral biases of investors in aggregate, all of which have been well studied in academic literature. Most of the equity ETFs used in this portfolio are Goldman Sachs ActiveBetaTM, which are Goldman Sach’s factor-based smart beta equity funds. The factors used in these funds are equal weighted and include the following: 1. Good Value When a company has solid earnings (after-tax net income), but has a relatively low price (i.e., there’s a relatively low demand by the universe of investors), its stock is considered to have good value. Allocating to stocks based on this factor gives investors exposure to companies that have high growth potential but have been overlooked by other investors. 2. High Quality High-quality companies demonstrate sustainable profitability over time. By investing based on this factor, the portfolio includes exposure to companies with strong fundamentals (e.g., strong and stable revenue and earnings) and potential for consistent returns. 3. Low Volatility Stocks with low volatility tend to avoid extreme swings up or down in price. What may seem counterintuitive is that these stocks also tend to have higher returns than high volatility stocks. This is recognized as a persistent anomaly among academic researchers because the higher the volatility of the asset, the higher its return should be (according to standard financial theory). Low-volatility stocks are often overlooked by investors, as they usually don’t increase in value substantially when the overall market is trending higher. In contrast, investors seem to have a systematic preference for high-volatility stocks based on the data and, as a result, the demand increases these stocks’ prices and therefore reduce their future returns. There are some interesting hypotheses behind this preference. One suggests that investors treat high-volatility stocks as lotteries and are therefore willing to accept lower expected returns by paying a premium to gamble on these stocks. 4. Strong Momentum Stocks with strong momentum have recently been trending strongly upward in price. It is well documented that stocks tend to trend for some time, and investing in these types of stocks allows you to take advantage of these trends. It’s important to define the momentum factor with precision since securities can also exhibit reversion to the mean—meaning that “what goes up must come down.” How can these factors lead to future outperformance? In specific terms, the factors that drive the smart beta portfolio strategy—while having varying performance year-to-year relative to their market cap benchmark—tend to outperform their respective benchmarks when combined, with a high degree of persistence. You can see an example of this in the chart of yearly factor returns for US large cap stocks below. You’ll see that although the ranking of the four factor indexes varies over time, the ranking of the equally weighted index returns is relatively stable and performs better than the S&P 500 most of the years. Hypothetical Performance Ranking of Smart Beta Indices vs. S&P 500 This chart is for illustrative purposes only, and the factor returns it references are not necessarily the same factor returns in the Goldman Sachs Smart Beta portfolio strategy. The chart above compares annual returns (data from Bloomberg) for the period from January 2000 to August 2017 and is used to illustrate the points discussed in this article. For each year, we have ranked the annual performance of each factor alongside an equal weighting of all four factors, using the S&P 500 as a comparison. The returns for Momentum, Quality, Value and Low volatility are calculated from the S&P 500 Momentum Index, S&P 500 Value Index, S&P 500 Quality Index and S&P Low-volatility Index, respectively. “Equal weighting of all four factors” was calculated by Betterment by giving each factor corresponding to each index listed above an equal weight to yield the hypothetical performance figures. This calculation was not provided by Goldman Sachs Asset Management. This analysis is for illustrative purposes only and does not reflect or predict future performance. Moreover, this analysis does not include fees, liquidity, and other costs associated with actually holding a portfolio based on these exact indexes that would lower returns of the portfolio. Why invest in a smart beta portfolio? As we’ve explained above, we generally only advise using Betterment’s choice smart beta strategy if you wish to attempt to outperform a market-cap portfolio strategy in the long term despite potential periods of underperformance. For investors who fall into such a scenario, our analysis, supported by academic and practitioner literature, shows that the four factors above can persistently drive higher returns than a portfolio that uses market weighting as its only factor. While each factor weighted in the smart beta portfolio strategy has specific associated risks, some of these risks have low or negative correlation, which allow for the portfolio design to offset constituent risks and control the overall portfolio risk. Of course, these risks and correlations are based on historical analysis, and no advisor could guarantee their outlook for the future. An investor who elects the Goldman Sachs Smart Beta portfolio strategy should understand that the potential losses of this strategy can be greater than those of market benchmarks. In the year of the dot-com collapse of 2000, for example, when the S&P 500 dropped by 10%, the S&P 500 Momentum Index lost 21% (see chart above). Given the systematic risks involved, we believe the evidence that shows that smart beta factors can lead to higher expected returns relative to market cap benchmarks, and thus, we are proud to offer the portfolio for customers with long investing horizons and a high degree of comfort with the risks involved. To get started, create a new goal account and select the Goldman Sachs Smart Beta portfolio strategy. Or, if you’re not yet a Betterment customer, open an account with our smart beta portfolio strategy. Factors, as applied in investing, can mean different things. In the context of asset allocation, factors are drivers of return within broader asset classes used as a lens to uncover return potential and minimize risk. The Goldman Sachs Smart Beta portfolios examine market capitalization, rates, emerging markets, credit, equity style, commodities and momentum to seek to avoid taking unnecessary risk while pursuing the best opportunities to drive portfolio returns.

Deriving an Assumption on Inflation While our assumption on inflation comes down to a judgment call in the end, we take a thoughtful approach to balancing the information coming from what we believe to be the best sources of data. Expected annual inflation is a key assumption used by our retirement savings and withdrawal advice, which help you plan for the future. To make these calculations, we must assume a specific growth rate for investments, but the rate of return that really matters is the “real” rate of return—i.e. the return adjusted for inflation. This is because the prices of everything that you buy tend to increase over time, so if you want to maintain the same ability to spend, your plans must take into account the fact that goods and services will cost more in the future. An example from Investopedia (that we have revised a bit) helps to illustrate this concept. Say you have $20,000 and want to buy a car that costs this same amount. Instead of purchasing the car now, you could decide to wait and invest the money for 1 year so as to have a cash cushion after buying the car. Assuming that you can earn 5% interest over a 12-month period, you will have $21,000 in one year. So it seems as if you can generate $1000 in savings by delaying your purchase for one year. But say inflation on car prices over the same one-year period is 2%. That same car will cost $20,400 in one year. The actual amount of money that remains after you purchase the car will be $600, i.e., 3% of your initial investment of $20,000. Your purchasing power due to investing only increases by $600 instead of $1000. 3% is indeed your real rate of return as it accounts for the effects of inflation. Multiple factors can drive the inflation rate including economic growth, public policy, and monetary policy. As a result, no one knows with certainty how the prices of the broad set of goods and services that you purchase will increase in the future. There are many different, credible sources of data for developing views on how inflation will evolve over time. No one source is necessarily going to give you the “right” answer so it is important that you use the multiple sources of information that will help you filter signal from noise. While our assumption on inflation comes down to a judgment call in the end, we take a thoughtful approach to balancing the information coming from what we believe to be the best sources of data. These sources include: Forward guidance from the Federal Reserve Market expectations derived from the pricing of US Treasuries and Treasury Inflation Protected Securities (TIPS). Customers with differing views on inflation can also override our assumption via the Edit Assumptions panel, which can be found on the Plan tab of a Retirement goal. We discuss each of these sources as well as our overall thought process in more detail below, but our broad conclusions based on the present state of the data are as follows: The Federal Reserve explicitly aims for an annual inflation rate of 2% over time and has demonstrated effectiveness in keeping inflation anchored to this level. Macroeconomic projections from the Fed also indicate that long-term inflation forecasts remain near 2% if not below this level. As of May 2, 2017, almost all inflation expectation measures derived from market prices suggest that the market expects inflation to be below 2% across multiple short- and long-term horizons. Since these measures are volatile, we will be keeping a close eye on how market expectations evolve going forward, but inflation expectations seem to be well- contained at the moment. Based on all of these sources, we assume a 2% rate of inflation in our financial planning calculations. The Target Inflation Rate The Federal Reserve explicitly states that an inflation rate of 2 percent is most consistent with their mandate for price stability and maximum employment over the long-run.1 But what data are Fed officials using to evaluate ongoing inflation trends? While they monitor multiple measures of inflation, it is widely recognized that the Fed prefers to use the core Personal Consumption Expenditures (PCE) index.2 This core measure strips out volatile components such as food and energy, allowing the Fed to better gauge long-term trends. Note that the monthly, year-over-year percent change in core PCE, a commonly used measure of inflation, has been strongly anchored to 2% since the early 1990s. Through its implementation of monetary policy—the process of raising or lowering the costs of borrowing through the U.S. federal funds rate—the Fed has demonstrated effectiveness in anchoring the long-term inflation rate to 2%.3 Accordingly, at Betterment we account for this trend and model inflation to remain stable for the foreseeable future. PCE Core Inflation Source: Federal Bank of St. Louis FRED, author's calculations However, we recognize that inflation target changes are possible as a result of macroeconomic conditions, political climate, public policy and Fed policy. Indeed, the 2% explicit inflation target itself is relatively new (introduced by Ben Bernanke in January of 2012).4 To address this possibility and help ensure our inflation expectations remain as accurate as possible, we monitor both forward inflation projections and implied inflation rates from the fixed income securities markets. Forward Fed Projections The Fed distributes their macroeconomic projections to the public on each FOMC meeting date (just hours after). These reports include information about the distribution of projections across all 17 Federal Open Market Committee (FOMC) participants for real GDP growth, the overall inflation rate, overall PCE inflation, core PCE inflation and the Fed Funds rate. The median and central tendency5 forecasts for one, two, and three years ahead as well as longer-term are provided. The ranges on the forecasts one, two, and three years ahead are also provided. An example of the Fed report from the March 2017 FOMC meeting is shown below. We monitor these reports closely and focus on any significant changes in projections for PCE and core PCE inflation in particular for any indication that we need to be adjusting our views accordingly. At present, inflation projections are tame with the relevant inflation statistics all near 2% and below this level in many cases. Forward Fed Projection Table Source: Federal Reserve Board Inflation Breakeven Rates Given pricing in the TIPS and US Treasury markets, we can derive the market's expectation for inflation at different horizons. This expectation is often referred to as the breakeven inflation rate. For a given maturity, the breakeven inflation rate is the difference between the yield on a US Treasury note (bond) and the yield on an inflation-protected US Treasury security (also known as TIPS) with the same maturity. If we perform this calculation for a 5-year maturity, for example, we get the market's expectation for inflation over the next five years. How does this make sense as an expectation for inflation? The cash flows on TIPS are tied to the Consumer Price Index (CPI), another common gauge for inflation. The principal on TIPS rises with CPI while the coupon rate represents a real return (i.e., return above inflation). To the extent that the semi-annual coupon payments and the final redemption value of TIPS track increases and decreases in CPI, investing in TIPS serves as a perfect hedge against inflation. In contrast, US Treasury bonds are fully exposed to inflation risk. Thus, the yield spread of a US Treasury bond over TIPS with the same maturity—often referred to as the TIPS spread—represents the premium an investor demands for being subjected to the risk of inflation in the future. The markets, in fact, give us a term structure of inflation expectations as shown below. Term Structure of Expected Inflation Rates Source: US Treasury; author's calculations This gives us the market's expectation for future inflation over 5-year, 7-year, 10-year, 20-year, and 30-year horizons. We see that only the breakeven inflation rate for the  30-year horizon is just north of 2% as of 2017-05-02. Since breakeven inflation rates are based on a pricing measure that changes regularly, they can provide an early indicator of meaningful increases in inflation. But as appealing as these market-based measures might be, they are not without their drawbacks and therefore cannot serve as the sole basis for formulating our inflation assumptions. For one, breakeven inflation rates reflect factors that may have nothing to do with long-term inflation expectations. For example, TIPS are not as liquid as plain vanilla US Treasuries and their yields may, therefore, have an embedded liquidity premium. Changes in risk appetite which cause nominal Treasury yields to rise and fall can also influence the TIPS spread. Additionally, regardless of maturity, whether 5-year, 7-year, 10-year, 20-year or 30-year, inflation expectations based on the TIPS spread are volatile as clearly shown below. Our goal is to forecast long-term inflation and we do not want to get whipped around by transitory changes in market expectations. We would need to see sustained and persistent increases in breakeven inflation rates above 2% across the term-structure before we would consider an increase in our long-term expected inflation assumption. Expected Inflation Rates Across All Available Maturities Source: US Treasury 5-year, 5-year Forward Inflation Expectations Rate Another long-term measure of the market's expectations for inflation expectations is the 5-year, 5-year forward inflation expectations rate. This is a measure of what the market expects inflation to be over a 5-year period five years from now. In other words, it is an inflation breakeven rate that, as shown in the figure below, applies to the five-year period starting five years from the respective dates in the x-axis. This market-based measure of long-term inflation expectations is preferred by the Fed as it is less sensitive to cyclical factors like energy prices. It, therefore, gives a better indication of whether the market thinks that the Fed is meeting its goal of long-term price stability. Currently, this measure suggests an expected inflation rate of under 2%. This market-based measure is also volatile and is just one additional source of information about inflation rates that we watch. 5-year, 5-year Forward Inflation Expectations Rate Source: Federal Bank of St. Louis FRED Conclusions Long-term historical trends suggest that the Fed has been very effective at keeping the long-term inflation rate anchored at 2%. Current Fed projections show that policymakers are not anticipating that this will change anytime soon. Furthermore, almost all market-based measures currently indicate that inflation expectations fall below the Fed’s 2% target and we would need to see more sustained deviations above this target level before changing our expected inflation assumption. For all these reasons, we assume a 2% inflation rate in our financial planning models and research. 1 See https://www.federalreserve.gov/faqs/economy_14400.htm 2 See https://www.federalreserve.gov/faqs/economy14419.htm and https://en.wikipedia.org/wiki/Coreinflation for more on this preference. 3 See https://research.stlouisfed.org/publications/review/12/01/65-82Thornton.pdf for a historical perspective on this. 4  https://en.wikipedia.org/wiki/Inflation_targeting 5 The sample mean, excluding the three highest and three lowest projections.

