Betterment Editors

Your year-end investing checklist Dec 1, 2023 12:22:40 PM As the year comes to a close, it's a good time to check in on your investing plan and set yourself up for the year ahead. Checklists make life easier. But if they get too long, they become overwhelming. That’s why our year-end checklist only has five items on it. How to use this checklist: Take five minutes to review the checklist. For each relevant item, schedule an hour of time to sit down and start completing the task. Your future self will thank you. Here's your 5-point checklist: Max out retirement account contributions: Various retirement accounts like 401(k)s and IRAs have different maximum contributions with different benefits. If you have a traditional 401(k), every dollar you invest lowers your taxable income. Keep in mind the deadline to contribute is December 31. For IRAs on the other hand, you have until tax day, allowing you more time to invest. And in a Roth IRA, these dollars grow tax-free once invested. Plan next year's retirement account contributions: Examine your current 401(k) or IRA contributions. Experts typically recommend saving 10% to 15% of your income for retirement. This can be difficult, so we recommend saving as much as you can and automating it ahead of time using scheduled deposits or contributions. At the very least, if your employer offers a 401(k) match, see if you’re able to contribute enough to get what is essentially free money. Consider a rollover: If you have retirement accounts at other providers, review your fees and investment options. If you find higher-than-average fees or limited investment choices, consider if a rollover is right for you. Additionally, rolling over other retirement accounts into a Betterment IRA can streamline your finances by consolidating investments on one platform. Double-check your beneficiaries: Beneficiaries are the people who receive your money if something happens to you. It’s important they stay updated on each account, especially given that beneficiary designations normally take precedence over what’s listed in a will. We recommend reviewing beneficiaries annually or as life changes. Review your goals for next year and beyond: A new car, a vacation, a home renovation, child care—the list goes on. Taking just a small amount of time can set you up to save the money needed to reach your goals (and needs). For short-term goals, we recommend a high-yield cash account to keep your money safe as it grows. For long-term goals, we recommend a diversified portfolio of stocks and bonds. Or both! It’s a new year and a chance to put your financial plans first. Remember: Tackling just one item from the checklist above can make a big difference in your financial life. You got this!

Compound interest: The 8th wonder of the world Dec 1, 2023 11:30:31 AM We show you the power of compound interest and how to visualize projected compound interest on your Betterment accounts. In this article, we show you the power of compound interest and teach you how to use our tools to see how your investing accounts may grow over time. The main idea: Compound interest is when your earnings from investments are reinvested, growing even more earnings or “compounding” over time. It’s one of the ways your savings grow. How it works: Don’t worry, we won’t get into the complicated math. Let’s look at a scenario instead. But first, we need to know that three things go into creating value with compound interest: Rate of return on your investment or savings. Usually listed as a historical annualized return for stock investing or an annual percentage yield (APY) for savings and cash accounts. Frequency of compounding. For stock investing, this means how often you earn dividends and for a savings or cash account, this means how often you are paid interest. Time period for which your money is invested. The longer this is, the more time your money has to compound. Now let's look at a hypothetical scenario. Pretend two people each have $5,000 of savings. Over a five-year period, from August 2018 to July 2023, they each manage their money differently. Person 1: Keeps the $5,000 in a checking account that earns 0% interest. They still have $5,000 in July 2023 because there was no chance for their money to experience compound interest. Person 2: Invested $5,000 into an investing portfolio on August 1, 2018. With dividends reinvested, they averaged 7.4% annualized returns after fees, and on July 31, 2023, their account was worth $7,145. Compounding works the same way in savings or cash accounts that pay interest. For example, our Cash Reserve account allows you to earn a variable rate APY to compound your savings. You generally pay taxes on earnings in both investing and cash accounts, but even with taxes, your money has the potential to grow over the long term due to compound interest. Visualize compound interest on your Betterment investing account: Our mobile app and desktop platform both offer simple tools to help you see how compounding could impact your goals. Mobile app: Navigate to your investing account and view the Projection graph to see a visualization of how your account may compound over time. Desktop platform: To use the goal forecaster, navigate to your investing goal. Select the “Plan” section, then click the “Open goal forecaster” button. Our goal forecaster tool allows you to enter scenarios for deposit and target date inputs. The projection graph will show you the estimated impact of compound interest on your investment portfolio along with the chance of reaching your goal based on your inputs.

