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Betterment’s portfolio construction methodology

Betterment’s portfolio construction methodology Jan 7, 2026 8:00:00 AM Learn more about the process that underpins all the portfolios we build on behalf of customers. Table of contents Introduction Global diversification and asset allocation Portfolio optimization Tax management using municipal bonds The Value Tilt portfolio strategy The Innovative Technology portfolio strategy The Socially Responsible Investing portfolio strategies Conclusion Citations I. Introduction Betterment builds investment portfolios designed to help you make the most of your money and live the life you want. This guide lays out our portfolio construction process, one informed by real-world evidence and systematic decision-making. The Betterment Core portfolio serves as the foundation for all of the globally-diversified portfolios we construct. From there, specific adjustments are applied to other portfolios based on the investment objective of their particular strategies. These adjustments include additional allocations to value-focused or innovative stocks, or adherence to Socially Responsible Investing (SRI) criteria. For more information on the third-party portfolios we offer, such as the Goldman Sachs Smart Beta portfolio, see their respective pages and disclosures. When building a portfolio, any investment manager faces two main tasks: asset class selection and portfolio optimization. We detail our approach to these in the sections that follow. Our fund selection process, while equally as important, is covered in a separate methodology. II. Global diversification and asset allocation An optimal asset allocation is one that lies on the efficient frontier, which is a set of portfolios that seek to achieve the maximum objective for any given feasible level of risk. The objective of most long-term portfolio strategies is to maximize return for a given level of risk, which is measured in terms of volatility—the dispersion of those returns. In line with our approach of making systematic decisions backed by research, Betterment’s asset allocation is based on a theory by economist Harry Markowitz called Modern Portfolio Theory.1 A major tenet of Modern Portfolio Theory is that any asset included in a portfolio should not be assessed by itself, but rather, its potential risk and return should be analyzed as a contribution to the whole portfolio. Modern Portfolio Theory seeks to maximize expected return given an expected risk level or, equivalently, minimize expected risk given an expected return. Other forms of portfolio construction may legitimately pursue other objectives, such as optimizing for income, or minimizing loss of principal. Asset class selection Our approach to asset allocation starts with a universe of investable assets, which could be thought of as the “global market” portfolio.2 To capture the exposures of the asset classes for the global market portfolio, we evaluate 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 fund selection methodology. All of our portfolios are constructed of the following asset classes: Stocks U.S. stocks International developed market stocks Emerging market stocks 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 stocks as a core part of the portfolio. Historically, stocks exhibit a high degree of volatility, but provide some degree of inflation protection. Even though significant historical drawdowns, such as the global financial crisis in 2008 and pandemic outbreak in 2020, demonstrate the possible risk of investing in stocks, longer-term historical data and our forward expected returns calculations suggest that developed market stocks remain a core part of any asset allocation aimed at achieving positive returns. This is because, over the long term, developed market stocks have tended to outperform bonds on a risk-adjusted basis. To achieve a global market portfolio, we also include stocks from less developed economies, called emerging markets. Generally, emerging market stocks tend to be more volatile than U.S. and international developed stocks. And while our research shows high correlation between this asset class and developed market stocks, their inclusion on a risk-adjusted basis is important for global diversification. Note that we exclude frontier markets, which are even smaller than emerging markets, due to their widely-varying definition, extreme volatility, small contribution to global market capitalization, and cost to access. We incorporate bond exposure because, historically, bonds have a low correlation with stocks, 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, we include exposure to several asset classes of bonds. Asset classes excluded from Betterment portfolios 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. Our 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 our portfolios. We do provide exposure to real estate, but as a sector within stocks. Adding additional real estate exposure by including a REIT asset class would overweight the exposure to real estate relative to the overall market. Incorporating awareness of a benchmark Before 2024, we managed our portfolios in a “benchmark agnostic” manner, meaning we did not incorporate consideration of global stock and bond indices in our portfolio optimization, though we have always sought to optimize the expected risk-adjusted return of the portfolios we construct for clients. The “risk” element