Betterment’s Model for Financial Advice: An Overview Saving enough, choosing the right accounts, deciding when you can buy a house or when to retire—all of these are essential decisions before you build an optimal portfolio. TABLE OF CONTENTS How Betterment Helps You Plan We Plan Despite the Future’s Uncertainty How We Estimate Market Performance How We Estimate Future Tax Rates How We Estimate Inflation Our Commitment to You: Constant Improvement Model Release Notes and Assumption Updates When it comes to investing, it’s easy to get lost in a myriad of decisions about strategies, diversification, investment costs, or funds to buy, to name a few. These decisions are important, but their apparent complexity can obscure an even more important question: What are you trying to accomplish with your portfolio? At Betterment, we deliver easy-to-use financial planning tools that help you design a plan to achieve your financial goals. And to that end, we continually update the tools we provide—factoring in new possible scenarios and redeveloping our assumptions as we learn about the future. In this article, we’ll outline how our model works and provide a list of updates we’ve made. Planning for your future with financial goals Establishing financial goals, and a plan to achieve them, is critical. This is why Betterment has been a goal-based investing service since the beginning. Goals help root your thinking about the future, and they have well-documented behavioral benefits. Your situation can change, as can your goals, so it’s essential to have flexibility in your plan, and the ability to answer key “what-if” questions. Goals help enable a financial advisor—automated or human—to give you quality advice, which can add significant value beyond the simple returns of a portfolio. How Betterment helps you plan Betterment’s online financial planning tools are designed to make it easy to set up a personalized, flexible, easy-to-track plan. Starting in our signup process, you establish your first goal, and can add other goals at any time once signed up. A goal is a future spending need, and will fall into one of four categories, each with different attributes and investing advice. These categories are: Safety Net Major Purchase Retirement General Investing Once you choose a category, you provide details about the goal so that we can recommend a portfolio, a level of risk, and how to save (or withdraw, if in retirement) to help achieve the goal. Then you can use our tools to see how a one-time deposit, recurring deposits, and the time horizon change how you can achieve your goal. For more complex goals like retirement, our built-in retirement planning advice factors in other variables, such as the impact of Social Security, other income streams like rental real estate, as well as future spending, tax rates, and inflation. Here are some examples of questions you can start to answer with Betterment’s financial planning tools: How much do I need to save to put a downpayment on a house in five years? When can I retire? Can I retire early? How much should I save to retire at age X? What if I save more or less than that? How can a poor market affect my savings plan or retirement? What if Social Security isn’t around? How much do I have to save then? Should I use my 401(k) or an IRA? Should I use a Roth IRA / 401(k)? How much should I save in my Safety Net? If I save X per month, what can it be worth in 10 years? Our tools help provide guidance on all of these questions and more. And we think they are better than most financial planning tools for two key reasons: We keep your balance up-to-date at a high frequency, so you know where you stand and what to do next. Changes are simple to make and applied in real time, so you can update your goals and form a better game plan. We plan despite the future’s uncertainty The key challenge in planning for the future is that nobody can truly forecast the future. You can’t be sure how or when your situation will change, and we can never predict how external factors like shifting markets, inflation, or tax rates will change. However, as the statistician George Box once said, “All models are wrong, but some are useful.” As investors, our lack of ability to know the future should not mean we give up and stop planning. Instead, we should aim to identify the “useful” models Box was referring to—tools that factor in potential variability and allow you to envision how various changes are likely to affect your plan. Tools like these help you understand the range of potential outcomes, which will better inform the decisions you make today. For example, if financial markets (and thus your portfolio) perform worse than the average we expect (a “poor market” scenario), your savings may be wholly inadequate to meet your spending needs in retirement. To help avoid this result, you could save more today to increase your projected future income, even if a poor market occurs. If you didn’t know this information in advance, it would be too late to adjust if a poor market scenario did occur. How we estimate market performance One of the key estimates about the future we make is how your portfolio will perform in the future. As you can see from the blue shading on our Advice tab in Figure 1, there is a wide range of potential portfolio growth results, depending on if the market performs poorly, or well over the time horizon of the goal. Figure 1: Setting a major purchase goal to buy a Tesla Model S using Betterment There are many ways to estimate future returns of a portfolio. The simplest way, used by many financial calculators, is to assume a constant average return which is typically based on historical returns of a typical benchmark, like the S&P 500 index. A common estimate is 7% for U.S. stocks. While there may be benefits to simple assumptions, this one has several problems: You are not usually invested exactly like that benchmark. For example, you might hold both stocks and bonds. Different mixes of these assets in your portfolio will have different ranges of outcomes. You probably have multiple financial goals, with different time horizons. For example, your retirement account should not be invested the same was as an education fund for your kids, because one is based on spending in (say) 30 years, the other in 15 years. Thus you may hold different risk portfolios for each goal which should not have the same returns assumption. Using a historical estimate is very sensitive to the time horizon used to calculate it. Betterment makes several improvements on this method to help make our estimates more accurate: We use a return estimate for the specific portfolio you select, for each goal. For example, our estimate for a 90% stock portfolio is different than that of a 85% stock portfolio. This estimate is based on the specific asset classes that you actually hold. We consider volatility in our returns estimates. This allows us to produce the range of returns you see on the Advice tab, and also allows configuring the chance of success of our models. For example, our savings estimates assume a somewhat conservative 40th percentile outcome (60% chance of success) rather than the simple average (a 50% chance of success). The return we assume is based on risk-free rate and an asset premium. The “risk free rate” (which is the return a risk-free asset such as a U.S. Treasury bill will return), and an equity (or bond) “risk premium” or excess return, which is how much we expect risky assets like stocks and bonds to return in addition to this risk-free rate. We assume risk-free returns vary over time. You probably know that interest rates (set by the Fed via it’s U.S. Treasury buying and selling program) are low right now, and most economists expect them to rise. The returns of each stock or bond fund in your portfolio are expected to be in addition to the safe or “risk-free” Treasury rates. So when rates rise, so should our expectations of your returns. Our projections assume these will increase from their low now to more normal rates in the future. (Learn more about this) Also, we make the typical assumption that longer term treasuries have higher returns than short term, due to the added interest rate risk they contain. How we estimate future tax rates Just like how no one can predict the outcome of a presidential election, we can’t predict what tax rates in the future will be. However, we are pretty sure that certain incomes and account types will be subject to some tax, so good planning tools like Betterment’s factor in some adjustment for taxes. This is most relevant in retirement planning, where taxes affect the account types you might use (e.g., IRA or Roth IRA) and your current and future income. How we incorporate tax rate estimates to our retirement planning advice: We use the latest federal tax data available. For federal taxes, these are known in advance and updated every Jan. 1. For state tax rates, this data is harder to come by, and we update them as soon as reasonably possible. Historically that is six to 12 months into the year. For example, given it’s early in 2018, we are still using 2017 state tax rates. Tax bracket ranges are typically adjusted for inflation, so we assume that inflation by itself will not cause major changes to tax rate assumptions. Your income will be different in the future, which affects your tax rate. We account for income increases due to inflation and typical salary growth (see our full retirement planning methodology for more information). We use these factors to estimate what your future tax rate might be. We allow tax deduction and dependent overrides, which can affect your personal rate. How we estimate inflation Like tax rates, we cannot know how inflation will change through time. There are certain known historical ranges and understood targets set by fiscal policy. The most important thing is to factor in some inflation, especially for long-term goals like retirement, because we know it won’t be zero. Good tools will always do this, even if assumptions vary from tool to tool. At Betterment, by default we currently assume a 2% inflation rate in our retirement planning advice and in our safe withdrawal advice, which is what the Fed currently targets. You can override this value in Edit Assumptions if you have a different view. Read more about our assumption on inflation. Inflation: 12-Month Average Consumer Price Index Growth Figure 2: Inflation through time, as shown by the Consumer Price Index for all consumers and all items. Seasonally adjusted. Data Source: Federal Reserve Economic Data Our commitment to you: constant improvement Just as you should review your goals and their status periodically, our commitment to you is to keep our tools updated and as forward-thinking as possible. Our Investment Committee and team of analysts periodically review our economic, tax, and returns assumptions, as well as make improvements to the capabilities of our tools. For example, we make regular updates to our risk-free rates, especially now that rates have started to move upward. An example of how we invest in our tools is the release of RetireGuide in 2015, which was the first time we factored Social Security, inflation, and taxes into our retirement calculations. These ongoing improvements, as well as actual performance of your account, can cause our recommendations to vary, so we recommend reviewing your goals and status at least once per year. In order to be transparent about the changes we make, we keep a log of all historical changes to our models. You can also review our Projections Methodology and methodology for more model details and limitations. Updates to Betterment’s Financial Advice Model         Month/Year Description May 2010 Portfolio Strategy Betterment launches service with a portfolio strategy composed of U.S. stocks and treasury bonds. Financial Planning Goal projections are introduced with expected returns based on historical returns. Sept. 2011 Portfolio Strategy International stocks are added to the Betterment Portfolio Strategy as a new asset class.• Expected returns estimates are updated to include this asset class. Nov. 2011 Financial Planning Betterment launches the option of having multiple sub-accounts within a Betterment account for goal-based advice. Dec. 2012 Financial Planning Goal tracking advice launches, which tells customers if an account is on track or off-track.New savings advice is introduced, based on a more conservative 40th percentile. Sept. 2013 Portfolio Strategy Betterment updates the Betterment Portfolio Strategy with new expected returns, utilizing a risk-free curve. Apr. 2014 Financial Planning Betterment launches safe withdrawal advice for retirement income, using conservative market outcome projections (1st percentile returns). June 2014 Assumptions Update Betterment updates the risk-free rate. Oct. 2014 Assumptions Update Betterment updates the risk-free rate. June 2014 Portfolio Strategy Municipal bonds added to the taxable portfolio, updated taxable expected returns and risk-free rates Tax Optimization Betterment introduces automated tax loss harvesting for taxable accounts. Jan. 2015 Assumptions Update Betterment updates the risk-free rate. Apr. 2015 Financial Planning Betterment introduces RetireGuide as a separate tool to enable retirement planning based on a customer’s Betterment accounts and non-Betterment accounts. Assumptions Update Betterment updates the risk-free rate. June 2015 Assumptions Update Betterment updates the risk-free rate. Jan. 2016 Tax Rates Betterment updates IRS tax rates, limits and phaseouts for 2016. Assumptions Update Betterment updates the risk-free rate. Apr. 2016 Assumptions Update Betterment updates the risk-free rate. Oct. 2016 Assumptions Update Betterment updates the risk-free rate. Dec. 2016 Tax Rates States tax rates are updated for 2016. Jan. 2017 Tax Rates Betterment updates IRS tax rates, limits, and phaseouts for 2017 Mar. 2017 Assumptions Update Betterment updates the risk-free rate. May 2017 Assumptions Update Betterment updates its capital markets assumptions for projections of all portfolios. Generally, our updated expected return assumptions are lower (more conservative) than our previous assumptions. Along with this update, we re-calibrate our retirement income advice to use 4th percentile returns. Betterment updates default economic assumption for inflation from 3% to 2%, equal to the long-term Fed inflation target. Assumptions Update Betterment updates the risk-free rate. July 2017 Portfolio Strategy Betterment introduces a second portfolio strategy designed for socially responsible investing, the Betterment SRI portfolio strategy. The portfolio strategy represents a 42% improvement in US Large Cap ESG ratings compared to the Betterment Portfolio Strategy. Optional for customers looking for an SRI approach. Sept. 2017 Portfolio Strategy Betterment introduces two additional portfolio strategies as alternative strategies that customers can utilize as options: The Goldman Sachs Smart Beta portfolio strategy and the BlackRock Target Income portfolio strategy. Nov. 2017 Portfolio Strategy Updated portfolio optimization methodology triggers changes to the Betterment Portfolio Strategy for tax-advantaged accounts. Tax Optimization Betterment introduces service for donating appreciated shares to charitable organizations to help customers save capital gains taxes, with the ability to deduct the gift on their taxes. Dec. 2017 Allocation Guidance Betterment enhances its allocation advice to provide a recommended allocation every month (rather than on an annual basis). Betterment also updated its Major Purchase and in-retirement allocation advice. Allocation Guidance Customer allocations in goals for retirement, major purchases, and building wealth become eligible to be adjusted automatically, in line with Betterment’s allocation advice. Exceptions include goals using the BlackRock Target Income portfolio strategy and goals that are classified as Safety Net goals. Feb. 2018 Portfolio Strategy Introducing the option to modify the asset class weights of the Betterment Portfolio Strategy for a degree of self-direction in an account. April 2018 Financial Planning Integrating retirement planning advice into goal-based investing interface, to help customers put retirement planning advice into action. Allocation Guidance Enable syncing of external accounts to specific goals, helping customers assess their overall allocation for a specific goal. July 2018 Portfolio Strategy Updated the Betterment Portfolio Strategy’s portfolio optimization methodology triggers changes to the Betterment Portfolio Strategy for taxable accounts. The Betterment SRI portfolio strategy replaced the market-capitalization weighted emerging markets fund with a socially responsible emerging markets fund. Aug. 2018 Money Management Betterment provides cash management solution called Smart Saver, designed to hold extra cash in a high-quality, short-term bond portfolio. Portfolio Strategy Added Short-term, Investment-grade bonds to portfolios with 42% stock allocation and below in the Betterment Core portfolio to further help optimize lower-risk Betterment portfolios. July 2019 Money Management Betterment replaces Smart Saver with Cash Reserve. Sept. 2019 Allocation Guidance Betterment’s recommended portfolio allocation for Safety Net goals changes from 40% stocks with a 30% buffer, to 15% stocks with a 15% buffer. March 2020 Portfolio Strategy In the Betterment SRI portfolio, the primary, secondary, and tertiary ETFs for U.S. Large Cap stock representation are now all SRI-based. An SRI-based Developed Market stock ETF is also introduced. January 2020 Money Management Betterment Cash Reserve expands to offer joint accounts, so that two users can save together. June 2020 Portfolio Strategy Betterment now projects and incorporates volatility of the risk-free rate in our projections, leading to slightly more uncertainty in the projection outcomes.

Asset Location Methodology In this paper, we discuss the various factors that must be considered by an optimal asset location strategy. We then present the methodology behind TCP, as well as results from performance simulations. TABLE OF CONTENTS Summary Part I: Asset Location For All: “We Have The Technology!” Part II: After-Tax Return—Deep Dive Part III: Asset Location in Popular Culture Part IV: TCP Methodology Part V: Monte Carlo on the Amazon—Betterment’s Testing Framework Part VI: Who’s Up With TCP? Our Results Part VII: Special Considerations Conclusion Authors Additional References Disclosures Asset location is widely regarded as the closest thing there is to a "free lunch" in the wealth management industry.1 When investments are held in at least two types of accounts (out of three possible types: taxable, tax-deferred and tax-exempt), asset location has been demonstrated to deliver additional after-tax returns, while maintaining the same level of risk. Generally speaking, this benefit is achieved by placing the least tax-efficient assets in the accounts taxed most favorably, and the most tax-efficient assets in the accounts taxed least favorably, all while maintaining the desired asset allocation in the aggregate. However, intelligently applying asset location to a globally diversified portfolio is a complex, mathematically rigorous, and continuous undertaking. Betterment’s Tax-Coordinated Portfolio (TCP) is a dynamic asset location service that automates the process, tailoring its approach to each investor’s personal circumstances. TCP is the first implementation of holistic asset location by an automated investment service, and is a milestone in the rapid advancement of investing technology. It makes this sophisticated strategy accessible to investors who either do not have the desire, expertise, or the time to effectively customize it, and manage it on an ongoing basis. Due to its undeniable value for long-term investors, automated asset location will eventually become table stakes for digital advisors. We believe that its proliferation in the investment management industry will set the stage for the gradual decline of target-date funds, for reasons we discuss below. TCP is seamlessly compatible with Tax Loss Harvesting+ (TLH+), Betterment’s automated tax loss harvesting service. While the latter derives value from the taxable account only, both work in tandem to improve after-tax return without disturbing the desired asset allocation. In this paper, we discuss the various factors that must be considered by an optimal asset location strategy. We then present the methodology behind TCP, as well as results from performance simulations. Part I: Asset Location For All: "We Have The Technology!" Introduction With each year, it is increasingly accepted that most investors are better off following a passive investment strategy, which is best implemented through a diversified portfolio of index funds. As passive investing has grown more popular, focus has shifted away from attempting to beat the market, and toward maximizing the net "take-home" value of the portfolio. This is done by reducing costs, which include fees and taxes, among other things. Maximizing after-tax return on investments can be complex. Still, most investors know that contributing to tax-advantaged (or "qualified") accounts is a relatively straightforward way to pay less tax on their retirement savings. Millions of Americans wind up with some combination of IRAs and 401(k) accounts, both available in two types: traditional or Roth. Investors can see the impact of a deductible contribution when they do their taxes. They may be aware that a Roth contribution makes sense in a year when one’s tax bracket is unusually low. Many will only save in a taxable account once they have maxed out their contribution limits for the qualified accounts. But while tax considerations are paramount when choosing which account to fund, less thought is given to the tax impact of which investments to then purchase across all accounts. Meanwhile, the tax profiles of the three account types (taxable, traditional, and Roth) have implications for what to invest in, once the account has been funded. Choosing wisely can significantly improve the after-tax value of one’s savings, when more than one account is in the mix. Almost