Socially Responsible Investing Portfolios Methodology Dec 1, 2023 9:00:00 AM Learn how Betterment constructs our Socially Responsible Investing (SRI) portfolios. Table of Contents Introduction How do we define SRI? The Challenges of SRI Portfolio Construction How is Betterment’s Broad Impact portfolio constructed? How is Betterment’s Climate Impact portfolio constructed? How is Betterment’s Social Impact portfolio constructed? Conclusion Introduction Betterment launched its first Socially Responsible Investing (SRI) portfolio in 2017, and has widened the investment options under that umbrella since then. Within Betterment’s SRI options, we currently offer a Broad Impact portfolio and two additional, more focused SRI portfolio options: a Social Impact SRI portfolio (focused on social governance mandates) and a Climate Impact SRI portfolio (focused on climate-conscious investments). These portfolios represent a diversified, relatively low-cost solution constructed using exchange traded funds (ETFs), which will be continually improved upon as costs decline, more data emerges, and as a result, the availability of SRI funds broadens. How do we define SRI? Our approach to SRI has three fundamental dimensions that shape our portfolio construction mandates: Reducing exposure to investments involved in unsustainable activities and environmental, social, or governmental controversies. Increasing exposure to investments that work to address solutions for core environmental and social challenges in measurable ways. Allocating to investments that use shareholder engagement tools, such as shareholder proposals and proxy voting, to incentivize socially responsible corporate behavior. SRI is the traditional name for the broad concept of values-driven investing (many experts now favor “sustainable investing” as the name for the entire category). Our SRI approach uses SRI mandates based on a set of industry criteria known as “ESG,” which stands for Environmental, Social and Governance. ESG refers specifically to the quantifiable dimensions of a company’s standing along each of its three components. Betterment’s approach expands upon the ESG-investing framework with exposure to investments that use complementary shareholder engagement tools. Betterment does not directly select companies to include in, or exclude from, the SRI portfolios. Rather, Betterment identifies ETFs that have been classified as ESG or similar by third-parties and considers internally developed “SRI mandates” alongside other qualitative and quantitative factors to select ETFs to include in its SRI portfolios. Using SRI Mandates One aspect of improving a portfolio’s ESG exposure is reducing exposure to companies that engage in certain activities that may be considered undesirable because they do not align with specific values. These activities may include selling tobacco, military weapons, civilian firearms, as well as involvement in recent and ongoing ESG controversies. However, SRI is about more than just adjusting your portfolio to minimize companies with a poor social impact. For each Betterment SRI portfolio, the portfolio construction process considers one or more internally developed “SRI mandates.” Betterment’s SRI mandates are sustainable investing objectives that we include in our portfolios’ exposures. SRI Mandate Description Betterment SRI Portfolio Mapping ESG Mandate ETFs tracking indices which are constructed with reference to some form of ESG optimization, which promotes exposure to Environmental, Social, and Governance pillars. Broad, Climate, Social Impact Portfolios Fossil Fuel Divestment Mandate ETFs tracking indices which are constructed with the aim of excluding stocks in companies with major fossil fuels holdings (divestment). Climate Impact Portfolio Carbon Footprint Mandate ETFs tracking indices which are constructed with the aim of minimizing exposure to carbon emissions across the entire economy (rather than focus on screening out exposure to stocks primarily in the energy sector). Climate Impact Portfolio Green Financing Mandates ETFs tracking indices focused on financing environmentally beneficial activities directly. Climate Impact Portfolio Gender Equity Mandate ETFs tracking indices which are constructed with the aim of representing the performance of companies that seek to advance gender equality. Social Impact Portfolio Racial Equity Mandate ETFs tracking indices which are constructed with the aim of allocating capital to companies that seek to advance racial equality. Social Impact Portfolio Shareholder Engagement Mandate In addition to the mandates listed above, Betterment’s SRI portfolios are constructed using a shareholder engagement mandate. One of the most direct ways a shareholder can influence a company’s decision making is through shareholder proposals and proxy voting. Publicly traded companies have annual meetings where they report on the business’s activities to shareholders. As a part of these meetings, shareholders can vote on a number of topics such as share ownership, the composition of the board of directors, and executive level compensation. Shareholders receive information on the topics to be voted on prior to the meeting in the form of a proxy statement, and can vote on these topics through a proxy card. A shareholder can also make an explicit recommendation for the company to take a specific course of action through a shareholder proposal. ETF shareholders themselves do not vote in the proxy voting process of underlying companies, but rather the ETF fund issuer participates in the proxy voting process on behalf of their shareholders. As investors signal increasing interest in ESG engagement, more ETF fund issuers have emerged that play a more active role engaging with underlying companies