of this statement represents volatility and the related drawdown potential of the portfolio, but it could also represent the risk in the deviation of the portfolio’s performance relative to a benchmark. In an evolution of our investment process, in 2024 we updated our portfolio methodology to become “benchmark aware,” as we now calibrate our exposures based on a custom benchmark that expresses our preference for diversifying across global stocks and bonds. A benchmark, which comes in the form of a broad-based market index or a combination of indices, serves as a reference point when approaching asset allocation, understanding investment performance, and aligning the expectations of portfolio managers and clients. In our case, we created a custom benchmark that most closely aligns with our future expectations for global markets. The custom benchmark we have selected is composed of: The MSCI All Country World stock IMI index (MSCI ACWI IMI) The Bloomberg U.S. Universal Bond index The S&P US Treasury Bond 0-1 Year Index (for <40% stock allocations) Our custom benchmark is composed of 101 risk levels of varying percentage weightings of the stock and bond indexes, which correspond to the 101 risk level allocations in our Core portfolio. At low risk levels (allocations that are less than 40% stocks), we layer an allocation to the S&P US Treasury Bond 0-1 Year Index, which represents short-term bonds, into the blended benchmark. We believe that incorporating this custom benchmark into our process reinforces the discipline of carefully evaluating the ways in which our portfolios’ performance could veer from global market indices and deviate from our clients’ expectations. We have customized the benchmark with 101 risk levels so that it serves clients’ varying investment goals and risk tolerances. As we will explore in the following section, establishing a benchmark allows us to apply constraints to our portfolio optimization that ensures the portfolio’s asset allocation does not vary significantly from the geographic and market-capitalization size exposures of a sound benchmark. Our benchmark selection also makes explicit that the portfolio delivers global diversification rather than the more narrowly-concentrated and home-biased exposures of other possible benchmarks such as the S&P 500. III. Portfolio optimization As an asset manager, we fine-tune the investments our clients hold with us, seeking to maximize return potential for the appropriate amount of risk each client can tolerate. We base this effort on a foundation of established techniques in the industry and our own rigorous research and analysis. While most asset managers offer a limited set of model portfolios at a defined risk scale, our portfolios are 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 our Core portfolio strategy to be customized to 101 different stock-bond risk levels. Optimizing portfolios Modern Portfolio Theory requires estimating variables such as expected-returns, covariances, and volatilities to optimize for portfolios that sit along an efficient frontier. We refer to these variables as capital market assumptions (CMAs), and they provide quantitative inputs for our process to derive favorable asset class weights for the portfolio strategy. While we could use historical averages to estimate future returns, this is inherently unreliable because historical returns do not necessarily represent future expectations. A better way is to utilize the Capital Asset Pricing Model (CAPM) along with a utility function which allows us to optimize for the portfolio with a higher return for the risk that the investor is willing to accept. Computing forward-looking return inputs Under CAPM assumptions, the global market portfolio is the optimal portfolio. Since we know the weights of the global market portfolio and can reasonably estimate the covariance of those assets, we can recover the returns implied by the market.3 This relationship gives rise to the equation for reverse optimization: μ = λ Σ ωmarket Where μ is the return vector, λ is the risk aversion parameter, Σ is the covariance matrix, and ωmarket is the weights of the assets in the global market portfolio.5 By using CAPM, the expected return is essentially determined to be proportional to the asset’s contribution to the overall portfolio risk. It’s called a reverse optimization because the weights are taken as a given and this implies the returns that investors are expecting. While CAPM is an elegant theory, it does rely on a number of limiting assumptions: e.g., a one period model, a frictionless and efficient market, and the assumption that all investors are rational mean-variance optimizers.4 In order to complete the equation above and compute the expected returns using reverse optimization, we need the covariance matrix as an input. This matrix mathematically describes the relationships of every asset with each other as well as the volatility risk of the assets themselves. In another more recent evolution of our investment process, we also attempt to increase the robustness of our CMAs by averaging in the estimates of expected returns and volatilities published by large asset managers such as BlackRock, Vanguard, and State Street Global Advisors. We weight the contribution of their figures to our final estimates based on our judgment of the external provider’s methodology. Constrained optimization for stock-heavy portfolios After formulating our CMAs for each of the