universally, such investors can benefit from a properly executed asset location strategy. The idea behind asset location is fairly straightforward. Certain investments generate their returns in a more tax-efficient manner than others. Certain accounts shelter investment returns from tax better than others. Placing, or "locating" less tax-efficient investments in tax-sheltered accounts should increase the after-tax value of the overall portfolio. Allocate First, Locate Second Let’s start with what asset location isn’t. All investors must select a mix of stocks and bonds, finding an appropriate balance of risk and expected return, in line with their goals. One common goal is retirement, in which case, the mix of assets should be tailored to match the investor’s time horizon. This initial determination is known as "asset allocation," and it comes first. When investing in multiple accounts, it is common for investors to simply recreate their desired asset allocation in each account. On a superficial level, this makes sense. If each account, no matter the size, holds the same assets in the same proportions, adding up all the holdings will also match the desired asset allocation. If all these funds, however scattered, are invested towards the same goal, this is the right result. The aggregate portfolio is the one that matters, and it should track the asset allocation selected for the common goal. Portfolio Managed Separately in Each Account However, as long as the desired asset allocation is maintained in the aggregate, each individual account does not necessarily need to reproduce the target portfolio. Enter asset location, which can only be applied once a desired asset allocation is selected. Each asset’s after-tax return is considered in the context of every available account. The assets are then arranged (unequally) across all coordinated accounts to maximize the after-tax performance of the overall portfolio. Same Portfolio Overall—With Asset Location To help conceptualize asset location, consider a team of runners. Some runners compete better on a track than a cross-country dirt path, as compared to their more versatile teammates. Similarly, certain asset classes benefit more than others from the tax-efficient "terrain" of a qualified account. Asset allocation determines the composition of the team, and the overall portfolio’s after-tax return is a team effort. Asset location then seeks to match up asset and environment in a way that maximizes the overall result over time, while keeping the composition of the team intact. Automatic for the People Asset location has theoretically made sense since qualified accounts were introduced in the 1970s. More recently, however, the strategy has gained increasing importance, as financial advice has expanded to cater to a wider demographic. The ultra-wealthy certainly take advantage of qualified accounts. However, due to contribution limits, such accounts typically represent a small percentage of a massive net worth (with exceptions, of course). Planning for such estates is more concerned with generational succession to wealth, rather than liquidation of all or most of a portfolio during one’s life. The rest of us hold a substantial portion of our savings in qualified accounts, and intend for these assets to be our source of income in retirement. These circumstances make asset location particularly valuable. Therefore, a scalable implementation of the strategy is highly desirable for advisors looking to improve outcomes for the average investor. This is easier said than done. Michael Kitces, a leading financial planner who has written extensively about asset location, summarizes both its potential and challenge: Asset location represents one of those unique "free lunch" opportunities for wealth creation—a mechanism by which investment strategies that are already being implemented can simply be done in a more tax-efficient manner that maximizes long-term wealth creation. Yet in practice, the idea of a "free" lunch for asset location may be slightly overstated, in that the complexity of implementing it effectively requires more work, with a far more intensive and proactive process to evaluate investments for their prospective return and tax-efficiency characteristics, establish an asset location priority list to be utilized, and then actually implement it—ostensibly with the assistance of rebalancing/trading software—on an ongoing basis.3 In other words, the theoretical value of asset location is limited by the difficulty of proper execution. Indeed, the difficulty is twofold. First, the initial calculation of a client-specific location requires a mathematically rigorous approach to what is essentially a complex optimization problem. Second, to maximize the benefit, this calculation must be performed continuously, in response to not only market movements and revised return expectations, but also the individual’s cash flows throughout the entire investment period. Deposits, withdrawals, rollovers, distributions, conversions and dividends will all shift the relative balances of the coordinated accounts. These shifts can necessitate location adjustments, big and small. While these challenges can be daunting and cost-prohibitive when performed manually, they are easily handled by software, which is strongest when it comes to mathematically complex, repeatable tasks. Automating these tasks takes far more work than manually solving for a single client. However, once the formulas have been derived, coded into algorithms, and deployed to a production environment, the incremental work required to apply the strategy to additional accounts is minimal. A team of Betterment quantitative analysts, tax experts, software engineers, designers, and product managers have been working for over a year, solving and automating all of these complexities. The result is software that can efficiently apply these calculations to millions of accounts. Betterment’s tightly integrated trading and position tracking systems allow for TCP’s decisions to be seamlessly executed for any individual client’s group of accounts, no matter the mix. RIP, TDF? Automated asset location makes sense for so many investors, that we believe most advice services will eventually have to provide some version of it to protect their value proposition. Seen through that lens, we believe that the release of TCP is the first step toward the eventual decline of the target-date fund (TDF). The primary appeal of a TDF is the "set it and forget it" simplicity with which it allows investors to select and maintain a diversified asset allocation, by purchasing only one fund. That simplicity comes at a price—because each TDF is a single, indivisible security, it cannot unevenly distribute its underlying assets across multiple accounts, and thus cannot deliver the additional after-tax returns of asset location. As soon as managing a single portfolio across multiple accounts becomes as easy as buying a TDF, its popularity should wane. Of course, TDFs are not disappearing any time soon. Disruption takes time—after all, Research In Motion recorded its highest ever profits on the Blackberry in the two years after the iPhone was released, before they started to slide. The structural friction in the investment management industry is an order of magnitude higher, and the transition will be slow. In particular, participants who are locked into 401(k) plans without automated management may find that a cheap TDF is still their best "hands off" option (plus, a TDF’s ability to satisfy the Qualified Default Investment Alternative (QDIA) requirement under ERISA ensures its baseline survival under current law). But change is coming—today, participants in a Betterment for Business plan can already enable TCP to manage a single portfolio across their 401(k), and any IRAs and taxable accounts they individually have with Betterment, squeezing additional after-tax returns from their aggregate long-term savings. Automated asset location (when integrated with automated asset allocation) replicates what makes a TDF so appealing, but effectively amounts to a "TDF 2.0"—an effortless, continuously managed portfolio, but one that can straddle multiple accounts for tax benefits. Next, we dive into the complex dynamics that need to be considered when seeking to optimize after-tax return of a diversified portfolio. Part II: After-Tax Return—Deep Dive The rules governing the taxation of investment income are dense and heavy on detail, but so was Ron Chernow’s "Alexander Hamilton," and look how that turned out. We first define a few key terms, and then dive into specifics. What a Drag It Is Getting Taxed A good starting point for a discussion of investment taxation is the concept of "tax drag." As the name implies, a growing portfolio encounters friction through the years, in the form of annual taxation. Tax drag is the portion of the return that is lost to tax on an annual basis. In particular, funds pay dividends, which are taxed in the year they are received. Gimme Shelter However, there is no annual tax in qualified accounts, also sometimes known as "tax-sheltered accounts." Therefore, placing assets that pay a substantial amount of dividends into a qualified account, rather than a taxable account, "shelters" those dividends, and reduces tax drag. Reducing the tax drag of the overall portfolio is one way that asset location improves the portfolio’s after-tax return. Importantly, investments are also subject to tax at liquidation, both in the taxable account, and in a traditional IRA (where tax is deferred). However, "tax drag", as that term it is commonly used, does not include liquidation tax. So while the concept of "tax drag" is intuitive, and thus a good place to start, it cannot be the sole focus when looking to minimize taxes. What We Talk About When We Talk About "Tax Efficiency" A closely related term is "tax efficiency" and this is one that most discussions of asset location will inevitably focus on. A tax-efficient asset is one that has minimal "tax drag." The less return that is lost to annual taxation, the more tax-efficient the asset generating that return is considered to be. By this definition, tax-efficient assets are typically those that generate most of their return through capital gains (taxed at liquidation), rather than through dividends. It is helpful to think of tax efficiency as a relative concept. An asset is only tax-efficient in the sense that it has less tax drag than another asset in the portfolio. Prioritizing assets on the basis of tax efficiency allows for asset location decisions to be made following a simple, rule-based approach. One goal of this paper is to demonstrate why this approach is too simple to be optimal. Since tax efficiency (as that term is commonly used) is only concerned with reducing annual tax drag, it has nothing to say about eventual liquidation tax. As we shall see, this narrow focus on a subset of the overall tax that must be paid makes tax efficiency an imperfect metric for trying to maximize after-tax return. However, the concept helps facilitate a basic understanding of how asset location adds a substantial amount of its value. Because it is a useful device, tax efficiency is referenced frequently in the discussion that follows. However, it is not worth dwelling too much on whether some asset is truly more or less tax-efficient than another. The ultimate objective is to maximize after-tax return of the portfolio, and tax efficiency is merely one piece of that puzzle. Tax Rates, Timing, and Account Types, Oh My! Both "tax drag" and "tax efficiency" are concepts pertaining to taxation of returns in a taxable account. Therefore, we first consider that account, where the rules are most elaborate. With an understanding of these rules, we can layer on the impact of the two types of qualified accounts. Returns in a Taxable Account There are two types of investment income, and two types of applicable tax rates, but they do not correlate neatly. Their interaction is easier to describe if we define the rates first. Two types of investment tax rates. All investment income in a taxable brokerage account is subject to one of two rate categories (with material exceptions noted). For simplicity, and to keep the analysis universal, this section only addresses federal tax (state tax is considered when testing for performance). Ordinary rate: For most, this rate mirrors the marginal tax bracket applicable to earned income (primarily wages reported on a W-2). For all but the lowest earners, that bracket will range from 25% to 39.6%. Preferential rate: This more favorable rate ranges from 15% to 20% for most investors. For especially high earners, both rates are subject to an additional tax of 3.8%, making the highest possible ordinary and preferential rates 43.4% and 23.8%, respectively. Two types of investment returns. Investments generate returns in two ways: by appreciating in value, and by making cash distributions. Capital gains: When an investment is sold, the difference between the proceeds and the tax basis (generally, the purchase price) is taxed as capital gains. If held for longer than a year, this gain is treated as long-term capital gains (LTCG) and taxed at the preferential rate. If held for a year or less, the gain is treated as short-term capital gains (STCG), and taxed at the ordinary rate. Barring unforeseen circumstances, passive investors should be able to avoid STCG entirely. Betterment’s automated account management avoids STCG,4 and the rest of this paper assumes only LTCG on liquidation of assets. Dividends: Bonds pay interest, which is taxed at the ordinary rate, whereas stocks pay dividends, which are taxed at the preferential rate (both subject to the exceptions below). An exchange-traded fund (ETF) pools the cash generated by its underlying investments, and makes payments that are called dividends, even if some or all of the source was interest. These dividends inherit the tax treatment of the source payments. This means that, generally, a dividend paid by a bond ETF is taxed at the ordinary rate, and a dividend paid by a stock ETF is taxed at the preferential rate. Qualified Dividend Income (QDI): There is an exception to the general rule for stock dividends. Stock dividends enjoy preferential rates only if they meet the requirements of qualified dividend income (QDI). Key among those requirements is that the company issuing the dividend must be a U.S. corporation (or a qualified foreign corporation). A fund pools dividends from many companies, only some of which may qualify for QDI. To account for this, the fund assigns itself a QDI percentage each year, which the custodian uses to determine the portion of the fund’s dividends that are eligible for the preferential rate.For stock funds tracking a U.S. index, the QDI percentage is typically 100%. However, funds tracking a foreign stock index will have a lower QDI percentage, sometimes substantially. For example, VWO, Vanguard’s Emerging Markets Stock ETF, had a QDI percentage of 38% in 2015, which means that 38% of its dividends for the year were taxed at the preferential rate, and 62% were taxed at the ordinary rate. Tax-exempt interest: There is also an exception to the general rule for bonds. Certain bonds pay interest that is exempt from federal tax. Primarily, these are municipal bonds, issued by state and local governments. This means that an ETF which holds municipal bonds will pay a dividend that is subject to 0% federal tax—even better than the preferential rate. The chart below summarizes these interactions. Note that this section does not consider tax treatment for those in a marginal tax bracket of 15% and below. These taxpayers are addressed in "Special Considerations."   Dividends (taxed annually) Capital Gains (taxed when sold) Ordinary Rate Most bonds Non-QDI stocks (foreign) Any security held for a year or less (STCG) Preferential Rate QDI stocks (domestic and some foreign) Any security held for more than a year (LTCG) No Tax Municipal bonds Any security transferred upon death or donated to charity The impact of rates is obvious: The higher the rate, the higher the tax drag. Equally important is timing. The key difference between dividends and capital gains is that the former are taxed annually, contributing to tax drag, whereas tax on the latter is deferred. Tax deferral is a powerful driver of after-tax return, for the simple reason that the savings, though temporary, can be reinvested in the meantime, and compounded. The longer the deferral, the more valuable it is. Putting this all together, we arrive at the foundational piece of conventional wisdom, where the most basic approach to asset location begins and ends: Bond funds are expected to generate their return entirely through dividends, taxed at the ordinary rate. This return benefits neither from the preferential rate, nor from tax deferral, making bonds the classic tax-inefficient asset class. These go in your qualified account. Stock funds are expected to generate their return primarily through capital gains. This return benefits both from the preferential rate, and from tax deferral. Stocks are therefore the most tax-efficient asset class. These go in your taxable account. Tax-Efficient Status: It’s Complicated Reality gets messy rather quickly, however. Over the long term, stocks are expected to grow faster than bonds, causing the portfolio to drift from the desired asset allocation. Rebalancing may periodically realize some capital gains, so we cannot expect full tax deferral on these returns (although if cash flows exist, investing them intelligently can reduce the need to rebalance via selling). Furthermore, stocks do generate some return via dividends. The expected dividend yield varies with more granularity. Small cap stocks pay relatively little (these are growth companies that tend to reinvest any profits back into the business) whereas large cap stocks pay more (as these are mature companies that tend to distribute profits). Depending on the interest rate environment, stock dividends can exceed those paid by bonds. International stocks pay dividends too, and complicating things further, some of those dividends will not qualify as QDI, and will be taxed at the ordinary rate, like bond dividends (especially emerging markets stock dividends). Already, we can see the simple conventional wisdom straining to account for this real-world complexity. How large of a dividend must a stock fund pay before we take the resulting tax drag seriously? Is an emerging markets stock fund really more tax-efficient than a bond fund? If a bond fund is tax-exempt, doesn’t that asset class make the most sense in the taxable account? To have the full framework for addressing these questions, we next consider taxation of investment income in the qualified accounts, to the extent there is any. Returns in a Tax-Deferred Account (TDA) Compared to a taxable account, a TDA is governed by deceptively simple rules. However, earning the same return in a TDA involves trade-offs which are not intuitive. Applying a different time horizon to the same asset can swing our preference between a taxable account and a TDA. Understanding these dynamics is crucial to appreciating why an optimal asset location methodology cannot ignore liquidation tax, time horizon, and the actual composition of each asset’s expected return. In this section, we examine these trade-offs, which are some of the toughest to grasp. Although growth in a traditional IRA or traditional 401(k) is not taxed annually, it is subject to a liquidation tax. All the complexity of a taxable account described above is reduced to two rules. First, all tax is deferred until distributions are made from the account, which should begin only in retirement. Second, all distributions are taxed at the same rate, no matter the source of the return. The rate applied to all distributions is the higher ordinary rate, except that the additional 3.8% tax will not apply to those whose tax bracket in retirement would otherwise be high enough.5 First, we consider income that would be taxed annually at the ordinary rate (i.e. bond dividends and non-QDI stock dividends). The benefit of shifting these returns to a TDA is clear. In a TDA, these returns will eventually be taxed at the same rate, assuming the same tax bracket in retirement. But that tax will not be applied until the end, and compounding due to deferral can only have a positive impact on the after-tax return, as compared to the same income paid in a taxable account.6 The effect on returns that would otherwise be taxed at the preferential rate is more complex. For these returns, tax deferral comes at a price: when it does get taxed, it will be at the higher ordinary rate. There is potential for "negative tax arbitrage"—a conversion of lower-taxed income into higher-taxed income, which can lower the after-tax return. This runs counter to the goal of asset location, and needs to be considered very seriously. In particular, the risk is that LTCG (which we expect plenty of from stock funds) will be taxed like ordinary income. Under the basic assumption that in a taxable account, capital gains tax is already deferred until liquidation, favoring a TDA for an asset whose only source of return is LTCG is plainly harmful. There is no benefit from deferral, which you would have gotten anyway, and only harm from a higher tax rate. This logic supports the conventional wisdom that stocks belong in the taxable account. Not only do bonds benefit more from a TDA, the reasoning goes, but stocks are actually hurt by it! Again, reality is more complex. First, as already discussed, stocks do generate some return via dividends, and that portion of the return will benefit from tax deferral. This is obviously true for non-QDI dividends, already taxed as ordinary income, but QDI can benefit too. If the deferral period is long enough, the value of compounding will offset the hit from the higher rate at liquidation. Second, it is not accurate to assume that all capital gains tax will be deferred until liquidation in a taxable account. Rebalancing may realize some capital gains "prematurely" and this portion of the return could also benefit from tax deferral. Placing stocks in a TDA is a trade-off—one that must