through proxy voting to advocate for more socially responsible corporate practices. These issuers use engagement-based strategies, such as shareholder proposals and director nominees, to engage with companies to bring about ESG change and allow investors in the ETF to express a socially responsible preference. For this reason, Betterment includes a Shareholder Engagement Mandate in its SRI portfolios. Mandate Description Betterment SRI Portfolio Mapping Shareholder Engagement Mandate ETFs which aim to fulfill one or more of the above mandates, not via allocation decisions, but rather through the shareholder engagement process, such as proxy voting. Broad, Climate, Social Impact Portfolios The Challenges of SRI Portfolio Construction For Betterment, three limitations have a large influence on our overall approach to building an SRI portfolio: 1. Many existing SRI offerings in the market have serious shortcomings. Many SRI offerings today sacrifice sufficient diversification appropriate for investors who seek market returns, and/or do not provide investors an avenue to use collective action to bring about ESG change. Betterment’s SRI portfolios do not sacrifice global diversification. Consistent with our core principle of global diversification and to ensure both domestic and international bond exposure, we’re still allocating to some funds without an ESG mandate, until satisfactory solutions are available within those asset classes. Additionally, all three of Betterment’s SRI portfolios include a partial allocation to an engagement-based socially responsible ETF using shareholder advocacy as a means to bring about ESG-change in corporate behavior. Engagement-based socially responsible ETFs have expressive value in that they allow investors to signal their interest in ESG issues to companies and the market more broadly, even if particular shareholder campaigns are unsuccessful. 2. Integrating values into an ETF portfolio may not always meet every investor’s expectations. For investors who prioritize an absolute exclusion of specific types of companies above all else, certain approaches to ESG will inevitably fall short of expectations. For example, many of the largest ESG funds focused on US Large Cap stocks include some energy companies that engage in oil and natural gas exploration, like Hess. While Hess might not meet the criteria of the “E” pillar of ESG, it could still meet the criteria in terms of the “S” and the “G.” Understanding that investors may prefer to focus specifically on a certain pillar of ESG, Betterment has made three SRI portfolios available. The Broad Impact portfolio seeks to balance each of the three dimensions of ESG without diluting different dimensions of social responsibility. With our Social Impact portfolio, we sharpen the focus on social equity with partial allocations to gender and racial diversity focused funds. With our Climate Impact portfolio, we sharpen the focus on controlling carbon emissions and fostering green solutions. 3. Most available SRI-oriented ETFs present liquidity limitations. While SRI-oriented ETFs have relatively low expense ratios compared to SRI mutual funds, our analysis revealed insufficient liquidity in many ETFs currently on the market. Without sufficient liquidity, every execution becomes more expensive, creating a drag on returns. Median daily dollar volume is one way of estimating liquidity. Higher volume on a given asset means that you can quickly buy (or sell) more of that asset in the market without driving the price up (or down). The degree to which you can drive the price up or down with your buying or selling must be treated as a cost that can drag down on your returns. We expect that increased asset flows across the industry into such SRI-oriented ETFs will continue to drive down expense ratios and increase liquidity over the long-run. To that end, Betterment reassesses the funds available for inclusion in these portfolios regularly. In balancing cost and value for the portfolios, the options are limited to funds of certain asset classes such as US stocks, Developed Market stocks, Emerging Market stocks, US Investment Grade Corporate Bonds, and US High Quality bonds. How is Betterment’s Broad Impact portfolio constructed? Betterment’s Broad Impact portfolio invests assets in socially responsible ETFs to obtain exposure to both the ESG and Shareholder Engagement mandates, as highlighted in the table above. It focuses on ETFs that consider all three ESG pillars, and includes an allocation to an engagement-based SRI ETF. Broad ESG investing solutions are currently the most liquid, highlighting their popularity amongst investors. In order to maintain geographic and asset class diversification and to meet our requirements for lower cost and higher liquidity in all SRI portfolios, we continue to allocate to some funds that do not reflect SRI mandates, particularly in bond asset classes. How is Betterment’s Climate Impact portfolio constructed? Betterment offers a Climate Impact portfolio for investors that want to invest in an SRI strategy more focused on the environmental pillar of “ESG” rather than focusing on all ESG dimensions equally. Betterment’s Climate Impact portfolio invests assets in socially responsible ETFs and is constructed using the following mandates that seek to achieve divestment and engagement: ESG, carbon footprint reduction, fossil fuel divestment, shareholder engagement, and green financing. The Climate Impact portfolio was designed to give investors exposure to climate-conscious investments, without sacrificing proper diversification and balanced cost. Fund selection for this portfolio follows the same guidelines established for the Broad Impact portfolio, as we seek to incorporate broad based climate-focused ETFs