asset classes we favor for inclusion in our portfolio methodology, we then solve for target portfolio allocation weights (the specific set of asset classes and the relative distribution among those asset classes in which a portfolio will be invested) with the range of possible solutions constrained by limiting the deviation from the composition of the custom benchmark. To robustly estimate the weights that best balance risk and return, we first generate several thousand random samples of 15 years of expected returns for the selected asset classes based on our latest CMAs, assuming a multivariate normal distribution. For each sample of 15 years of simulated expected return data, we find a set of allocation weights subject to constraints that provide the best risk-return trade-off, expressed as the portfolio’s Sharpe ratio, i.e., the ratio of its return to its volatility. Averaging the allocation weights across the thousands of return samples gives a single set of allocation weights optimized to perform in the face of a wide range of market scenarios (a “target allocation”). The constraints are imposed to make the portfolio weights more benchmark-aware by setting maximum and minimum limits to some asset class weights. These constraints reflect our judgment of how far the composition of geographic regions within the portfolio’s stock and bond allocations should differ from the breakdown of the indices used in the benchmark before the risk of significantly varied performance between the portfolio strategy and the benchmark becomes untenable. For example, the share of the portfolio’s stock allocation assigned to international developed stocks should not be profoundly different from the share of international developed stocks within the MSCI ACWI IMI. We implement caps on the weights of emerging market stocks and bonds, which are often projected to have high returns in our CMAs, and set minimum thresholds for U.S. stocks and bonds. This approach not only ensures our portfolio aligns more closely with the benchmark, but it also mitigates the risk of disproportionately allocating to certain high expected return asset classes. Constrained optimization for bond-heavy portfolios For Betterment portfolios that have more than or equal to a 60% allocation of bonds, the optimization approach differs in that expected returns are maximized for target volatilities assigned to each risk level. These volatility targets are determined by considering the volatility of the equivalent benchmark. Manually established constraints are designed to manage risk relative to the benchmark, instituting a declining trend in emerging market stock and bond exposures as stock allocations (i.e., the risk level) decreases. Meaning that investors with more conservative risk tolerances have reduced exposures to emerging market stocks and bonds because emerging markets tend to have more volatility and downside-risk relative to more established markets. Additionally, as the stock allocation percentage decreases, we taper the share of international and U.S. aggregate bonds within the overall bond allocation, and increase the share of short-term Treasury, short-term investment grade, and inflation-protected bonds. This reflects our view that investors with more conservative risk tolerances should have increased exposure to short-term Treasury, short-term investment grade, and inflation-protected bonds relative to riskier areas of fixed income. The lower available risk levels of our portfolios demonstrate capital preservation objectives, as the shorter-term fixed income exposures likely possess less credit and duration risk. Clients invested in the Core portfolio at conservative allocation levels will likely therefore not experience as significant drawdowns in the event of waves of defaults or upward swings in interest rates. Inflation-protected securities also help buffer the lower risk levels from upward drafts in inflation. IV. Tax management using municipal bonds For investors with taxable accounts, portfolio returns may be further improved on an after-tax basis by utilizing municipal bonds. This is because the interest from municipal bonds is exempt from federal income tax. To take advantage of this, we incorporate municipal bonds within the bond allocations of taxable accounts. Other types of bonds remain for diversification reasons, but the overall bond tax profile is improved by incorporating municipal bonds. For investors in states with some of the highest tax rates—New York and California—Betterment can optionally replace the municipal bond allocation with a more narrow set of bonds for that specific state, further saving the investor on state taxes. Betterment customers who live in NY or CA can contact customer support to take advantage of state-specific municipal bonds. V. The Value Tilt portfolio strategy Existing Betterment customers may recall that historically the Core portfolio held a tilt to value companies, or businesses that appear to be potentially undervalued based on metrics such as price-to-earnings (P/E) ratios. Recent updates, however, have deprecated this explicit tilt that was expressed via large-, mid-, and small-capitalization U.S. value stock ETFs, while maintaining some exposure to value companies through broad market U.S. stock funds. We no longer favor allocating to value stock ETFs within our portfolio methodology in large part as a result of our adoption of a broad market benchmark, which highlights the