weigh the potential harm from negative rate arbitrage against the benefit of tax deferral. Valuing the latter means making assumptions about dividend yield and turnover. On top of that, the longer the investment period, the more tax deferral is worth. Kitces demonstrates that a dividend yield representing 25% of total return (at 100% QDI), and an annual turnover of 10%, could swing the calculus in favor of holding the stocks in a TDA, assuming a 30-year horizon.7 For foreign stocks with less than perfect QDI, we would expect the tipping point to come sooner. All of the above suggests that we should be wary of overloading a TDA with assets expected to generate substantial capital gains, if the time horizon is relatively short. However, the goal of this section is not to precisely define the circumstances under which stocks perform better in a TDA. Rather, it is to demonstrate that the problem defies a "rule of thumb" approach. Not all stocks are the same, and time horizon matters. The solution must optimize around these trade-offs. Returns in a Tax-Exempt Account (TEA) Investments in a Roth IRA or Roth 401(k) grow tax free, and are also not taxed upon liquidation. Since it eliminates all possible tax, a TEA presents a particularly valuable opportunity for maximizing after-tax return. The trade-off here is managing opportunity cost—every asset does better in a TEA, so how best to use its precious capacity? Clearly, a TEA is the most favorably taxed account. Conventional wisdom thus suggests that if a TEA is available, we use it to first place the least tax-efficient assets. But that approach is wrong. Everything Counts in Large Amounts—Why Expected Return Matters The powerful yet simple advantage of a TEA helps illustrate the limitation of focusing exclusively on tax efficiency when making location choices. Returns in a TEA escape all tax, whatever the rate or timing would have been, which means that an asset’s expected after-tax return equals its expected total return. A tax-inefficient asset is one that loses a relatively large portion of its annual return to taxes, whereas a tax-efficient one loses a relatively small portion. However, ranking assets in this way does not incorporate the absolute size of their returns. A small portion of a large return could benefit from sheltering more than a large portion of a small return. Even the least tax-efficient asset may not be the best candidate for permanent tax-avoidance, if its total return is expected to be relatively low. Savings from avoiding any annual tax do compound, but a small enough number will not amount to much. On the other hand, avoiding all tax on a large expected return may present a larger savings opportunity, even if that return is highly tax-efficient (taxed at liquidation, at the preferential rate). Putting this in concrete terms, when both a taxable account and a TEA are available, it may be worth putting a high-growth, low-dividend stock fund into the TEA, instead of a bond fund, even though the stock fund is vastly more tax-efficient. Not only that, but similar reasoning can apply to placement in a TDA as well, as long as the tax-efficient asset has a large enough expected return, and presents some opportunity for tax deferral (i.e., some portion of the return comes from dividends). In other words, an optimal asset location must consider both tax efficiency and expected return. Tax efficiency has something to say about the degree to which an asset will benefit from a qualified account, but the absolute amount of expected savings is what actually matters. Part III: Asset Location in Popular Culture To be sure, much like tax efficiency, "popular" is a relative concept. Still, much has been publicly written about asset location. The strategy is also (we assume) a topic of frequent rumor, conjecture, and innuendo. In this section, we look at existing approaches to asset location, and consider their advantages and limitations. But before diving into methodology, it is worth clearing up a few popular misconceptions. "The Tax Is Coming From Inside the Account!": Debunking Some Urban Legends Urban Legend 1: Asset location is a one-time process. Just set it and forget it. While an initial location may add some value, doing it properly is a continuous process, and will require adjustments in response to changing conditions. Note that overlaying asset location is not a deviation from a passive investing philosophy, because optimizing for location does not mean changing the overall asset allocation (the same goes for tax loss harvesting). Rick Ferri, a financial analyst and respected investing expert, has this to say: The problem with asset location is that nothing is static. Tax rates change, tax brackets change, tax preferences change, and on and on. What was a logical tax location one year may turn out to be a lousy one a few years later, but you're stuck in the one you have.8 Other things that will change, all of which should factor into an optimal methodology: expected returns (both the risk-free rate, and the excess return), dividend yields, QDI percentages, and most importantly, relative account balances. Contributions, rollovers, and conversions can increase qualified assets relative to taxable assets, continuously providing more room for additional optimization. Ferri is also making the point that future location adjustments may be limited if the assets we want to relocate out of the taxable account have appreciated substantially (and adjusting our asset location would not be worth the tax cost of realizing those gains). This is a legitimate consideration, but should not prevent us from optimizing around what we know today. A rigorous strategy should weigh the costs and benefits of a potential future adjustment. In particular, during one’s working years, a steady stream of deposits (as well as dividends) will provide constant opportunities to move closer to whatever the optimal location is at that time. Urban Legend 2: Taking advantage of asset location means you should contribute more to a particular qualified account than you otherwise would. Definitely not! Asset location should play no role in deciding which accounts to fund. It optimizes around account balances as it finds them, and is not concerned with which accounts should be funded in the first place. Just because the presence of a TEA makes asset location more valuable, does not mean you should contribute to a TEA, as opposed to a TDA. That decision is primarily a bet on how your tax rate today will compare to your tax rate in retirement. To hedge, some may find it optimal to make contributions to both a TDA and TEA (this is called "tax diversification"). While these decisions are out of scope for this paper, Betterment’s retirement planning tools can help clients with these choices. Urban Legend 3: Asset location has very little value if one of your accounts is relatively small. It depends. Asset location will not do much for investors with a very small taxable balance and a relatively large balance in only one type of qualified account, because most of the overall assets are already sheltered. However, a large taxable balance and a small qualified account balance (especially a TEA balance) presents a better opportunity. Under these circumstances, there may be room for only the least tax-efficient, highest-return assets in the qualified account. Sheltering a small portion of the overall portfolio can deliver a disproportionate amount of value. Urban Legend 4: Asset location has no value if you are investing in both types of qualified accounts, but not in a taxable account. Not so. A TEA offers significant advantages over a TDA. Zero tax is better than a tax deferred until liquidation. While tax efficiency (i.e. annual tax drag) plays no role in these location decisions, expected returns and liquidation tax do. The assets we expect to grow the most should be placed in a TEA, and doing so will plainly increase the overall after-tax return. There is an additional benefit as well. Required minimum distributions (RMDs) apply to TDAs but not TEAs. Shifting expected growth into the TEA, at the expense of the TDA, will mean lower RMDs, giving the investor more flexibility to control taxable income down the road. In other words, a lower balance in the TDA can mean lower tax rates in retirement, if higher RMDs would have pushed the retiree into a higher bracket. This potential benefit is not captured in our results. Urban Legend 5: Enough with the fancy talk. Bonds always go in the IRA, and that’s all there is to it. Possibly, but not necessarily. This commonly asserted rule is a simplification, and will not be optimal under all circumstances. It is discussed at more length below. Existing Approaches to Asset Location: Advantages and Limitations Optimizing for After-Tax Return While Maintaining Separate Portfolios One approach to increasing after-tax return on retirement savings is to maintain a separate, standalone portfolio in each account with roughly the same level of risk-adjusted return, but tailoring each portfolio somewhat to take advantage of the tax profile of the account. Effectively, this means that each account separately maintains the desired exposure to stocks, while substituting certain asset classes for others. Generally speaking, managing a fully diversified portfolio in each account means that there is no way to avoid placing some assets with the highest expected return in the taxable account. Based on the discussion above, it should be obvious that a strategy which completely rules out the possibility of sheltering such assets cannot be optimal. The presence of a TEA, which is unambiguously best for the highest growth assets, only underscores this limitation. This approach does include a valuable tactic, which is to differentiate the high-quality bonds component of the allocation, depending on the account they are held in. The allocation to the component is the same in each account, but in a taxable account, it is represented by municipal bonds which are exempt from federal tax (MUB), and in a qualified account, by taxable investment grade bonds (AGG). This variation is effective because it takes advantage of the fact that these two asset classes have very similar characteristics (expected returns, covariance and risk exposures) allowing them to play roughly the same role from an asset allocation perspective. Municipal bonds, however, are highly tax-efficient, and are very compelling in a taxable account. Taxable investment grade bonds have significant tax drag, and work best in a qualified account. Betterment has applied this substitution since 2014. As we shall see, this MUB/AGG substitution is incorporated into TCP’s methodology. The Basic Priority List For those looking to unevenly distribute a single portfolio across multiple account types with no help from software, a rule-based approach has obvious appeal. The presence of multiple assets, and a highly personal ratio of account balances make for a complex problem. Most DIY investors and professional advisors are not mathematicians, so tackling the optimization with maximum precision is not viable. In other words, when implemented manually, this is a strategy crying for a heuristic—a simple set of rules that will produce an asset location which is hopefully "good enough." The easiest way to determine "what goes where" is to have confidence that at least with respect to certain assets, "this goes there first." Armed with such conviction, the casual locator can start "filling up" the qualified account, prioritizing those assets which are perceived to benefit most from sheltering. Moving down the list requires only basic arithmetic—subtract the dollar amount allocated to an asset from the available balance, look to the next asset, and repeat until the qualified account is full (and what’s left goes in the taxable). That list, more often than not, is a ranking of assets based solely on tax efficiency. At one extreme you may have say, high-yield bonds, which generate all of their returns as dividends, taxed annually at the ordinary rate (high tax drag). At the other extreme would be say, U.S. small cap stocks—mostly capital gains, and the few dividends they do generate are QDI, taxed at the preferential rate (very little tax drag). Everything else goes in between, with bonds and stocks clustering together on opposite ends. This basic prioritization is the source for the conventional wisdom that "bonds go in the IRA." As one would expect, the desire to reduce complexity, if taken too far, eventually leads to suboptimal results. One immediately obvious exception is that municipal bonds are maximally tax-efficient, and belong in a taxable account. Still, other bonds are, in fact, highly tax-inefficient. Yet, as many have pointed out, in the current low-yield environment, bonds just do not return that much, so the potential savings are low. Is there a hidden opportunity cost to blindly prioritizing bonds in the qualified accounts, no matter what? "Smile" Like You Mean It Numerous experts have published research on how to best navigate the complex trade-offs discussed so far. The conclusion is more often than not: "It just depends." However, manual asset locators need an approach that is more sophisticated than prioritization by tax efficiency, while still being rule-based and thus easy to implement. Gobind Daryanani and Chris Cordaro sought to balance considerations around tax efficiency and expected return, and illustrated that when both are very low, location decisions with respect to those assets have very limited impact.9 That study inspired Michael Kitces, who leverages its insights into a more sophisticated approach to building a priority list.10 To visually capture the relationship between the two considerations, Kitces bends the one-dimensional list into a "smile." Asset Location Priority List The rendering is both effective, and delightfully simple. Assets with a high expected return that are also very tax-efficient go in the taxable account. Assets with a high expected return that are also very tax-inefficient go in the qualified accounts, starting with the TEA. The "smile" guides us in filling the accounts from both ends simultaneously, and by the time we get to the middle, whatever decisions we make with respect to those assets just "don’t matter" much. It’s clear why this heuristic is better than a straight ranking—plotting the assets in two dimensions allows the location decisions to factor in the interaction between two independent variables, both of which are important. Prioritizing with a "smile" means that the valuable real estate in the qualified accounts will not be occupied by assets that may have high tax drag, but very little to actually drag. However, Kitces augments the graph in short order, recognizing that the basic "smile" does not capture a third key consideration—the impact of liquidation tax. Because capital gains will eventually be realized in a taxable account, but not in a TEA, even a highly tax-efficient asset might be better off in a TEA, if its expected return is high enough. The next iteration of the "smile" illustrates this preference. Asset Location Priority List With Limited High Return Inefficient Assets A two-dimensional representation of a relationship between three variables immediately raises questions. Just how high must its return be, for a tax-efficient asset to bump a tax-inefficient asset out of the TEA? How high must its tax drag be, for that tax-inefficient asset to retain its tax-exempt perch? Unlike at the bottom of the smile, these are decisions that "matter," but the rules are no longer clear. Two dimensions are not enough! To push the optimization further, we need to revisit the limitation of "tax efficiency" as a metric. It is a poor measure for what we are actually seeking to maximize, which is after-tax return. Tax efficiency, as it is used in asset location discussions, is only concerned with annual tax drag in the taxable account. However, "liquidation tax drag" also exists, and varies across all accounts (moderate in the taxable, highest in a TDA, and absent in a TEA). In other words, we must also attempt to quantify "liquidation tax efficiency," but doing so is complex, because it involves all three accounts, whereas the accepted definition of tax efficiency described the taxable account only. We would need to derive an annualized after-tax return for each asset, in each account. This metric is driven by the expected return, but also incorporates both annual and liquidation tax, and is sensitive to time horizon. Suddenly, we are quite far from rules of thumb, lists, and graphs. This is not to say that investors taking advantage of a sophisticated heuristic, whether through their own efforts, or with the help of a skilled advisor, will not select a beneficial asset location. Far from it. As Kitces summarizes, nailing the corners of his "smile" and not worrying about the middle will undoubtedly add value: "Just get those two right and you’ve done yourself a ton of good."11 We wholeheartedly agree. With automation, we should be able to do even better. Too many important factors cannot be accounted for with a prioritization approach. However many rules we devise, we'll land on "good enough" when the answer is not apparent. Only a mathematical optimization can squeeze maximum benefit from a given set of inputs. Part IV: TCP Methodology By now, it should be clear that there is no one-size-fits-all asset location for every set of inputs. Some circumstances apply to all investors, but shift through time—the expected return of each asset class (which combines separate assumptions for the risk-free rate and the excess return), as well as dividend yields, QDI percentages, and tax laws. Other circumstances are personal—which accounts the client has, the relative balance of each account, and the client’s time horizon. Solving for multiple variables while respecting defined constraints is a problem that can be effectively solved by linear optimization. This method is used to maximize some value, which is represented by a formula called an "objective function." What we seek to maximize is the after-tax value of the overall portfolio at the end of the time horizon. We get this number by adding together the expected after-tax value of every asset in the portfolio, but because each asset can be held in more than one account, each portion must be considered separately, by applying the tax rules of that account. We must therefore derive an account-specific expected after-tax return for each asset. Deriving Account-Specific After-Tax Return To define the expected after-tax return of an asset, we first need its total return (i.e., before any tax is applied). The total return is the sum of the risk-free rate (same for every asset) and the excess return (unique to every asset). Betterment derives excess returns using the Black-Litterman model as a starting point. This common industry method involves analyzing the global portfolio of investable assets and their proportions, and using them to generate forward-looking expected returns for each asset class. Next, we must reduce each total return into an after-tax return.12 The immediate problem is that for each asset class, the after-tax return can be different, depending on the account, and for how long it is held. In a TEA, the answer is simple—the after-tax return equals the total return—no calculation necessary. In a TDA, we project growth of the asset by compounding the total return annually. At liquidation, we apply the ordinary rate to all of the growth.13 We use what is left of the growth after taxes to derive an annualized return, which is our after-tax return. In a taxable account, we need to consider the dividend and capital gain component of the total return separately, with respect to both rate and timing. We project growth of the asset by taxing the dividend component annually at the ordinary rate (or the preferential rate, to the extent that it qualifies as QDI) and adding back the after-tax dividend (i.e., we reinvest it). Capital gains are deferred, and the LTCG is fully taxed at the preferential rate at the end of the period. We then derive the annualized return based on the after-tax value of the asset.14 Note that for both the TDA and taxable calculations, time horizon matters. More time means more value from deferral, so the same total return can result in a higher annualized after-tax return. Additionally, the risk-free rate component of the total return will also depend on the time horizon, which affects all three accounts. William Reichenstein and William Meyer express a key insight into what this really means: "The same asset, whether stock or bond, is effectively a different asset when held in a TDA or taxable account."15 Because we are accounting for the possibility of a TEA, as well, we actually have three distinct after-tax returns, and thus each asset effectively becomes three assets, for any given time horizon (which is specific to each Betterment customer). The Objective Function To see how this comes together, we first consider an extremely simplified example. Let’s assume we have a taxable account, both a traditional and Roth account, with $50,000 in each one, and a 30-year horizon. Our allocation calls for only two assets: 70% equities (stocks) and 30% fixed income (bonds). With a total portfolio value of $150,000, we need $105,000 of stocks and $45,000 of bonds. 