with sufficient liquidity relative to their size in the portfolio. How can the Climate Impact portfolio help to positively affect climate change? The Climate Impact portfolio is allocated to iShares MSCI ACWI Low Carbon Target ETF (CRBN), an ETF which seeks to track the global stock market, but with a bias towards companies with a lower carbon footprint. By investing in CRBN, investors are actively supporting companies with a lower carbon footprint, because CRBN overweights these stocks relative to their high-carbon emitting peers. One way we can measure the carbon impact a fund has is by looking at its weighted average carbon intensity, which measures the weighted average of tons of CO2 emissions per million dollars in sales, based on the fund's underlying holdings. Based on weighted average carbon intensity data from MSCI, Betterment’s 100% stock Climate Impact portfolio has carbon emissions per unit sales that are nearly 43% lower than Betterment’s 100% stock Core portfolio as of September 30, 2023. Additionally, a portion of the Climate Impact portfolio is allocated to fossil fuel reserve funds. Rather than ranking and weighting funds based on a certain climate metric like CRBN, fossil fuel reserve free funds instead exclude companies that own fossil fuel reserves, defined as crude oil, natural gas, and thermal coal. By investing in fossil fuel reserve free funds, investors are actively divesting from companies with some of the most negative impact on climate change, including oil producers, refineries, and coal miners such as Chevron, ExxonMobile, BP, and Peabody Energy. Another way that the Climate Impact portfolio promotes a positive environmental impact is by investing in bonds that fund green projects. The Climate Impact portfolio invests in iShares Global Green Bond ETF (BGRN), which tracks the global market of investment-grade bonds linked to environmentally beneficial projects, as determined by MSCI. These bonds are called “green bonds.” The green bonds held by BGRN fund projects in a number of environmental categories defined by MSCI including alternative energy, energy efficiency, pollution prevention and control, sustainable water, green building, and climate adaptation. How is Betterment’s Social Impact portfolio constructed? Betterment offers a Social Impact portfolio for investors that want to invest in a strategy more focused on the social pillar of ESG investing (the S in ESG). Betterment’s Social Impact portfolio invests assets in socially responsible ETFs and is constructed using the following mandates: ESG, gender equity, racial equity, and shareholder engagement. 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 help promote social equity? The Social Impact portfolio shares many of the same holdings as Betterment’s Broad Impact portfolio. The Social Impact portfolio additionally looks to further promote the “social” pillar of ESG investing, by allocating to 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 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. Should we expect any difference in an SRI portfolio’s performance? One might expect that a socially responsible portfolio could lead to lower returns in the long term compared to another, similar portfolio. The notion behind this reasoning is that somehow there is a premium to be paid for investing based on your social ideals and values. A white paper written in partnership between Rockefeller Asset Management and NYU Stern Center for Sustainable Business studied 1,000+ research papers published from 2015-2020 analyzing the relationship between ESG investing and performance. The primary takeaway from this research was that they found “positive correlations between ESG performance and operational efficiencies, stock performance, and lower cost of capital.” When ESG factors were considered in the study, there seemed to be improved performance potential over longer time periods and potential to also provide downside protection during periods of crisis. It’s important to note that performance in the SRI portfolios can be impacted by several variables, and is not guaranteed to align with the results of this study. Dividend Yields Could Be Lower Using the SRI Broad Impact portfolio for reference, dividend yields over a one year period ending September 30, 2023 indicate that SRI income returns have been lower than those of Core portfolio. Oil and gas companies like BP, Chevron, and Exxon, for example, currently have relatively high dividend yields and excluding them from a given portfolio can cause its income return to be lower. Of course, future dividend yields are uncertain variables and past data may not provide accurate forecasts. Nevertheless, lower dividend yields can be a factor in driving total returns for SRI portfolios to be lower than those of Core portfolios. Comparison of Dividend Yields Source: Bloomberg, Calculations by Betterment for one year period ending September 30, 2023. Dividend yields for each portfolio are calculated using the dividend yields of the primary ETFs used for taxable allocations of Betterment’s portfolios as of September 2023. How does the legacy SRI portfolio compare to the current SRI portfolios? Certain clients may be invested in Betterment’s original, “legacy” SRI portfolio. 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 that 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 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. Conclusion Despite the various limitations that all SRI implementations face today, Betterment will continue to support its customers in further aligning their values to their investments. Betterment may add additional socially responsible funds to the SRI portfolios and replace other ETFs as more socially responsible products become available.