idiosyncratic nature of such tilts, sometimes referred to as “off benchmark bets.” We believe our chosen benchmark that represents stocks through the MSCI ACWI IMI, which holds a more neutral weighting to value stocks, more closely aligns with the risk and return expectations of Betterment’s diverse range of client types across individuals, financial advisors, and 401(k) plan sponsors. Additionally, as markets have grown more efficient and value factor investing more popularized, potentially compressing the value premium, we have a marginally less favorable view of the forward-looking, risk-adjusted return profile of the exposure. That being said, we have not entirely lost conviction in the research supporting the prudence of value investing. The value factor’s deep academic roots drove decisions to incorporate the value tilt into Betterment’s portfolios from our company’s earliest days. For investors who wish to remain invested in a value strategy, we have added the Value Tilt portfolio, a separate option from the Core portfolio, to our investing offering. The Value Tilt portfolio maintains the Core portfolio’s global diversification across stocks and bonds while including a sleeve within the stock allocation of large-, mid-, and small-capitalization U.S. value funds. We calibrated the size of the value fund exposure based on a certain target historical tracking error to the backtested performance of the latest version of the Core portfolio. Based on this approach, investors should expect the Value Tilt portfolio to generally perform similarly to Core, with the potential to under- or outperform based on the return of U.S. value stocks. With the option to select between the Value Tilt portfolio or a Core portfolio now without an explicit allocation to value, the investment flexibility of the Betterment platform has improved. VI. The Innovative Technology portfolio strategy In 2021, Betterment launched the Innovative Technology portfolio to provide access to the thematic trend of technological innovation. The portfolio’s investment premise is based upon the thesis that, over the long term, the companies innovating and disrupting their respective industries are shaping our global economy and may be the winners of the next industrial revolution. Some of these themes the portfolio seeks to provide increased exposure to are: Artificial intelligence Alternative finance Clean energy Manufacturing Biotechnology Similar to the Value Tilt portfolio, the Core portfolio is used as the foundation of construction for the Innovative Technology portfolio. With this portfolio strategy, we calibrated the size of the innovative technology funds’ exposure based on a certain target historical tracking error to the backtested performance of the latest version of the Core portfolio. Through this process, the Innovative Technology portfolio maintains the same globally-diversified, low-cost approach that is found in Betterment’s investment philosophy. The portfolio, however, has increased exposure to risk given that innovation requires a long-term view, and may face uncertainties along the way. It may outperform or underperform depending on the return experience of the innovative technology funds’ exposure and the thematic landscape. To learn more, read the Innovative Technology portfolio disclosure. VII. The Socially Responsible Investing portfolio strategies Betterment introduced its first Socially Responsible Investing (SRI) portfolio in 2017 and has since expanded the options to include three distinct portfolios: Broad Impact, Social Impact, and Climate Impact. These SRI portfolios are built on the same foundational principles as the Core portfolio, utilizing various asset classes to create globally-diversified portfolios. However, they incorporate socially-responsible ETFs that align with specific Environmental, Social, and Governance (ESG) and shareholder engagement mandates, tailored to each SRI focus. Betterment’s SRI approach emphasizes three core dimensions: Reducing exposure to companies engaged in unsustainable activities Increasing investments in those addressing environmental and social challenges Allocating to funds that utilize shareholder engagement to promote responsible corporate behavior. This methodology ensures diversified, cost-efficient portfolios that resonate with investors' values. For more information, read our full Socially Responsible Investing portfolios methodology. VIII. Conclusion After setting the strategic weight of assets in our various Betterment portfolios, the next step in implementing the portfolio construction process is our fund selection methodology, which selects the appropriate ETFs for the respective asset exposure in a generally low-cost, tax-efficient way. In keeping with our philosophy, that process, like our 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. The level of granularity in allocation management provides the flexibility to align to multiple goals with different timelines and circumstances. Most of our portfolios contain 101 individualized risk levels (each with a different percentage of the portfolio invested in stocks vs. bonds, informed by your financial goals, time horizon and risk tolerance). Finally, our overlay features of automated rebalancing, tax-loss harvesting, and our methodology for automatic asset location, which we call Tax Coordination, 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. IX. 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.