1. These are constants whose value we already know (as derived above). req,tax is the after-tax return of stocks in the taxable account, over 30 years req,trad is the after-tax return of stocks in the traditional account, over 30 years req,roth is the after-tax return of stocks in the Roth account, over 30 years rfi,tax is the after-tax return of bonds in the taxable account, over 30 years rfi,trad is the after-tax return of bonds in the traditional account, over 30 years rfi,roth is the after-tax return of bonds in the Roth account, over 30 years 2. These are the values we are trying to solve for (called "decision variables". xeq,tax is the amount of stocks we will place in the taxable account xeq,trad is the amount of stocks we will place in the traditional account xeq,roth is the amount of stocks we will place in the Roth account xfi,tax is the amount of bonds we will place in the taxable account xfi,trad is the amount of bonds we will place in the traditional account xfi,roth is the amount of bonds we will place in the Roth account 3. These are the constraints which must be respected. All positions for each asset must add up to what we have allocated to the asset overall. All positions in each account must add up to the available balance in each account. xeq,tax + xeq,trad + xeq,roth = 105,000 xfi,tax + xfi,trad + xfi,roth = 45,000 xeq,tax + xfi,tax = 50,000 xeq,trad + xfi,trad = 50,000 xeq,roth + xfi,roth = 50,000 4. This is the objective function, which uses the constants and decision variables to express the after-tax value of the entire portfolio, represented by the sum of six terms (the after-tax value of each asset in each of the three accounts). maxx req,taxxeq,tax + req,tradxeq,trad + req,rothxeq,roth + rfi,taxxfi,tax + rfi,tradxfi,trad + rfi,rothxfi,roth Linear optimization turns all of the above into a complex geometric representation, and mathematically closes in on the optimal solution. It assigns values for all decision variables in a way that maximizes the value of the objective function, while respecting the constraints. Accordingly, each decision variable is a precise instruction for how much of which asset to put in each account. If a variable comes out as zero, then that particular account will contain none of that particular asset. An actual Betterment portfolio can have up to twelve asset classes,16 depending on the allocation. That means TCP must effectively handle up to 36 "assets", each with its own after-tax return. However, the full complexity behind TCP goes well beyond increasing assets from two to twelve. Updated constants and constraints will trigger another part of the optimization, which determines what TCP is allowed to sell, in order to move an already coordinated portfolio toward the newly optimal asset location, while minimizing taxes. Reshuffling assets in a TDA or TEA is "free" in the sense that no capital gains will be realized.17 In the taxable account, however, TCP will attempt to move as close as possible towards the optimal asset location without realizing capital gains. The full optimization on an actual set of accounts must solve for hundreds of variables subject to hundreds of constraints, and reproducing the full objective function would take many pages. Good news! The computer will do it. Even better news: Because the calculation is automated, it can run every time any of our constants or constraints change, using every opportunity to either maintain, or move closer to the optimal asset location. Expected returns will periodically be updated, either because the risk-free rate has been adjusted, or because new excess returns have been derived via Black-Litterman. Future cash flows may be even more material. Additional funds in one or more of the accounts could significantly alter the constraints which define the size of each account, and the target dollar allocation to each asset class. Such events (including dividend payments, subject to a de minimis threshold) will trigger a recalculation, and potentially a reshuffling of the assets. Cash flows, in particular, can be a challenge for those managing their asset location manually. Inflows to just one account (or to multiple accounts in unequal proportions) create a tension between optimizing asset location and maintaining asset allocation, which is hard to resolve without mathematical precision. To maintain the overall asset allocation, each position in the portfolio must be increased pro-rata. However, some of the additional assets we need to buy "belong" in other accounts from an asset location perspective, even though new cash is not available in those accounts. If the taxable account can only be partially reshuffled due to built-in gains, we must choose either to move farther away from the target allocation, or the target location.18 With linear optimization, our preferences can be expressed through additional constraints, weaving these considerations into the overall problem. When solving for new cash flows, TCP penalizes allocation drift higher than it does location drift—another complexity not represented by the simplified objective function above. All the Math in the World Cannot Predict the Future We can reason our way into these choices, though some may be less intuitive than others. We can debate the many assumptions discussed above—changing any of them may impact these decisions. Linear optimization is only as good as its inputs, but extremely effective within that framework. Still, even linear optimization may not land on what will turn out to have been the optimal asset location, in retrospect. Events nobody can predict make this improbable, especially over a long horizon. But that is no reason not to select an optimized asset location based on what is known today, adjusting when new information becomes available. When asset location is automated, these adjustments are made centrally, and seamlessly propagated across all accounts. This makes the ongoing component of location management extremely efficient and consistent. However, it cannot be emphasized enough that expected returns (the key input into TCP, and portfolio management generally) are educated guesses at best. No matter how airtight the math, reasonable people will disagree on the "correct" way to derive them. The future may not cooperate, making a mockery of our best-laid plans, especially in the short-term. There is no guarantee that any particular asset location will add the most value, or even any value at all. But given decades, our certainty in the outcome grows. Part V: Monte Carlo on the Amazon—Betterment’s Testing Framework To test the output of the linear optimization method, we turned to a rigorous Monte Carlo testing framework,19 built entirely in-house by Betterment’s experts. The forward-looking simulations model the behavior of the TCP strategy down to the individual lot level. We simulate the paths of these lots, accounting for dividend reinvestment, rebalancing, and taxation. As far as we are aware, this level of analysis for an asset location strategy has never been made public in the investment management industry. The forward market scenarios were derived from parametric sampling of a multivariate Gaussian distribution, where the mean was estimated using an equilibrium forecast method. Each set of assumptions was subject to at least 1,000 market scenarios. The covariance matrix was generated from historical returns. Forward dividends were simulated by sampling from a univariate Gaussian distribution, with the first and second moments derived from historical data, and with the same current dividend frequency. For QDI, we assumed the percentages reported by funds for 2015, over the whole period. The simulations applied Betterment’s rebalancing methodology, which corrects drift from the target asset allocation in excess of 3%, but stops short of ever realizing STCG. Betterment’s management fees were assessed in all accounts, and ongoing taxes were paid annually from the taxable account. All taxable sales first realized available losses before touching LTCG. The simulations assumed no additional cash flows other than dividends. This is not because we do not expect them to happen. Rather, it is because making assumptions around these very personal circumstances does nothing to isolate the benefit of TCP specifically. Asset location is driven by the relative sizes of the accounts, and cash flows will change these ratios, but the timing and amount is highly specific to the individual.20 Avoiding the need to make specific assumptions here helps keep the analysis more universal. We used equal starting balances for the same reason.21 R&D in the Cloud: Harder, Better, Faster, Stronger Betterment is hosted by Amazon Web Services (AWS), which allows us to dynamically increase or decrease the computing power available to our software in response to variable demand. The purpose of this infrastructure is to provide a consistently robust experience to customers in a scalable and efficient manner. However, an added benefit is that our R&D team has access to a platform that can temporarily support an extremely demanding computing load. Tracking positions at the tax lot level means accounting for basis on the fly, even for small trades, which Betterment executes using fractional shares. Each taxable sale is processed through our TaxMin lot selection algorithm, and all transactions (including purchases in qualified accounts) are run through our wash sale avoidance algorithms, which are described in our TLH+ white paper. All of this means that a 30-year simulation runs for multiple hours. AWS allows us to spin up thousands of servers simultaneously, each running a different market scenario in parallel. Each set of assumptions (combination of accounts, stock allocation) was tested under at least 1,000 market scenarios. The research presented here is the product of over 150,000 computer-hours, at times running on up to 3,000 AWS servers simultaneously. For every set of assumptions, we ran each market scenario while managing each account as a standalone (uncoordinated) Betterment portfolio as the benchmark.22 We then ran the same market scenarios with TCP enabled. In both cases, we calculated the after-tax value of the aggregate portfolio after full liquidation at the end of the period.23 Then, for each market scenario, we calculated the after-tax annualized internal rates of return (IRR) and subtracted the benchmark IRR from the TCP IRR. That delta represents the incremental tax alpha of TCP for that scenario. The median of those deltas across all market scenarios is the estimated tax alpha we present below for each set of assumptions. It is important to note that these results do not express the value of Betterment’s management vis-à-vis some particular non-Betterment investing strategy. Rather, they measure the incremental tax alpha of TCP, as compared to Betterment’s management of its uncoordinated portfolios in the same accounts. Still, these results are a reasonable measure of the effectiveness of Betterment’s implementation of asset location as applied to a passive investing strategy. Part VI: Who’s Up With TCP? Our Results If you have read this far, you are truly a tax management paladin, and our hats are off to you. We should hang out sometime. If you skipped ahead to get here, that’s okay too, as long as you promise to read the "Special Considerations" section, and the disclosures. All of the following projections assume a 30-year horizon, with an initial balance of $50,000 in each account. However, the specific tax rates matter when actually calculating tax alpha. We use the following assumptions, with deductibility of state taxes incorporated into the federal rate: "Moderate" tax rate: 28% federal tax bracket, the capital gains rates corresponding that bracket, and a state tax rate of 9.3% (the CA bracket corresponding to the 28% federal bracket). "High" tax rate: assumes 39.6%, the highest federal bracket, the capital gains rates corresponding to that bracket, and a state tax rate of 13.3% (the highest bracket in CA). Asset location for taxpayers in a 15% federal bracket or lower is driven by substantially different considerations, which are discussed below under "Special Considerations." The first set of results assumes a taxpayer subject to the Moderate tax rate both during the period, and in liquidation. 1. Three Accounts: TAX/TRAD/ROTH (Moderate tax) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.82% 70% Stocks 0.48% 90% Stocks 0.27% 2. Two Accounts: TAX/TRAD (Moderate tax) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.51% 70% Stocks 0.22% 90% Stocks 0.10% 3. Two Accounts: TAX/ROTH (Moderate tax) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.69% 70% Stocks 0.43% 90% Stocks 0.29% In the next set, we project tax alpha for a taxpayer subject to the highest rates. However, in this case, we want to use different rates for accumulation and liquidation, for a more realistic scenario. It is unlikely that a taxpayer in the 39.6% bracket during the working years will not be able to structure their taxable income in retirement to reduce the bracket substantially. We assume a Moderate rate in retirement, which applies on up to $230,000 of taxable income for a married couple filing jointly. 4. TAX/TRAD/ROTH (High tax, but Moderate tax for liquidation) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.77% 70% Stocks 0.49% 90% Stocks 0.34% 5. Two Accounts: TAX/TRAD (High tax, but Moderate tax for liquidation) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.54% 70% Stocks 0.27% 90% Stocks 0.20% 6. Two Accounts: TAX/ROTH (High tax, but Moderate tax for liquidation) Asset Allocation Additional Tax Alpha with TCP (Annualized) 50% Stocks 0.71% 70% Stocks 0.46% 90% Stocks 0.38% More Bonds, More Alpha The clearest pattern is that a higher allocation to bonds leads to a dramatically higher benefit across the board. This makes sense—the heavier your allocation to tax-inefficient assets, the more asset location can do for you. To be extremely clear: this is not a reason to select a lower allocation to stocks! Over the long-term, we expect a higher stock allocation to return more (because it’s riskier), both before, and after tax. These are measurements of the additional return due to TCP, which say nothing about the absolute return of the asset allocation itself. Conversely, a very high allocation to stocks shows a smaller (though still real) benefit. However, younger customers invested this aggressively should gradually reduce risk as they get closer to retirement (to something more like 50% stocks). Looking to the 70% stock allocation is therefore an imperfect but reasonable way to generalize the value of the strategy over a 30-year period. More Roth, More Alpha Another pattern is that the presence of a Roth makes the strategy more valuable. This also makes sense—a taxable account and a TEA are on opposite ends of the "favorably taxed" spectrum, and having both presents the biggest opportunity for TCP’s "account arbitrage." But again, this benefit should not be interpreted as a reason to contribute to a TEA over a TDA, or to shift the balance between the two via a Roth conversion. These decisions are driven by other considerations. TCP’s job is to optimize the relative balances as it finds them. Enabling TCP On Existing Taxable Accounts All of these results assume that TCP is enabled before the taxable account is funded, meaning that the initial location can be optimized without the need to sell potentially appreciated assets. A Betterment customer with an existing taxable account who enables TCP should not expect the full incremental benefit we project here, to the extent that assets with built-in capital gains need to be sold to achieve the optimal location. This is because TCP conservatively prioritizes avoiding a certain tax today, over potentially reducing tax in the future. However, the optimization is performed every time there is a deposit (or dividend) to any account. With future cash flows, the portfolio will move closer to whatever the optimal location is determined to be at the time of the deposit. Part VII: Special Considerations Low Bracket Taxpayers: Beware Taxation of investment income is substantially different for those who qualify for a marginal tax bracket of 15% or below. To illustrate, we have modified the chart from Part II to apply to such low bracket taxpayers.   Dividends Capital Gains Ordinary Rate N/A Any security held for a year or less (STCG) Preferential Rate N/A N/A No Tax Qualified dividends from any security are not taxed Any security held for a year or more is not taxed (LTCG) TCP is not designed for these investors. Optimizing around this tax profile would reverse many assumptions behind TCP’s methodology. Municipal bonds no longer have an advantage over other bond funds. The arbitrage opportunity between the ordinary and preferential rate is gone. In fact, there’s barely tax of any kind. It is quite likely that such investors would not benefit much from TCP, and may even reduce their overall after-tax return. If the low tax bracket is temporary, TCP over the long-term may still make sense.  Also note that some combinations of account balances can, in certain circumstances, still add tax alpha for investors in low tax brackets. One example is when an investor only has traditional and Roth IRA accounts, and no taxable accounts being tax coordinated. Low bracket investors should very carefully consider whether TCP is suitable for them. As a general rule, we do not recommend it. Potential Problems with Coordinating Accounts Meant for Different Time Horizons We began with the premise that asset location is sensible only with respect to accounts that are generally intended for the same purpose. This is crucial, because unevenly distributing assets will result in asset allocations in each account that are not tailored towards the overall goal (or any goal at all). This is fine, as long as we expect that all coordinated accounts will be available for withdrawals at roughly the same time (e.g. at retirement). Only the aggregate portfolio matters in getting there. However, uneven distributions are less diversified. Temporary drawdowns (e.g., the 2008 financial crisis) can mean that a single account may drop substantially more than the overall coordinated portfolio. If that account is intended for a short-term goal, it may not have a chance to recover by the time you need the money. Likewise, if you do not plan on depleting an account during your retirement, and instead plan on leaving it to be inherited for future generations, arguably this account has a longer time horizon than the others and should thus be invested more aggressively. In either case, We do not recommend managing accounts with materially different time horizons as a single portfolio. For a similar reason, you should avoid applying asset location to an account that you expect will be long-term, but one that you may look to for emergency withdrawals. For example, a Safety Net Goal should never be managed by TCP. Large Upcoming Transfers/Withdrawals If you know you will be making large transfers in or out of your tax-coordinated accounts, you may want to delay enabling our tax coordination tool until after those transfers have occurred. This is because large changes in the balances of the underlying accounts can necessitate rebalancing, and thus may cause taxes. With incoming deposits, we can intelligently rebalance your accounts by purchasing asset classes that are underweight. But when large withdrawals or transfers out are made, despite Betterment’s intelligent management of executing trades, some taxes can be unavoidable when rebalancing to your overall target allocation. The only exception to this rule is if the large deposit will be in your taxable account instead of your IRAs. In that case, you should enable tax-coordination before depositing money into the taxable account. This is so our system knows to tax-coordinate you immediately. The goal of tax coordination is to reduce the drag taxes have on your investments, not cause additional taxes. So if you know an upcoming withdrawal or outbound transfer could cause rebalancing, and thus taxes, it would be prudent to delay enabling tax coordination until you have completed those transfers. Mitigating Behavioral Challenges Through Design There is a broader issue that stems from locating assets with different volatility profiles at the account level, but it is behavioral. Uncoordinated portfolios with the same allocation move together. Asset location, on the other hand, will cause one account to dip more than another, testing an investor’s stomach for volatility. Those who enable TCP across their accounts should be prepared for such differentiated movement. Rationally, we should ignore this—after all, the overall allocation is the same—but that is easier said than done. Rick Ferri has an interesting example of how this played out during the last big downturn: "[T]here is a hidden risk with having different allocations in taxable versus non-taxable, and we saw this risk turn into reality during 2008 and early 2009. A few clients terminated their higher risk taxable portfolio because that specific portfolio was losing more money than the more conservative non-taxable portfolio. In other words, they separated their portfolios in their mind and compared returns rather than looking at the big picture."24 This is an important consideration, and should not be ignored. A good advisor should seek to maximize a client’s returns net of tax, fees, and behavior. So while this effect is real, we believe that intelligent product design can mitigate it somewhat for the modern investor. Clients using a digital investment service can access their balance and returns in real-time, and in our experience, rely far less on traditional statements, which are account-specific. Generally, this is behaviorally undesirable: an unavoidable cost of online investing. In this case, however, it presents an opportunity. App design has more latitude in presenting information than a statement does. A well-designed interface can surface aggregate performance only, nudging the client towards the "big picture," and deprioritizing counterproductive information.25 So while a client can still access each account’s balance and infer account-level performance, behaviorally sensitive UX can make an impact on what clients focus on. How TCP Interacts with Tax Loss Harvesting+ Asset location is highly compatible with tax loss harvesting. While the latter derives value from the taxable account only, both work in tandem to improve after-tax return. The reason they work well together is that both derive their benefit without disturbing the desired asset allocation. Operational Compatibility Betterment’s implementations of both strategies are especially compatible, because of certain design decisions made when building TLH+, Betterment’s automated tax loss harvesting service. For that strategy, effective wash sale management was paramount. Special attention was paid to avoiding a type of wash sale that permanently disallows a realized loss. This