Two timeless tips from a legendary investor Nov 28, 2023 11:06:49 AM Warren Buffett may be the greatest investor to ever live. But his mentor is a legend with some timeless advice for all of us. Warren Buffett’s mentor was Benjamin Graham. He wrote two of the most famous investing books ever written, with his most well-known book being The Intelligent Investor. The book was published in 1949 and his advice is still relevant today. If you don’t want to read Graham’s hundreds of pages of investment advice, don’t worry, we’ve summarized a couple of our favorite tips for you. Tip 1: Know what type of investor you are. Graham warned of, “...speculating when you think you are investing…” Graham divided investors into two camps: Defensive and aggressive investors. Both need to be cautious of becoming speculators, throwing money into the “hot” stocks of the moment. Defensive, or passive, investors want to avoid serious losses and the need to make frequent investing decisions. Aggressive, or active, investors have a willingness to devote time and care, and hopefully skill, to the selection of individual investments. Most people lean towards passive investing, but either way, avoid the temptation to speculate, especially unplanned speculation during market crazes (ahem, meme stocks). Tip 2: Be comfortable with market volatility. Graham writes, “Every investor who owns common stock must expect to see them fluctuate in value over the years.” When thinking about stock market volatility—the ups and downs of the market—consider this summary of Graham’s advice: Avoid timing the market. Graham was a big believer that it was nearly impossible for the general public to be successful at timing the market. We couldn’t agree more. You don’t need to watch your portfolio’s performance “like a hawk” as Graham wrote. Simply check it from time to time throughout the year to make sure your strategy aligns with your long-term investing goals. Bonus tips: For passive investors weathering a volatile market, Graham recommends (so do we!) the following investing approaches: Invest in low-cost funds: Look for well-diversified portfolios pre-built by experts to save you time. Use dollar-cost averaging: Consider depositing the same amount of money at fixed intervals (weekly, monthly, etc) over a period of time.

Life and taxes, not death and taxes Nov 2, 2023 4:23:09 PM Taxes aren’t fun but your life should be. We’ve got a couple of tools to help with taxes. See if they’re right for you. Benjamin Franklin once said, "In this world, nothing can be said to be certain, except death and taxes." At Betterment, we prefer a more optimistic take: Nothing is certain, except life and taxes. And we want to help you live a better life by helping you save money on taxes as you invest. The main idea: Unlike many investment managers, we automate advanced tax-efficient strategies, making life easier if the features are right for you, including: Tax Loss Harvesting+ (TLH+) Tax Coordination Let’s see how each strategy works. What is TLH+? TLH+ seeks to increase the annual returns in a taxable account by automating an advanced tax-saving strategy. When investments lose value, Betterment looks for opportunities to sell them to help offset the taxes that come with income and capital gains. You can offset up to $3,000 of your ordinary income each year with tax losses. TLH+ coordinates harvests across your household’s Betterment accounts, including IRAs, 401(k)s, joint accounts, and trusts. What is Tax Coordination? Tax Coordination is designed to optimize and automate a strategy called asset location. It organizes your portfolio so that the highest-tax assets go into the accounts with the biggest tax breaks. Using Tax Coordination can help you make the most out of every dollar you invest for retirement because it is designed to minimize your tax liability while maximizing your after-tax returns. Tax Coordination only manages accounts held at Betterment within a retirement goal, so it may be worth considering your personal situation and if rolling over an IRA or 401(k) prior to adding a taxable account is the right call for you. The big picture: Taxes aren’t fun but your life should be. So we do our best to automate these advanced tax strategies for you. Want to see if these tax-efficient strategies are for you? Log in to your Betterment account from a web browser and navigate to the “Performance” section. You can learn more about TLH+ and Tax Coordination and turn them on if they’re right for you.

Why it’s not your time to time the market Nov 2, 2023 4:12:16 PM History shows that timing the market is a fool's errand. Instead, here are two investing approaches to help build wealth over time. The main idea: Timing the market can be risky and takes a lot of effort and skill (or luck!) to be successful. History is not on the side of timing the market. Study after study after study after study—you get the point—has shown the risks of timing the market and how a more general buy-and-hold strategy can help investors increase their portfolio performance. The risks of timing the market include: Poor timing and investing when asset prices are at a higher point. Missing high-performing periods, even single days or months, when the market increases. Timing the market also takes a lot of work: Successful market timing usually requires analysis and forecasting techniques that can be quite advanced. Market timing also requires a dedication of time as you need to be constantly tracking and analyzing the market. Instead, consider these two approaches. Both can work well if you have long-term investing goals. Lump-sum investing is depositing the entire balance of cash at once. This method works well if you have extra cash and are looking to maximize the time your funds are invested. It lowers the likelihood that you miss out on any high-performing periods. Keep in mind that your entire lump sum is at risk if the market decreases. Dollar-cost averaging is depositing the same amount of money at fixed intervals (weekly, monthly, etc) over a period of time. This approach works well if you want to take less risk with a lump sum of cash and protect against short-term market declines, or if you only have money to save after each paycheck. Either way, both options are less risky than timing the market and less work for you to manage.