can happen when a security is sold at a loss in a taxable account, and a substantially identical security is purchased in a qualified account within the wash sale window. TLH+ was designed around a "tertiary ticker" system, which ensures that no purchase in an IRA or 401(k) managed by Betterment will interfere with a harvested loss in a Betterment taxable account. A sale in a taxable account, and a subsequent repurchase of the same asset class in a qualified account would be incidental for accounts managed as separate portfolios. Under TCP, however, we expect this to occasionally happen by design. When "relocating" assets, either during initial setup, or as part of ongoing optimization, TCP will sell an asset class in one account, and immediately repurchase it in another. The tertiary ticker system allows this reshuffling to happen seamlessly, while protecting any tax losses that are realized in the process. Conceptualizing Blended Performance Estimating the benefit of TCP and TLH on a standalone basis already requires making many generalized assumptions. However, modeling their combined benefit is even more difficult to generalize. Simulations of both strategies must be at the tax lot level, and combined performance is highly path dependent. They are expected to add more value together than either one would on its own, but simply adding up the two standalone estimates is clearly inaccurate, and a better answer is elusive. TCP will affect the composition of the taxable account in ways that are hard to predict, because its decisions will be driven by changes in relative balances among the accounts. Meanwhile, the weight of specific asset classes in the taxable account is a material predictor of the potential value of TLH (more volatile assets should offer more harvesting opportunities). The precise interaction between the two strategies is far more dependent on personal circumstances, such as today’s account balance ratios and future cash flow patterns, than on generally applicable inputs like asset class return profiles and tax rules. These dynamics are best understood as a hierarchy. Asset allocation comes first, and determines what mix of asset classes we should stick to overall. Asset location comes second, and continuously generates tax alpha across all coordinated accounts, within the constraints of the overall portfolio. Tax loss harvesting comes third, and looks for opportunities to generate tax alpha from the taxable account only, within the constraints of the asset mix dictated by asset location for that account. Decision logic at each tier is encapsulated, following the architectural principle of "information hiding." To illustrate in concrete terms: TCP knows only that the overall allocation must be 70% stocks, but should not be concerned with what drove that determination. Similarly, TLH does not need to know why the taxable account must hold (for example) municipal bonds and domestic equities only. Both seek to optimize after-tax return within their domain, playing the hand they are dealt. To sum up, it is worth highlighting why asset location sets the parameters for tax loss harvesting, and not the other way around. TLH is most effective in the first several years after an initial deposit to a taxable account. Over decades, however, we expect it to generate value only from subsequent deposits and dividend reinvestments. Eventually, even a substantial dip is unlikely to bring the market price below the purchase price of the older tax lots. Meanwhile, TCP continues to deliver tax alpha over the entire balance of all three accounts for the entire holding period. Conclusion An investment strategy intended to maximize the after-tax value of a portfolio should focus on increasing annualized after-tax return. Traditional approaches to asset location are concerned with prioritizing assets in certain accounts based on their relative "tax efficiency", with the objective of sheltering income from annual tax. This narrow focus ignores numerous factors which affect annualized after-tax return, but are hard to account for without a mathematically rigorous approach. To reach its potential, an optimal asset location methodology must incorporate these realities, which include liquidation tax, time horizon, expected total return, and the actual composition of each expected return. Automation provides us with an opportunity to tackle these complexities. Betterment’s TCP considers both generally applicable inputs and customer-specific circumstances when optimizing an asset location for each set of accounts. TCP’s reliance on linear optimization makes it a "living implementation" of asset location. As material assumptions change, TCP can be easily adjusted across the entire customer base, without the need to rewrite its fundamental rules. Accordingly, the service can optimize after-tax returns for Betterment’s customers based on today’s expectations, without sacrificing operational flexibility, which will be utilized in the years to come. Addendum As of May 2020, for customers who indicate that they’re planning on using a Health Savings Account (HSA) for long-term savings, we allow the inclusion of their HSA in their Tax-Coordinated Portfolio. If an HSA is included in a Tax-Coordinated Portfolio, we treat it essentially the same as an additional Roth account. This is because funds within an HSA grow income tax-free, and withdrawals can be made income tax-free for medical purposes. With this assumption, we also implicitly assume that the HSA will be fully used to cover long-term medical care spending. The tax alpha numbers presented above have not been updated to reflect the inclusion of HSAs, but remain our best-effort point-in-time estimate of the value of TCP at the launch of the feature. As the inclusion of HSAs allows even further tax-advantaged contributions, we contend that the inclusion of HSAs is most likely to additionally benefit customers who enable TCP. 1"Boost Your After-Tax Investment Returns." Susan B. Garland. Kiplinger.com, April 2014. 3Pg. 13, The Kitces Report. March/April 2014. 4This does not include withdrawals or customer-directed allocation changes. If these are substantial enough, realizing STCG may be unavoidable. In such cases, Betterment customers are notified before they confirm their instruction, via Tax Impact Preview. 5But see "How IRA Withdrawals In The Crossover Zone Can Trigger The 3.8% Medicare Surtax," Michael Kitces, July 23, 2014. 6It is worth emphasizing that asset location optimizes around account balances as it finds them, and has nothing to say about which account to fund in the first place. Asset location considers which account is best for holding a specified dollar amount of a particular asset. However, contributions to a TDA are tax-deductible, whereas getting a dollar into a taxable account requires more than a dollar of income. 7Pg. 5, The Kitces Report. January/February 2014. 8 "Problems with Reichenstein's "Asset Location Decision Revisted." Bogleheads.org. Nov. 10, 2013. 9Daryanani, Gobind, and Chris Cordaro. 2005. "Asset Location: A Generic Framework for Maximizing After-Tax Wealth." Journal of Financial Planning (18) 1: 44–54. 10The Kitces Report, March/April 2014. 11 "Minimizing the Tax Drag on Your Investments," By Carla Fried. The New York Times, Feb. 7, 2014. 12While the significance of ordinary versus preferential tax treatment of income has been made clear, the impact of an individual’s specific tax bracket has not yet been addressed. Does it matter which ordinary rate, and which preferential rate is applicable, when locating assets? After all, calculating the after-tax return of each asset means applying a specific rate. It is certainly true that different rates should result in different after-tax returns. However, we found that while the specific rate used to derive the after-tax return can and does affect the level of resulting returns for different asset classes, it makes a negligible difference on resulting location decisions. The one exception is when considering using very low rates as inputs (the implication of which is discussed under "Special Considerations"). This should feel intuitive: Because the optimization is driven primarily by the relative size of the after-tax returns of different asset classes, moving between brackets moves all rates in the same direction, generally maintaining these relationships monotonically. The specific rates do matter a lot when it comes to estimating the benefit of the asset location chosen, so rate assumptions are laid out in the "Results" section. In other words, if one taxpayer is in a moderate tax bracket, and another in a high bracket, their optimal asset location will be very similar and often identical, but the high bracket investor may benefit more from the same location. 13In reality, the ordinary rate is applied to the entire value of the TDA, both the principal (i.e., the deductible contributions) and the growth. However, this will happen to the principal whether we use asset location or not. Therefore, we are measuring here only that which we can optimize. 14TCP today does not account for the potential benefit of a foreign tax credit (FTC). The FTC is intended to mitigate the potential for double taxation with respect to income that has already been taxed in a foreign country. The scope of the benefit is hard to quantify and its applicability depends on personal circumstances. All else being equal, we would expect that incorporating the FTC may somewhat increase the after-tax return of certain asset classes in a taxable account—in particular developed and emerging markets stocks. If maximizing your available FTC is important to your tax planning, you should carefully consider whether TCP is the optimal strategy for you. 15Note that Reichenstein and Meyer develop this concept to optimize asset allocation—an approach known as "after-tax asset allocation." They stress that pre-tax contributions to TDAs are "partnerships", and the government is effectively a minority partner, with an interest in part of the return and principal. This view has implications for what the asset allocation should be, when factoring in liquidation tax. After-tax asset location prioritizes allocation over after-tax return, and is not without its detractors. TCP today does not optimize for after-tax allocation. 16One component of the portfolio gets special treatment, as previewed in an earlier section. The overall asset allocation treats high-quality bonds as one asset class. However, when solving for this asset class, the optimizer uses MUB’s return for the after-tax return in the taxable account, and AGG’s return for the after-tax return in the qualified accounts. The resulting decision variables tell us the dollar value of high-quality bonds that goes in each account, but the actual purchases follow the same split—MUB in the taxable, AGG in the qualified. The sum of the MUB position and AGG positions will equal the overall allocation to high-quality bonds. 17Standard market bid-ask spread costs will still apply. These are relatively low, as Betterment considers liquidity as a factor in its investment selection process. Betterment customers do not pay for trades. 18Additionally, in the interest of making interaction with the tool maximally responsive, certain computationally demanding aspects of the methodology were simplified for purposes of the tool only. This could result in a deviation from the target asset location imposed by the TCP service in an actual Betterment account. 19Another way to test performance is with a backtest on actual market data. One advantage of this approach is that it tests the strategy on what actually happened. Conversely, a forward projection allows us to test thousands of scenarios instead of one, and the future is unlikely to look like the past. Another limitation of a backtest in this context—sufficiently granular data for the entire Betterment portfolio is only available for the last 15 years. Because asset location is fundamentally a long-term strategy, we felt it was important to test it over 30 years, which was only possible with Monte Carlo. Additionally, Monte Carlo actually allows us to test tweaks to the algorithm with some confidence, whereas adjusting the algorithm based on how it would have performed in the past is effectively a type of "data snooping". 20In simulations, as in the actual product, Betterment uses cash flows to purchase underweight assets first, helping reduce portfolio drift and reducing the likelihood that a taxable sale will be required to rebalance. This will increase the after-tax return both for TCP, and for uncoordinated accounts baseline. However, note that when accounts are coordinated, there is a higher likelihood that taxable sales can be avoided. Because we are now managing a single portfolio, TCP will make whatever use it can of the qualified accounts to reduce overall drift, and to the extent that the overweight asset is available in a qualified account, it will sell that position. For all transactions, the algorithms have a preference for correcting allocation drift first, but will attempt to optimize for location as part of the same transaction, if possible. 21That said, the strategy is expected to change the relative balances dramatically over the course of the period, due to unequal allocations. We expect a Roth balance in particular to eventually outpace the others, since the optimization will favor assets with the highest expected return for the TEA. This is exactly what we want to happen. 22For the uncoordinated taxable portfolio, we assume an allocation to municipal bonds (MUB) for the high-quality bonds component, but use investment grade taxable bonds (AGG) in the uncoordinated portfolio for the qualified accounts. While TCP makes use of this substitution, Betterment has offered it since 2014, and we want to isolate the additional tax alpha of TCP specifically, without conflating the benefits. 23Full liquidation of a taxable or TDA portfolio that has been growing for 30 years will realize income that is guaranteed to push the taxpayer into a higher tax bracket. We assume this does not happen, because in reality, a taxpayer in retirement will make withdrawals gradually. The strategies around timing and sequencing decumulation from multiple account types in a tax-efficient manner are out of scope for this paper. 24https://www.bogleheads.org/forum/viewtopic.php?t=98662 25Since inception, Betterment has never displayed daily performance of individual ETFs in a portfolio, and has generally de-emphasized daily performance of a portfolio, since focusing on short-term volatility is not productive, and instead increases the probability of suboptimal investor behavior. Instead, the interface was designed to emphasize information that an investor can and should act on—such as an indication of whether the portfolio is on track to reaching its specified goal, and if not, what can be done to put it back on track. Authors Boris Khentov, J.D., is VP of Operations and Legal Counsel at Betterment. He has a B.A. in Computer Science from Harvard University and a J.D. from Northwestern University School of Law. Prior to Betterment, Boris was a software engineer at Antenna Software, and practiced tax and capital markets law at Cleary Gottlieb Steen & Hamilton LLP. Boris helped oversee the development of Tax-Coordinated Portfolio, and wrote so very many words. No capital gains were realized in the writing of this paper. Rukun Vaidya is a Product Manager at Betterment. He has a degree in Operations Research from Cornell University. Prior to Betterment, Ruk spent five years performing risk research at Highbridge Capital, where he focused on statistical arbitrage, quantitative macro, and quantitative commodities. As the lead Product Manager for Tax-Coordinated Portfolio, Ruk conceived its methodology and led the implementation team. Ruk had a joke in here, but it did not make it through compliance. Lisa Huang, Ph.D., is Head of Quantitative Analysis & Research at Betterment. She holds a degree in mathematics and biochemistry from UCLA, and a Ph.D. in theoretical physics from Harvard University. Prior to Betterment, Lisa was a quantitative strategist at Goldman Sachs, leading research collaborations and building models for fixed income strategies. She is the brains behind the "Cloud Ferrari" that is Betterment’s Monte Carlo performance testing framework. Lisa is always right, especially when the problem is so hard that everyone else barely has a clue. Additional References Berkin. A. "A Scenario Based Approach to After-Tax Asset Allocation." 2013. Journal of Financial Planning. Jaconetti, Colleen M., CPA, CFP®. Asset Location for Taxable Investors, 2007. https://personal.vanguard.com/pdf/s556.pdf. Poterba, James, John Shoven, and Clemens Sialm. "Asset Location for Retirement Savers." November 2000. https://faculty.mccombs.utexas.edu/Clemens.Sialm/PSSChap10.pdf. Reed, Chris. "Rethinking Asset Location - Between Tax-Deferred, Tax-Exempt and Taxable Accounts." Accessed 2015. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2317970. Reichenstein, William, and William Meyer. "The Asset Location Decision Revisited." 2013. Journal of Financial Planning 26 (11): 48–55. Reichenstein, William. 2007. "Calculating After-Tax Asset Allocation is Key to Determining Risk, Returns, and Asset Location." Journal of Financial Planning (20) 7: 44–53. Disclosures The value provided by Tax-Coordinated Portfolio (TCP) will vary depending on each investor’s personal circumstances. Investors who have a short time horizon may get little to no value from the asset location strategy employed by TCP. Under certain circumstances, investors could conceivably even decrease their after-tax returns by enabling TCP. As a general matter, asset location strategies like the one implemented by TCP distribute assets unevenly across multiple accounts based on the varying return profiles of each asset (separately considering the potential for capital appreciation and dividend yield). These figures are "expected returns"—projections for what future returns might be. While these figures are empirically derived (using the Black-Litterman method as a starting point) they are still speculative, and actual returns will differ year-to-year, often substantially. Therefore, while the reasonable expectation may be that asset A will pay more dividends than asset B (and/or appreciate more than asset B), the opposite could happen in any given year, or across a number of years, such that asset location decisions based on differing expectations do not maximize after-tax returns. The longer the investing period, the more likely it is that the relative performance of the various assets in the portfolio will converge on what is expected. Shorter periods, however, are more likely to produce unexpected results. Asset location seeks to place assets with higher expected returns into tax-advantaged accounts. Therefore, toward the end of the accumulation phase, an investor should expect his or her tax-advantaged accounts to have a higher balance than they otherwise would have had (and the taxable retirement account to have a lower balance than it would have had, had an asset location strategy not been deployed). While under most circumstances, more growth in a tax-advantaged account (in exchange for less growth in a taxable account) is desirable, there are potential trade-offs which should be considered. For instance, tax-advantaged accounts incur penalties for early withdrawal, so to the extent that access to funds prior to retirement becomes necessary, liquidity may come at a higher cost for a portion of funds that might otherwise be accessible penalty-free (had that appreciation taken place in the taxable account instead). If the tax-advantaged assets are primarily or exclusively tax-deferred, rather than tax-exempt (e.g., a traditional IRA vs. a Roth IRA), then additional considerations should be weighed. Because all distributions from a tax-deferred account are taxed at ordinary rates, including amounts that would be taxed as long-term capital gains when realized in a taxable account, shifting such appreciation could amount to a conversion of lower taxed income into higher taxed income. Over a long enough period, the tax deferral (i.e., the ability to continually reinvest the tax savings and compound that growth, before eventually paying the tax) is expected to be valuable enough to justify such a conversion. This is especially likely when the taxpayer expects to be in a lower income tax bracket in retirement than during the accumulation phase (often, though not always the case). However, when asset location is practiced over a short period (years, not decades) and the taxpayer maintains a high income tax bracket at the time of distribution, conversion of some capital gains into ordinary income may dominate the after-tax return, thereby rendering the asset location strategy counterproductive. As a separate matter, a higher tax-deferred balance could mean higher required minimum distributions (RMDs) in retirement, which could be an important consideration for those seeking to minimize their RMDs. No performance estimates are based on actual client trading history, and actual Betterment clients may experience different results. Factors which will determine the actual benefit of TCP include, but are not limited to, market performance, the relative size of each account included in TCP, the equity exposure of the portfolio, the frequency and size of deposits into the various accounts, the tax rates applicable to the investor in a given tax year and in future years, and the time elapsed before liquidation of any of the accounts becomes necessary. Nothing herein should be interpreted as tax advice, and Betterment does not represent in any manner that the tax consequences described herein will be obtained, or that any Betterment product will result in any particular tax consequence. Please consult your personal tax advisor as to whether TCP is a suitable strategy for you, given your particular circumstances. The tax consequences of asset location are complex and uncertain. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return. Betterment assumes no responsibility for the tax consequences to any client of any transaction.