The Betterment Core Portfolio Strategy Oct 11, 2023 12:00:00 AM We continually improve the Core portfolio construction methodology over time in line with our research-focused investment philosophy. TABLE OF CONTENTS Introduction Global Diversification and Asset Allocation Portfolio Optimization Tax Management Using Municipal Bonds Conclusion Citations I. Introduction Betterment has a singular objective: to help you make the most of your money, so that you can live better. Our investment philosophy forms the basis for how we pursue that objective: Betterment uses real-world evidence and systematic decision-making to help increase our customers’ wealth. In building our platform and offering individualized advice, Betterment’s philosophy is actualized by our five investing principles. Regardless of one’s assets or specific situation, Betterment believes all investors should: Make a personalized plan. Build in discipline. Maintain diversification. Balance cost and value. Manage taxes. To align with Betterment’s investing principles, a portfolio strategy must enable personalized planning and built-in discipline for investors. The Betterment Core Portfolio Strategy is comprised of 101 individualized portfolios, in part, because that level of granularity in allocation management provides the flexibility to align to multiple goals with different timelines and circumstances. In this guide to the Betterment Core Portfolio Strategy construction process, our goal is to demonstrate how the methodology, in both its application and development, contributes to how Betterment carries out its investing principles. When developing a portfolio strategy, any investment manager faces two main tasks: asset class selection and portfolio optimization. How we select funds to implement the Betterment construction process is also guided by our investing principles, and is covered separately in our Investment Selection Methodology paper. II. Global Diversification and Asset Allocation An optimal asset allocation is one that lies on the efficient frontier, which is a set of portfolios that seek to achieve the maximum objective for the lowest amount of risk. The objective of most long-term portfolio strategies is to maximize return, while the associated risk is measured in terms of volatility—the dispersion of those returns. In line with our investment philosophy of making systematic decisions backed by research, Betterment’s asset allocation is based on a theory by economist Harry Markowitz called Modern Portfolio Theory, as well as subsequent advancements based on that theory.1 A major tenet of Modern Portfolio Theory is that any asset included in a portfolio should not be assessed by itself, but rather, its potential risk and return should be analyzed as a contribution to the whole portfolio. Modern Portfolio Theory seeks to optimize maximizing expected returns and minimizing expected risk. Other forms of portfolio construction may legitimately pursue other objectives, such as optimizing for income, or minimizing loss of principal. However, our portfolio construction goes beyond traditional Modern Portfolio Theory in five important ways: Estimating forward looking returns Estimating covariance Tilting specific factors in the portfolio Accounting for estimation error in the inputs Accounting for taxes in taxable accounts Asset Classes Selected for Betterment’s Core Portfolio Strategy The Betterment Core Portfolio Strategy’s asset allocation starts with a universe of investable assets. Leaning on the work of Black-Litterman, the universe of investable assets for us is the global market portfolio.2 To capture the exposures of the asset classes for the global market portfolio, Betterment evaluates available exchange-traded funds (ETFs) that represent each class in the theoretical market portfolio. We base our asset class selection on ETFs because this aligns portfolio construction with our investment selection methodology. Betterment’s portfolios are constructed of the following asset classes: Equities U.S. Equities International developed market equities Emerging market equities Bonds U.S. short-term treasury bonds U.S. inflation protected bonds U.S. investment grade bonds U.S. municipal bonds International developed market bonds Emerging market bonds We select U.S. and international developed market equities as a core part of the portfolio. Historically, equities exhibit a high degree of volatility, but provide some degree of inflation protection. Even though significant historical drawdowns, such as the global financial crisis of 2008, demonstrate the possible risk of investing in equities, longer-term historical data and our forward expected returns calculations suggest that developed market equities remain a core part of any asset allocation aimed at achieving positive returns. This is because, over the long term, developed market equities have tended to outperform bonds on a risk-adjusted basis. To achieve a global market portfolio, we also include equities from less developed economies, called emerging markets. Generally, emerging market equities tend to be more volatile than U.S. and international developed equities. And while our research shows high correlation between this asset class and developed market equities, their inclusion on a risk-adjusted basis is important for global diversification. Note that Betterment excludes frontier markets, which are even smaller than emerging markets, due to their widely varying definition, extreme volatility, small contribution to global market capitalization, and cost to access. The Betterment Core Portfolio Strategy incorporates bond exposure because historically, bonds have a low correlation with equities, and they remain an important way to dial down the overall risk of a portfolio. To promote diversification and leverage various risk and reward tradeoffs, the Betterment Core Portfolio Strategy includes exposure to several asset classes of bonds. Asset Classes Excluded from the Betterment Core Portfolio Strategy While Modern Portfolio Theory would have us craft a portfolio to represent the total market, including all available asset classes, we exclude some asset classes whose cost and/or lack of data outweighs the potential benefit gained from their inclusion. The Betterment Core portfolio construction process excludes commodities, and natural resources asset classes. Specifically, while commodities represent an investable asset class in the global financial market , we have excluded commodities ETFs because of their low contribution to a global stock/bond portfolio's risk-adjusted return. In addition, real estate investment trusts (REITs), which tend to be well marketed as a separate asset class, are not explicitly included in the Core Portfolio Strategy. Betterment does provide exposure to real estate, but as a sector within equities. Adding additional real estate exposure by including a REIT asset class would overweight the exposure to real estate relative to the overall market. III. Portfolio Optimization While asset selection sets the stage for a globally diversified portfolio strategy, we further optimize the Betterment Core Portfolio Strategy by tilting the portfolio to drive higher return potential. While most asset managers offer a limited set of model portfolios at a defined risk scale, the Betterment Core Portfolio Strategy is designed to give customers more granularity and control over how much risk they want to take on. Instead of offering a conventional set of three portfolio choices—aggressive, moderate, and conservative—our portfolio optimization methods enable the Betterment Core Portfolio Strategy to contain 101 different portfolios. Optimizing Portfolios Modern Portfolio Theory requires estimating returns and covariances to optimize for portfolios that sit along an efficient frontier. While we could use historical averages to estimate future returns, this is inherently unreliable because historical returns do not necessarily represent future expectations. A better way is to utilize the Capital Asset Pricing Model (CAPM) along with a utility function which allows us to optimize for the portfolio with a higher return for the risk that the investor is willing to accept. Computing Forward-Looking Return Inputs Under CAPM assumptions, the global market portfolio is the optimal portfolio. Since we know the weights of the global market portfolio and can reasonably estimate the covariance of those assets, we can recover the returns implied by the market.3 This relationship gives rise to the equation for reverse optimization: μ = λ Σ ωmarket Where μ is the return vector, λ is the risk aversion parameter, Σ is the covariance matrix, and ωmarket is the weights of the assets in the global market portfolio.4 By using CAPM, the expected return is essentially determined to be proportional to the asset’s contribution to the overall portfolio risk. It’s called a reverse optimization because the weights are taken as a given and this implies the returns that investors are expecting. While CAPM is an elegant theory, it does rely on a number of limiting assumptions: e.g., a one period model, a frictionless and efficient market, and the assumption that all investors are rational mean-variance optimizers.5 In order to complete the equation above and compute the expected returns using reverse optimization, we need the covariance matrix as an input. The covariance matrix mathematically describes the relationships of every asset with each other as well as the volatility risk of the assets themselves. Our process for estimating the covariance matrix aims to avoid skewed analysis of the conventional historical sample covariance matrix and instead employs Ledoit and Wolf’s shrinkage methodology, which uses a linear combination of a target matrix with the sample covariance to pull the most extreme coefficients toward the center, which helps reduce estimation error.6 Tilting the Betterment Portfolios based on the Fama-French Model Academic research also points to persistent drivers of returns that the market portfolio doesn’t fully capture. A framework known as the Fama-French Model demonstrates how equity returns are driven by three factors: market, value, and size.7 The underlying asset allocation of the Betterment Core Portfolio Strategy ensures the market factor is incorporated, but to gain higher returns from value and size, Betterment tilts the portfolios. For the actual mechanism of tilting, we turn to the Black-Litterman model. Black-Litterman starts with our global market portfolio as the asset allocation that an investor should take in the absence of views on the underlying assets. Then, using the Idzorek implementation of Black-Litterman, the Betterment Core Portfolio Strategy is tilted based on the level of confidence we have for our views on size and value.8 These views are computed from historical data analysis, and our confidence level is a free parameter of the implementation. Tilts are expressed, taking into account the constraints imposed by the liquidity of the underlying funds. Monte Carlo Simulations Betterment uses Monte Carlo simulations to predict alternative market scenarios. By performing an optimization of the portfolio under simulated market scenarios, Betterment averages the weights of asset classes in each scenario, which provides a more robust estimate of the optimal weights. Betterment believes this secondary optimization analysis alleviates the portfolio construction’s sensitivity to returns estimates and leads to more diversification and expected performance over a broader range of potential market outcomes. Thus, through our method of portfolio optimization, the Betterment Core Portfolio Strategy is weighted based on the tilted market portfolio, based on Fama-French, averaged by the weights produced by our Monte Carlo simulations. This portfolio construction process gives us a portfolio designed to be optimal at any risk level for not just diversification and expected future value, but also ideal for good financial planning and for managing investor behavior. IV. Tax Management Using Municipal Bonds For investors with taxable accounts, portfolio returns may be further improved on an after-tax basis by utilizing municipal bonds. This is because the interest from municipal bonds is exempt from federal income tax. To take advantage of this, the Betterment Core Portfolio Strategy in taxable accounts is also tilted toward municipal bonds because interest from municipal bonds is exempt from federal income tax, which