How Betterment Protects Your Investments Your investments with Betterment are protected by SIPC. History suggests that even if you had millions of dollars invested with a brokerage firm that became insolvent, it is extremely likely that you would be made whole. Insurance is meant to provide a safety net in the case of an emergency. Health insurance covers the cost of a broken limb; dental insurance covers a root canal; homeowners insurance covers leaky plumbing. The Securities Investor Protection Corporation (SIPC) provides insurance that protects your investments, including those held by our broker, Betterment Securities. It covers up to $500,000 of missing assets, including a maximum of $250,000 for cash claims.1 But the difference between SIPC and some other types of insurance is that there’s a very good chance you’ll never have to use it. Since the inception of SIPC in 1971, fewer than 1% of all SIPC member broker-dealers have been subject to a SIPC insolvency proceeding.2 During those proceedings, 99% of total assets distributed to investors came directly from the insolvent broker-dealer’s assets, and not from SIPC.3 Of all the claims ever filed (625,200), less than one-tenth of a percent (352) exceeded the limit of coverage.4 History suggests that even if you had millions of dollars invested with a brokerage firm that became insolvent, it is extremely likely that you would be made whole. How SIPC Insurance Works All brokers are required to be SIPC members. The $500,000 coverage limit applies to each legally distinct account. For example, if you have a taxable account, an IRA, and a trust, each is eligible for its own $500,000 of coverage. The limit applies only to the value of missing securities, not losses due to market volatility. If there are securities identified as belonging to the customer, these (or their equivalent value) will be returned regardless of account size, and the $500,000 limit will apply only to the difference. Some investors mistakenly think that they should never have more than $500,000 in a single brokerage account, but the coverage applies to what’s missing, not to the overall balance. Let’s walk through an example to see how it works. You have an account with three different brokers, and each account holds $2 million in assets. Each of those accounts is covered separately by SIPC, up to $500,000. If one of those brokerage firms were to go bankrupt, a judge would appoint a trustee to sort through the broker’s books and distribute assets back to you and other clients. Here are some possible outcomes, with specific numbers just to illustrate: The trustee recovers your original assets—that’s your $2 million—from the insolvent broker-dealer, and you are made whole. You would experience zero loss on your account. (Since the inception of SIPC in 1971, 99% of total assets distributed have come directly from the insolvent broker-dealer, not from SIPC.)5 If the trustee can only recover $1.5 million of your assets, the remaining $500,000 would be covered by SIPC insurance, and you’d be made whole. If the trustee can only recover $1 million, you would still be covered for $500,000 on the missing amount, but you would incur a partial loss for the remaining $500,000. Historical data shows how extremely rare this is: Over the 46 years that SIPC has existed, there have only been 352 people who have ever had a loss where SIPC wasn’t able to make them whole.6 Three Illustrative Outcomes for an Investor After Brokerage Failure While SIPC is sometimes compared to the Federal Deposit Insurance Corporation (FDIC), it is neither a government agency nor a regulatory body. It’s a private nonprofit group funded by the brokerage industry (every member pays semi-annual dues). It’s not completely on its own, however. SIPC is allowed to borrow from the U.S. Treasury if its own resources are strained—so there is very little chance that SIPC would not meet its coverage obligations. It’s also important to note that FDIC guarantees your principal up to its coverage limit, whereas SIPC does not cover market fluctuations, only missing assets. Insurance That Is Rarely Invoked Why is SIPC insurance so rarely called upon? Because an elaborate set of guardrails around a broker-dealer’s financial operations makes SIPC an absolute last resort. There is a vast framework of regulatory safety checks and audits that custodian broker-dealers undergo on a daily, weekly, monthly, and annual basis. For example, the requirement to segregate client assets from those of the broker greatly increases the likelihood that account holders can be made whole without having to use SIPC funds. If this segregation is properly maintained, account holders should be made whole in case of firm insolvency, no matter the account size. Close monitoring of a broker’s net capital cushion serves a similar purpose. Again, adherence to these safeguards is a foremost focus of a custodian broker-dealer—every single day a custodian broker-dealer is required to perform applicable safety-checks and immediately report problems to its regulators. Of course, there are outliers when an institution fails under more nefarious circumstances. In the most notorious example, the Bernard Madoff Ponzi scheme, some investors could not be compensated when it turned out they didn’t own the securities they thought they did. Madoff just lied and said that they owned them. (Additional rules were enacted post-Madoff, which are discussed in more detail below.) Betterment Securities holds only publicly traded ETFs in client portfolios, allowing for complete transparency. All of our clients can track their assets and returns on a daily basis. High-profile cases such as Madoff are exceptions, overshadowing the fact that SIPC proceedings are very rare. As shown in the chart below, there have been just 328 proceedings since the organization was set up in 1971, out of more than 39,600 brokers who have been SIPC members over that period. There were 109 proceedings initiated in the first four years, and since then, no year has had more than 13. In fact, in the 10 years through 2013, a tumultuous time for the financial markets and the financial-service industry, no year has seen more than five proceedings initiated. In 2014, there were none. Customer Protection Claims, 1971-2014 Be Proactive: How to Protect Your Investments SIPC is important when it comes to protecting your investments, but it’s also necessary for you to consider these key safety points when choosing a brokerage firm: Your assets are never commingled with the brokerage’s operational funds. Your holdings are completely transparent at all times. You should be able to review publicly available audits of your firm. If you are being promised something “too good to be true,” there is reason to be cautious. Never Allow Your Assets to Be Commingled With any brokerage you use, your money and the firm’s operational funds (e.g., what the firm uses to pay its bills) should never be mixed. With Betterment Securities, operational funds and customer funds live not only in different accounts, but in separate universes—separated by numerous digital (and human-supervised) firewalls. Regulators require us to file our detailed financials on a monthly basis; we must report both firm capital and any customer cash that we hold. As Betterment Securities is the custodian of our customers’ assets, we must also maintain substantially higher levels of net capital than an introducing firm, which is a broker that delegates custody to a third party. Another guideline is to avoid brokers that engage in proprietary trading for their own account, while also handling yours. On occasion, such a broker might “blow up” over some failed exotic trade made in the house account. As a result, the need to cover a shortfall can create the temptation to “temporarily” borrow funds that are off limits, such as those from customer accounts. Betterment Securities never does any proprietary trading for its own account. That is not our business, and never will be. Always Be Able to Verify Your Assets One of the great pitfalls for Madoff investors was that they could not verify their assets—in fact, Madoff lied about their existence. With Betterment, you have full visibility into your exact positions at any time. You can follow your performance over any time period, directly from your account (on mobile or on the Web). We believe in complete transparency—on any day, after every trade, we disclose the precise number of shares of every ETF in which you’re invested. That differentiates us from many portfolio and fund managers who do not openly share this information with their clients. Look at the Public Record You don’t need to take your broker’s word at face value—you can and should verify regulatory audits to ensure you’re in good hands. The U.S. Securities and Exchange Commission (SEC) issued an amendment in 2010 (post-Madoff) that applies to investment advisors who custody their clients' assets, or who use a related party to do so. We are the latter case. Betterment LLC, the investment advisor, is an affiliate of Betterment Securities, the custodian. Under rule 206(4)-2 of the Investment Advisers Act of 1940, the investment advisor must be subject to an annual surprise exam from an independent public accountant. We don't know when the surprise exam will happen. The accountants just show up in the office one day. The auditors verify the internal books and records of the affiliate custodian. They reconcile every share, and every dollar we say we have, against our actual holdings. They spot check several hundred random customer accounts. They contact customers directly, and verify that the account statements we issue to them match our internal records for these accounts. They ask questions if something doesn't add up by even a penny. Ernst & Young LP, one of the Big Four accounting firms, performs our annual surprise exam. The firm then issues a report to summarize its findings, and this report must be filed with the SEC. Learn more by reviewing our past reports. Trust Your Instincts: There Are No Shortcuts to Investing Not all brokers deserve your caution in equal measure. It is not a coincidence that Madoff’s fund handily beat the market year after year after year. If something seems “too good to be true,” it probably is. Similarly, be wary of overly complex, exotic strategies that you cannot understand. At best, such complexity creates circumstances for you to be overcharged, on account of perceived sophistication. At worst, it’s a red flag for smoke and mirrors. Betterment is designed for market returns over time, and we make no promises we cannot keep. We buy global index fund ETFs on your behalf, and charge you a small management fee. It’s that simple, and when it comes to assessing risk, simplicity is your friend. While SIPC insurance and regulatory oversight can help protect you from mismanagement by all but the most devious frauds, it can’t save you from yourself. President Richard Nixon, of all people, made that clear when he signed into law the Securities Investor Protection Act, the bill that created the SIPC. “Just as the FDIC protects the user of banking services from the danger of bank failure, so will the SIPC protect the user of investment services from the danger of brokerage firm failure, he said. “It does not cover the equity risk that is always present in stock market investment.” Of course, all investing comes with risk, but that risk is the price you pay for return. Fortunately, you can take only the risk necessary to achieve your goals, by staying properly diversified to smooth out volatility and cushion the impact of bear markets as you invest for the long haul. That is what Betterment is designed for. All blog posts and investment advice are produced by Betterment LLC. 1SIPC insurance does not cover commodity futures, fixed annuities, foreign currency—none of which are part of the Betterment portfolio. SIPC also does not cover losses associated with market fluctuations. You can learn more at www.sipc.org. 2SIPC Annual Report 2014, page 8  3 SIPC Annual Report 2014, page 30 4 SIPC Annual Report 2014, page 9  5SIPC Annual Report 2014, page 30 6SIPC Annual Report 2014, page 9

How Betterment Helps Keep You on Track Through Tough Markets Historical data suggests that customers who follow our advice will stay on track to reach their goals, even in a market downturn as bad as the 2008 crisis. Imagine going for a weekend upstate New York. You rent a car, load your destination into your phone’s GPS. It lets you know that you have about a two-hour journey ahead of you, and it suggests that you take the highway. About an hour and a half into your drive, your GPS notices that there is an accident on the highway up ahead. It knows that it will slow you down, so it reacts by advising you to take a different route, using back roads, in order to get to your destination as quickly as possible. Because of the accident, it's going to take a bit longer (not much—just 20 minutes or so)—but you're back on track.  This example is very similar to Betterment’s goal-based advice; just as the GPS recommends the best route to take to reach your destination, we recommend the smart path to take to reach your financial goals. And just as the GPS updates its recommended route based on road conditions and accidents, we update our advice based on various circumstances, such as a shorter time horizon as you approach your target date, or a market downturn.   Because our advice is constantly taking these factors into account, you’re always taking on the right level of risk and saving the right amount (if you’re following our advice). Historical data suggests that customers who follow our advice will stay on track to reach their goals, even in a market downturn as bad as the 2008 crisis. How Our Advice Works At the beginning of your journey with Betterment, we’ll recommend your starting risk level. We’ve chosen this risk by considering what stock allocation would be appropriate in a bad-market scenario. That means that even in a worse-than-expected market, you’ll be taking on the right level of risk for the goal you want to achieve, and you’ll be set up to ultimately reach your goal. Second, we’ll estimate how much you need to save, and adjust that not for average returns, but, to be conservative, slightly below-average returns (the 40th percentile, if you’re being precise). So we’ve built in some degrees of conservatism from the outset. From that point, you’re on your way but not on your own. As you get closer to your goal, making your time horizon shorter, we’ll update our advice for your recommended risk level and suggested monthly savings amount. While you might experience interim losses or market drops before your goal’s target date, subsequent positive returns are likely to offset them. Close to your target date, your portfolio will be designed to take on less risk, as you will have less time to recover. As a result, you won’t take on significant goal risk, which is the chance you’ll miss your goal by a large amount of money or time. In the case of a really big market drop, we might advise you to do something about it, such as make a deposit, which will help keep your goal on track. But if it’s early on in a long-term goal, it’s unlikely you’ll need to change anything significantly, because you still have a lot of saving to do. Historical Performance of Our Advice To see how this advice plays out, let’s review a scenario that many people worry about: a goal that has two pretty unpleasant market drawdowns over its term. We’ll use a hypothetical investor who opens a Betterment Major Purchase goal with $100,000 on Jan. 1, 2000. The goal has a target date of March 2009, and a target balance of $150,000. We’re using a Major Purchase goal because the investor intends to completely liquidate that goal at the target date (as opposed to a Retirement goal that wouldn’t be liquidated all at once). This time period (January 2000 to March 2009) was one of the worst times to invest. The investor would have had to contend with both a market drop from 2000 to 2004, and the fact that the market would have dropped right at the end of her investing period, in 2008-09. Recommended Asset Allocation Because this was a Major Purchase goal (where the funds are liquidated at the target date), Betterment would have recommended a high stock allocation early on, but decreased that significantly as the goal date approached. When the goal has roughly one year left, our advice would have been to have 27% stocks, with 18% of the portfolio in cash. The graph below depicts our allocation advice over the term of the goal. Recommended Asset Allocation, 2000-2009 Portfolio Weight in Stocks and Bonds as the Investor Nears Goal Portfolio Returns Below we show the cumulative returns of the portfolio. This investor would have seen two large drawdowns over her investing period, in 2001 and 2008. Compared with keeping the initial allocation, the allocation takes on less risk over time. This means it goes down slower when markets fall, but also up slower when they rally. Over this period, the investor would have seen a cumulative return of 28.6%, which averages out to 2.7% per year. Even in a pretty unlucky environment, still positive returns. Growth of First $1 Invested, 2000-2009 At the very end it avoids the crash a bit, not because we saw it coming, but because it wasn’t appropriate to take on lots of risk so close to the goal date. Note that the portfolio still experienced drawdowns along the way, in fact, for most of the first three years. Would you have stuck with Betterment through that period? Savings Advice In the beginning, it seems possible the investor would hit her target with no savings, given the $100,000 starting balance. Of course, we realize markets rarely deliver average returns: It bounces up and down around the average. Early on in this goal, market returns are below average (global stock markets measured by the ACWI ETF dropped nearly 50%), and so the probability of achieving her goal dips below 50%. Probability of Success, 2000-2009 This causes our advice to change: Our response is to do the one thing that’s guaranteed to improve the investor’s odds—increase her monthly savings amount. Starting in late 2001 (during the crash) through mid-2003, we’d recommend an increasing savings amount—up to $250 a month. At that point, the market starts increasing rapidly. Recommended Monthly Savings Amount, 2000-2009 Rather than reduce savings, we view this as a chance to increase the probability of the investor achieving her goal. Results: Portfolio Value But, here is the key graph—the portfolio value. In this case, the investor was aiming for a final value of $150,000. As you can see, even with savings, the portfolio value was flat for the first three years. That would have been a long time to stick with an investment manager, even if this was just what global markets were doing. Starting in 2003, the stock market takes off, and the combination of savings plus returns gets us to our goal in 2007, two years early. However, if the investor had stayed invested, she’d have experience a pretty dramatic, significant drawdown toward the end. But because Betterment was recommending decreasing risk, it’s not a big deal. And, even despite the 2008 crisis, she reaches her goal. Portfolio Value, 2000-2009 Even better than probability of success is projected shortfall in a bad market, given the current balance and savings rate. We can see below that while the crash in 2008-09 definitely hits the balance, the expected shortfall from our goal is relatively minor. Shortfall Amount, 2000-2009 As time time horizon reduces, and the portfolio risk reduces, we decrease the uncertainty of the outcome. The graph below depicts, for any point in time looking forward, the expected range of outcomes at the target date. The range does follow portfolio returns and savings paths, but is always decreasing at the effects of time and portfolio risk reduce. Uncertainty Reduces Over Time, 2000-2009 A good financial advisor is always updating advice to take into account your current situation and goals. This might mean adapting to setbacks and unlucky outcomes, but being proactive about what clients need to do in order to get back on track. It’s almost guaranteed you’ll have losses in your portfolio at some point in time, so it’s critical to plan for how those setbacks impact your plan. While Betterment can’t guarantee risk-free high returns, we can guarantee we’ll always be giving you advice that’s personalized to your goals and circumstances, and completely up to date. A word about backtested performance data: These results are hypothetical and past performance does not guarantee future results. The Betterment portfolio historical performance numbers are based on a backtest of the ETFs or indexes tracked by each asset class in a Betterment Taxable portfolio. All percentage returns include the Betterment fee (0.15% for $100,000 or more, charged quarterly), standard rebalancing, reinvesting dividends and the expenses of the underlying ETFs. All values are nominal. Monthly contributions are assumed to be made at the beginning of the month. Performance returns are calculated using the time-weighted rate of return methodology that ignores cash flows. We've updated our pricing structure since this article was published. Learn more at betterment.com/pricing. Data and performance returns shown are for illustrative purposes only. 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 individual investor performance has and will vary depending on the time of the initial investment, amount and frequency of contributions, and intra-period allocation changes and taxes. Please see additional details at: https://www.betterment.com/returns-calculation/.

Why’d I Do That? Never Forget with the Investing Journal The Investing Journal is a Betterment feature that allows customers to add personal notes to transactions. To our algorithms, your $1,000 withdrawal on May 17, 2014, is just another record in the database. But to you, it was a graduation present for your son or daughter, or cash for unexpected car repairs. The decisions and transactions you make in your Betterment account tell a story of your financial life, but until recently there was nowhere to record the color of that story. The Investing Journal is a new Betterment feature that allows customers to add personal notes to transactions. This lets you document why you made a given decision, never forget what caused it, and help you learn more about yourself. And, of course, it helps us improve our advice by understanding the needs and motivations of our customers. Record the “Why” of Your Decisions The Investing Journal allows you to annotate each withdrawal or allocation change you make in your account. Any time you complete one of those transactions, you’ll see this optional form, which you can use to record a category and any details, similar to what you might write in the “memo” field on a check. When you review your transactions on the Activity tab, you’ll see your notes along with the normal automatically generated descriptions. As we expand the feature, you will see your notes show up in more places throughout the app. By annotating your transactions with the Investing Journal, your Betterment account will become a more informative and transparent experience, reflecting your history and decisions. If you get to the end of the year and wonder how you ended up ahead of schedule or have some catching up to do, you can reference the series of decisions that got you there. You’ll never have to look at your statement at the end of the year and wonder, “Why did I withdraw $500 in February?” Learn More from Your Experience; Never Forget Why In addition to personalizing your financial experience with Betterment, recording the reasons behind your decisions is a great way to learn about yourself as a saver and investor. Seasoned investors will often cite their years of experience through business cycles and investing fads as the reason they are able to make good decisions today. It clearly helps to have witnessed moments of uncertainty and see that it turned out OK, or to have taken risks and felt the payoff. But research shows that investors often lack an accurate understanding of what has happened, and the lessons we learn can only be as good as our understanding of the facts. Our memories are not a perfect record of what happened, and psychologists have shown that the errors are not random. For example, the peak-end rule originally offered by Nobel Laureate Daniel Kahneman describes how we typically remember the most extreme and most recent events in a sequence. Applied to investing experience, this would mean that investors typically remember the most extreme periods of gains or losses as well the most recent performance of their portfolio, but mostly forget the average periods in between. The problem is that these salient memories are not a good summary of the overall experience, so using them to inform decisions about the future is risky. Another way our memory plays tricks on us is the hindsight bias, which describes how unpredictable events seem obvious in retrospect. For example, imagine a time when the market has declined 3% over the previous two weeks. It is very difficult to predict whether it will continue downward, rebound, or stay where it is. When looking back at how things turned out, however, many will be tempted to say, “I knew it all along!” Many well-designed experiments in sports, politics, and finance show that the outcome only feels inevitable after the fact. Our predictions in the moment are not nearly as good as we feel they would have been afterward. When we don’t put our predictions in writing, it’s easy to feel more prescient than we are and become overconfident as a result. For customers who make frequent ad-hoc deposits or withdrawals, the Investing Journal can help to paint a clearer picture of where all that money is coming from and where it’s going. Consider a customer reviewing the progress she has made in the last year on her house down payment goal. She might discover by reviewing her Investing Journal memos that many of the unanticipated withdrawals were for car repairs. Identifying the total impact of those expenses could lead to creating a new more appropriate “Car Repairs” goal or revising the savings rate for the downpayment goal. Using the Investing Journal to record your thoughts and feelings at the time of each investment decision is a great way to build a more accurate impression of your investing experience. What Motivates You? Help Us Offer More Personalized Advice Finally, we want to provide the most personalized advice possible to all of our customers. By asking customers to categorize the motivation for their actions (if they choose), we can differentiate between otherwise similar events. Consider one withdrawal motivated by fears about the markets and another being made to make a down payment as planned. The first is a good opportunity for us to encourage a buy-and-hold long term perspective to help maximize returns, while the second is cause for congratulations. To offer advice that matches each of our customers’ needs, we need to listen and understand their goals and motivations. The Investing Journal is a small step toward an exciting future of doing that in a much more comprehensive fashion. The Investing Journal turns a generic list of transactions into a personal history of your transactions. Recording the reasons behind each action you take helps build a more accurate understanding of your own saving and investing experience. And as we learn more about the motivations behind each customer’s actions, our data and behavioral team can continue to improve the Betterment experience.

The Forward Curve: How Betterment Forecasts Interest Rates Does your automated investing service regularly update its forecasted future risk-free rate assumption? At Betterment, the answer is yes, on a quarterly basis. The SEC and FINRA issued an alert in May 2015 about automated investing services. In the process, they surfaced some good questions consumers should ask before placing their money with a service that uses algorithms to drive advice and portfolio management. As transparency is one of the core principles of Betterment, we make ongoing efforts to educate investors on the assumptions that we use in our algorithms. We took this alert as an opportunity to do more of just that. The alert specifically drew focus to interest rate assumptions underlying automated investing: “If the automated tool assumes that interest rates will remain low but, instead, interest rates rise, the tool’s output will be flawed.” This is another way of saying, “Does your automated investing service regularly update its forecasted future risk-free rate assumption?” At Betterment, the answer is yes, on a quarterly basis. But what does that mean, and why is it significant? To answer that, we’ll need to understand the forward interest rate curve. The Risk-Free Rate The risk-free rate is a rate of return for an investment with nearly zero risk—such as an ultra short-term Treasury. The fact that the issuer is the U.S. government means it has insignificant credit risk, and the ultra short-term maturity means it has minimal interest rate exposure. Of course, this ignores inflation risk, but you know exactly what your return will be, in nominal returns. For as long as I can remember, economics and finance textbooks spoke of a risk-free rate pegged from 2% to 5%. This made classroom math easier, but for the past decade of low interest rates, the number doesn’t come close to reflecting the real world. When we calculate returns, both historic and forward-looking, we consider a portfolio’s performance in the context of the risk-free rate in the same period. If you could have achieved the same (or higher) return risk free, why would you take the risky asset? In the typical classroom example, if an investment earned a 12% return last year, we would want to adjust that down by the risk-free rate—let’s say 5%—which paints that investment as a seven percentage point return above the risk-free rate. This is what we call an excess return—a return above the risk-free rate. From the other perspective, if an investor wants to consider a new potential investment that takes on risk, it would need to offer an expectation of a return greater than the risk-free rate. Otherwise, why bother? In these examples, the ultra short-term U.S. Treasury is usually the stand in for risk-free rate. While that was 5% or more for years (that was the rate in 2000), today the three-month U.S. Treasury yield is actually just 0.04%. Risk-Free Rate Since 1982 So, the first implied question in the regulatory alert item is: Does the Betterment algorithm know that the three-month U.S. Treasury yield is no longer anywhere near 5%, but a lot closer to 0.04%? The answer is yes. And, that number is automatically updated in the underlying algorithm on a quarterly basis. Future Risk-Free Rates: What Will They Be? Of course, if you have a 30-year goal with Betterment, you don’t expect risk-free rates to be at zero over the next 30 years. But how might we forecast future risk-free rates, especially without resorting to overconfident expert judgments? Well, we can use the market’s estimate. Because the bond market is very efficient, we can use market prices to estimate the expected yields at specific points in time in the future. The classic example is a bond with a two-year maturity and a bond with a five-year maturity need to move together, so that an investor could buy the two-year instrument and then afterward invest in some three-year instrument to bring him to the total return of the five-year instrument. If the yields are known on the two-year and on the five-year bonds, calculating what the three-year note would yield becomes the question at hand. The CFA Institute gives a nice example of how this works. If our two-year bond is paying 2%, then the math is: 100 x (1.02) x (1.02) = 100 x (1.02)^2 = $104.4 If our five-year bond is paying 5%, then the math equation would be similar: 100 x (1.05)^5 = $127.63 Future forward rates refer to what is the implied rate for a bond we could hold for years three, four, and five, whose return would allow the owner of the two-year bond to have the same total return as the original five-year bond. A simple equation to solve for the missing variable (i) would be: $104.04 x (1 + i)^3 = $127.63 That means the first return, times 1 plus the missing interest rate, and that raised to the power equal to the number of years, has to equal the return from the full five-year yield. Doing some easy algebra brings you to: Forward interest rate = [($127.63/$104.4)^⅓] - 1 In this example, i = 0.070489, or 7.05% So, the answer is that the forward rate, implied by the two original returns, means that an investor could earn 2% on the two-year bond, then invest that in a three-year bond yielding 7.05%, to equal what he could have also got through owning the five-year bond yielding 5%. Note that the three-year bond will have a higher yield than the average yield of the five-year. Because the five-year is an average over five years, if the first two years are below average, the following years must be above average. We can see this relationship in the actual bootstrapped forward curve below—the implied forward curve is higher than the yield curve. Yield and Forward Curves What This Means for You Expected future returns are comprised of two parts—the risk premium (above the risk-free rate) that assets earn, and the risk-free rate. Expected Return = Risk-Free Rate + Risk Premium (or excess return) When we forecast our forward-looking returns, the risk-premium component of the portfolio changes at a gradual rate, but the risk-free component can reflect the bond market’s forecasts over the course of your goal.   For customers, what’s important is that our estimates of expected returns are being updated to take into account market forecasts of future risk-free rates. If future risk-free rates are anemic, this means you might need to save more to achieve the same goal. On the other hand, if future rates rise, it may mean you will have more certainty about having at least as much as, if not more than, your goal target. We adjust this quarterly so that our forecasts can be as accurate as possible for our clients, be their goals short term or long term. We don’t believe more frequent than quarterly would be beneficial. While future risk-free rates are important for our savings advice, they don’t influence our allocation advice. Betterment’s investment philosophy is that you should diversify a portfolio and hold it for the long term, adjusting frequently, but not taking big bets that can easily be off. As for the original question posed by the SEC about the underlying assumptions used in the algorithm, rest assured that Betterment’s algorithm is using current and accurate data.

Allocation Advice for Betterment Portfolios Unlike the risk questionnaires, our algorithm weights investment time horizon and downside risk more heavily, and allows you to deviate from our advice if you want to deviate. TABLE OF CONTENTS We start with your goals How we balance risk and time How we manage downside risk The result? Betterment's glide path Including customer risk preference If you have ever worked with a traditional investment manager or have a 401(k) plan at work, you have likely answered a “standard” risk questionnaire. It often starts with your estimated retirement date and how much money you have, and then ask you what kind of returns you want to see. But these questionnaires measure what kind of risk-taker you think you are, not what kind you need to be in order to achieve your goals. At Betterment, we believe that your investment horizon—how long until you will need your money—is one of the most important determinants of how much risk you should take. The more long-term your investing goals, the more risk you can afford to safely take. Money saved for short- and medium-term goals, such as saving for a house or buying a car, can be invested at a different risk level than a longer-term goal, such as retirement. Another consideration is how you plan to use the money when you need it. Will you take out the investment in a lump sum or will you gradually make withdrawals over time and use that money for income? These are key pieces of information we use when providing personalized investment advice. Below, we walk you through the rationale of our risk advice model. Unlike the standard risk questionnaires, our algorithm weights investment time horizon and downside risk more heavily, and allows you to deviate from our advice if you want to deviate. This is the heart of Betterment's risk advice algorithm. We start with your goals First, let's talk about goals. At Betterment, you can think of goals like different investment buckets. They are technically subaccounts that you can use to silo your retirement savings from vacation savings, for example. Every goal you set up at Betterment (and every customer can set up several) will have its own customized allocation of stocks and bonds. Each goal has different final liquidation assumptions, so it is important to select the one that most closely matches your real intentions. Below we can see the diversity of goals you can manage at Betterment. ...and then look at your investment horizon. Once we know your goal, we next consider how long you will be invested in that goal, as well as the withdrawal plan for that goal. Is it a goal that you plan on cashing out in 10 years, or a goal such as retirement in 30 years, give or take a few years? That actually makes a big difference in the advice we'll give. We assume you will spend your Major Purchase goal savings at a specific point in time. You might withdraw your entire House goal investment after 10 years when you have hit the savings mark for your down payment. In contrast, with a Retirement goal, we assume you will spend funds over a number of years rather than in one lump sum withdrawal. That's the nature of a nest egg—it's the basis for your monthly income in retirement. If you don’t have a specific investment horizon or target amount, we will use your age to set your investment horizon (our default target date is your 65th birthday) in a General Investing goal. It has a similar spending assumption as retirement, but maintains a slightly riskier portfolio even when you hit the target date, since it's not clear you'll liquidate those investments soon. With this information about your time horizon and goals, we can determine an optimal risk level for your investment horizon. We do this by assessing the possible outcomes for your time horizon across a wide variety of bad to average markets. Getting to an optimal risk level, generally attained through exposure to stocks versus bonds, involves weighing the trade-offs between potential gains from higher risk investments and the potential for falling short by playing it safe. We have designed our formula so that it works especially well with our portfolio, which contains multiple globally diversified asset classes. Now, we know we can't predict what the future will be. So we use a projection model that includes this uncertainty by including many possible futures, weighted by how likely we believe they are.  We use these probability-weighted futures to build our recommendation based on a range of outcomes, giving slightly more weight to potential negative outcomes and building in a margin of safety—which technically is called 'downside risk' and uncertainty optimization. If you're interested, you can also read more about our projection methodology. Paying particular attention to below-average scenarios we are able to select a level of risk that aims to minimize potential downside risk at every investment horizon. By some standards, we have a fairly conservative allocation model—but as we mentioned above, our mission is to help you get to your goal through steady saving and appropriate allocation, rather than taking on unnecessary risk. How we balance risk and time Now, let's consider now how risk and time work together. The example below shows the forecasted growth of $100,000 in a 70% stock portfolio over three years. The expected return, or median outcome, for this portfolio is $121,917, but the range of possible outcomes moves from at least $180,580 for the top 5% of potential outcomes to no better than $82,312 for the bottom 5%. This is a great example of how stocks can bring both a lot of upside—as well as downside in the short-term. Outcome and risk over a three-year term If the graph above shows an example of the predicted volatility that stocks can bring to very short-term time horizons, what happens to the same portfolio over a 10-year time horizon? Outcome and risk over a 10-year term After 10 years, our models predict that you are less likely to lose money and more likely to come out ahead on an absolute dollar basis. How we manage downside risk Now that the relationship between risk and time is clear, let's turn back to allocation. In order to make an appropriate recommendation of stocks and bonds, we have to look at potential outcomes for everything from 0% stocks to 100% stocks. To do this, we evaluate stock allocations and look at how they might perform at similar percentiles over a fixed investment horizon. This analysis helps us finely tune the stock-and-bond ratio. In the example below, we see the 15th percentile outcome for every stock allocation over a 20-year investment horizon. We use the 15th percentile to represent a 'bad' outcome, i.e., poor predicted market performance. With shorter-term horizons (seven years and less), our modeling shows a majority bond portfolio beats a majority stock portfolio in this ‘bad case.'  However, by year 12, the same model predicts higher stock allocations begin to overcome bond-heavy portfolios. By year 20 all majority stock portfolios (at least 50.1%) have better outcomes than majority bond portfolios, even though this is still a 'bad' outcome in terms of investment performance. Returns at the 15th percentile, or a 'bad case' scenario Within this bad outcome scenario let's focus on the best allocation at each time period. Measured by returns, the best expected outcomes are equivalent to the top of this graph (traced in red). Another way to view this best allocation line is to change the y-axis from absolute value in dollars to the stock allocation. If we plot the same 15th percentile best allocation line on a new plot we get the following graph. Portfolio value as a measure of stock allocation at the 15th percentile This new view of the same line clearly shows which allocation would have performed best for a given period. For example, in the ‘bad’ scenario, a 65% stock portfolio would have performed best over a period that lasted 10 years and nine months on the predicted model. Allocation and time Our advice doesn’t only consider the bad outcomes. We seek to find the best stock allocation for outcomes from the expected 50th percentile to the 5th percentile (a 'worst case' scenario, but not THE worst case scenario). You can see the result of this exercise in the graph below, which maps investment horizon against best stock allocation, given the percentile chosen. Percentiles by 5%, from 5th to 50th Our goal is to provide the best possible expected returns. That means aiming to provide you with the best chance of making money and not losing it. To do that, we then must look at the the median outcome—and an average of all the outcomes that are considered bad, which is everything from the 5th percentile to the 50th. (Why 50th? Percentiles over the 50th, the median will show that 100% stocks are the best allocation.) The dark blue line represents the average ‘best’ stock allocation across all percentiles. Since we have included more downside scenarios in this average, it weighs the potential for loss more than equivalent upside. But note that over longer time periods, even with a downside risk focus, we predict that it is still better to be in a majority stock portfolio compared to a majority bond portfolio. Average of all percentiles For long-term goals, those with time horizons over 20 years or more, we recommend 90% stocks. For short-term time horizons, we recommend 10% stocks. And for intermediate-term goals, the recommended stock allocation rises very quickly. This is based on a conservative downside-weighted risk measure which accounts for your specific time horizon in each goal to help ensure you are taking on the right risk for the level of return you should realize. The result is Betterment's glide path The result is a general framework for the risk allocation advice Betterment uses across all goals, which can supply a goal-specific glide path recommendation. In investing, a glide path is the formula used for asset allocation that progressively gets more and more conservative as the liquidation date nears. Many retirement-oriented target-date funds are based on a glide path (though every firm has its own formula.) At Betterment, we adjust the recommended allocation and portfolio weights of the glide path based on your specific goal and time horizon. This means Betterment glide path recommendations are more personalized to your specific goals and investment horizons. For example, in our Major Purchase goals, shown below, the recommended glide path takes a more conservative path than a recommended retirement glide path—moving to near-zero risk—for very short time horizons. Why is that? This is because we expect that you will fully liquidate your investment at the intended date and will need the full balance. With Retirement goals, in contrast, the glide path we recommend remains at a higher risk allocation even when the target date is reached, as we assume liquidation will be gradual, and you still have years in retirement for your investments to grow before they are liquidated. Learn how this advice varies by goal type. Mixing bonds and stocks across percentiles The bottom line: Our allocation advice is designed at a goal level to help ensure you're taking on the right level of risk based on your personal situation, unlike the impersonal and often unexplained glide path offered by target-date funds. Including customer risk preference How should we modify this analysis for a conservative or aggressive approach? The glidepath derived above is downside optimized because it gives equal weight to each percentile outcome from the median down to the first percentile over a given time horizon. To tailor this guidance to a more conservative or aggressive approach, we’ll change the weights to reflect the degree to which investors care about the worse outcomes versus median average outcomes. A quantitative approach We’ll define a ‘conservative’ approach as giving the median (50th percentile outcome) about 40% of the weight of the 5th percentile outcome. Conversely, the ‘aggressive’ approach gives the 5th percentile outcome about 40% of the weight of the median. Weight Given to Outcome for Different Approaches The result is a set of optimal aggressive and conservative glidepaths, as shown below for a major purchase goal. Deviation from the Recommended Approach This approach does allow for deviation by risk level, which produces a non-linear guidance range. It is wider at moderate allocations, and tighter at the bottom and top of the risk range. Optimal Stock Allocation One reason is simply mechanical: at higher risk levels, you can’t deviate up very much. At lower risk levels, you can’t deviate down much. Taken across the entire range our outcomes, we have determined that ± 7% is a reasonable deviation. We believe a stable range across recommended levels is easier to understand and follow, and there is sufficient noise in the more extreme tails of these estimates to justify allowing a higher range at the tails. We therefore give guidance that the acceptable range of deviation is -7% for customers wanting a conservative approach, and +7% for customers wanting an aggressive approach to that goal. Very conservative More than 7% beneath recommendation Appropriately Conservative Between 3% and 7% beneath recommendation Moderate Within 3% of recommendation, inclusive. Appropriately Aggressive Between 3% and 7% above recommendation Too aggressive ✢ More than 7% above recommendation Unknown When lack of information regarding significant external assets means it’s not possible to reach a conclusive opinion ✢  Betterment for Advisors customers see ‘Very aggressive’ instead. Goal-term guidance Our quantitative approach above allows us to establish a set of recommended risk ranges given our goals. However, an investor may choose to deviate from our risk guidance if they see fit, and there may be appropriate reasons for those deviations. That being said, we provide investors with feedback regarding the potential implications of such deviations and, in doing so, we treat upwards and downwards deviations differently. If an investor decides to take on more risk than we recommend, we communicate the fact that we believe their approach is “too aggressive” given their goal and time horizon. We flag this because even in a setting where an investor cares about the downsides less than the average outcome, it still isn’t rational to take on more risk (viewing this particular goal in isolation). If the investor is unlucky with returns over that period, the losses in a portfolio flagged as “too aggressive” will be very difficult to recover from. In contrast, if an investor chooses a risk level lower than our “conservative” band, we'll communicate that their choice is “very conservative.” This is because the downside of taking on a lower risk level in a moderate outcome scenario is simply needing to save more. And we believe investors should choose a level of risk which is aligned with their ability to stay the course through the short term. Aligning risk level with short-term risk tolerance An allocation cannot be optimal if the investor is not comfortable committing to it in both good markets and bad ones. As a point of reference, our 70% stock portfolio would have lost 46% from Nov. 2007 to Mar. 2009, and been in the red until 2011. While this performance would have been very disappointing, it is important to remember we only recommend 70% stock allocations for goals expected to be held eight years or longer. To ensure that investors understand and feel comfortable with the short term risk in their portfolios, we present them with both extremely good and extremely poor return scenarios for their selection over a one-year time period.