can further optimize portfolio returns. Other types of bonds remain for diversification reasons, but the overall bond tax profile is improved by tilting towards municipal bonds. For investors in states with some of the highest tax rates—New York and California—Betterment can optionally replace the municipal bond allocation with a more narrow set of bonds for that specific state, further saving the investor on state taxes. Betterment customers who live in NY or CA can contact customer support to take advantage of state specific municipal bonds. Conclusion After setting the strategic weight of assets in the Betterment Core Portfolio Strategy, the next step in implementing the portfolio construction process is Betterment’s investment selection, which selects the appropriate ETFs for the respective asset exposure in a low-cost, tax-efficient way. In keeping with our philosophy, that process, like the portfolio construction process, is executed in a systematic, rules-based way, taking into account the cost of the fund and the liquidity of the fund. Beyond ticker selection is our established process for allocation management—how we advise downgrading risk over time—and our methodology for automatic asset location, which we call Tax Coordination. Finally, our overlay features of automated rebalancing and tax-loss harvesting are designed to be used to help further maximize individualized, after-tax returns. Together these processes put our principles into action, to help each and every Betterment customer maximize value while invested at Betterment and when they take their money home. Citations 1 Markowitz, H., "Portfolio Selection".The Journal of Finance, Vol. 7, No. 1. (Mar., 1952), pp. 77-91. 2 Black F. and Litterman R., Asset Allocation Combining Investor Views with Market Equilibrium, Journal of Fixed Income, Vol. 1, No. 2. (Sep., 1991), pp. 7-18. Black F. and Litterman R., Global Portfolio Optimization, Financial Analysts Journal, Vol. 48, No. 5 (Sep. - Oct., 1992), pp. 28-43. 3 Litterman, B. (2004) Modern Investment Management: An Equilibrium Approach. 4 Note that the risk aversion parameter is essentially a free parameter. 5 Ilmnen, A., Expected Returns. 6 Ledoit, O. and Wolf, M., Honey, I Shrunk the Sample Covariance Matrix, Olivier Ledoit & Michael Wolf. 7 Fama, E. and French, K., (1992). "The Cross-Section of Expected Stock Returns". The Journal of Finance.47 (2): 427. 8 Idzorek, T., A step-by-step guide to the Black-Litterman Model.

Your 3 steps for fall financial planning Oct 9, 2023 4:24:07 PM Fall is here. Here are three steps to take to end the year feeling good. By the time December rolls around, the last thing most of us want to think about is finances. That’s why we’ve compiled three steps to take this fall to make the end of this year (and the start of next year) less stressful. By spending a few hours looking at your investing plan, potential charitable donations, and tax situation, you can decrease year-end stress, and set yourself up for long-term success. Your three steps for fall financial planning: 1) Review your asset allocation based on your goals Review your investment accounts outside of Betterment: To get a full understanding of your asset allocation, be sure to review your investments across all platforms. Look at your 401(k), taxable investment accounts, and even cash. You may have appropriate asset allocation on one platform, but when you look at your accounts holistically, you may notice you are over or under-invested in a specific asset class. Tip: To make sure you are not forgetting any accounts, use our “connected accounts” feature to get a clearer picture of all of your financial assets (and debt). Review your investing goals: To make sure your asset allocation is still appropriate, review each of your investing goals. For shorter-term goals, a Cash Reserve account can be a good option. But for longer-term goals, we recommend diversified investment portfolios. You can set up a new goal in your Betterment account and we’ll recommend the asset allocation based on your inputs. 2) Plan your year-end charitable giving Set a budget: If you have a larger budget for your spending, make sure to include charitable giving as a line item. Even if you don’t track a budget, think about how much you can afford to donate this year. This can help make sure your giving fits into your spending during the final months of the year. Tip: If you feel like your budget is not as high as you’d like, you can also volunteer time. Consider donating shares: Donating shares that you’ve held for more than a year can boost your charitable giving and offer a tax benefit. We've partnered with well-known charities across a range of causes to make it simple for you to donate. Learn how to donate shares. 3) Optimize your tax planning Plan for a tax bill: Look at your past year’s sources of income. If you have income from freelance work or interest income from high-yield savings, make sure you plan ahead to be able to pay your tax bill. Increase 401(k) contributions: You have until December 31st each year to contribute to your 401(k). Consider increasing your contribution during the final months of the year which can lower your taxable income. Consider tax coordination: If you are investing in multiple accounts, a sophisticated tax optimization strategy known as asset location can increase your after-tax returns. While asset location requires detailed, continual work if you're trading on your own, our Tax Coordination approach is automated and can be used with retirement goals at Betterment. Learn more about Tax Coordination. Consider tax loss harvesting: Tax loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or "harvesting" a loss, investors are able to offset taxes on both gains and income. The sold security is replaced by a similar one, ideally maintaining an optimal asset allocation and expected returns. Our Tax Loss Harvesting+ service is automated once enabled and available at no additional cost to Betterment users. Bonus tip: As you end the year, review your emergency savings. If you haven’t saved at least three months’ worth of living expenses consider setting up an Emergency Fund goal in your Betterment account. You can automate small deposits each month to start saving today.