Refreshed portfolios are right around the corner

Refreshed portfolios are right around the corner Jan 5, 2026 8:30:00 AM New actively-managed bonds, fine-tuned U.S. exposure, and lower crypto costs highlight this year’s portfolio updates. Key takeaways As part of our automated investing offering, we regularly update our portfolios to ensure they reflect the latest long-term market forecasts. This year’s updates will be rolling out soon and require no action on the part of Betterment customers. They include a new actively-managed bond fund, small tweaks to U.S. stock and bond allocations, and lower crypto ETF costs. Between tariffs, AI, and shutdowns, investors faced all sorts of uncertainty in 2025. But if you're invested in a Betterment-built portfolio, you don't have to worry whether your investing is keeping up with the times. That’s because we update our portfolios each year based on the latest long-term forecasts. These updates include adjusting the weights of various asset classes, as well as swapping in new funds that deliver lower costs and/or better exposure. They're just a few of the ways our automated investing delivers value, and they’ll be rolling out soon. So without further ado, let’s preview what's new for 2026: Expanded access to bond markets Fine-tuned U.S. exposure Lower crypto ETF costs Expanded access to bond markets Passive investing—tracking preset indexes or lists of investments—is still the bedrock of our portfolio strategy thanks to its low costs and strong track record, but it has limitations in the world of fixed income. That’s because many passively-managed bond funds reflect only a portion of the total market. And it’s these under-represented sectors—high-yield and securitized offerings, among others—that can help investors capitalize on changing market conditions like falling interest rates. So to take advantage of these opportunities, we’re making a new actively-managed bond fund a central piece of the following portfolios’ bond allocations: Core Innovative Tech Value Tilt Flexible portfolio US-only portfolio (exclusive to Betterment Premium and not available in Betterment 401(k)s) While the bond market is relatively ripe for active management, much of that edge hinges on the expertise of the team who manages the fund. That’s why when using these types of funds in our portfolios, we use a robust quantitative and qualitative method to size up fund managers. Fine-tuned U.S. exposure Similar to last year, we’re making minor adjustments to our allocation of U.S. stocks. This allocation breaks down along three subasset classes, with each defined by their underlying companies’ current market valuations: Small-cap (less than $2 billion) Mid-cap (between $2 billion and $10 billion) Large-cap (more than $10 billion) We’re dialing down exposure to mid-cap stocks—bringing their allocation in line with small-cap—and in turn increasing our allocation to large-cap stocks. These changes apply to the same portfolios above, and better align them with the relative size of each subasset class within the stock market. Beyond these tweaks, some risk levels of our portfolios (including all three of our Socially Responsible Investing portfolios) may see modest increases in exposure to short-term Treasuries. This helps smooth out the glide path for customers using our auto-adjust feature and de-risk their investing as target dates near. Lower crypto ETF costs In the Betterment Crypto ETF portfolio (not available in Betterment 401(k)s), we’re increasing our bitcoin allocation to align with its market capitalization weight. Further changes include swapping in lower-cost funds, which reduces the portfolio’s weighted average expense ratio by 0.10%. As part of our fund selection methodology, we continually look for opportunities to lower investing costs as new funds become available. For more information on the Crypto ETF portfolio, please see the portfolio disclosure. Sit back and enjoy the switch Similar to last year’s portfolio updates, we’ll gradually implement this year’s changes in the weeks to come, with our technology designed to seek the most tax-efficient path for taxable accounts. Tax-advantaged accounts such as Betterment IRAs and Betterment 401(k)s won’t see any tax impact as a result of these updates. To find the refreshed portfolio weights, check out the relevant portfolio pages on our website. Customers can also see their updated holdings in the Betterment app with only a few clicks. It’s yet another example of how we make it easy to be invested.

Betterment's tax lot selection methodology

Betterment's tax lot selection methodology Dec 23, 2025 12:00:00 AM Selecting tax lots efficiently can address and reduce the tax impact of your investments. Every time you have a transaction in a Betterment account that involves a sale—such as a withdrawal, transfer, or rebalance—Betterment’s technology determines (1) which security or securities to sell, and (2) within each security, which specific tax lots to sell. With tax-smart technology, selecting tax lots efficiently can address and reduce the tax impact of your investments. Selecting tax lots efficiently can address and reduce the tax impact of your investments. When choosing which tax lots of a security to sell, our 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 are 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. Basis reporting 101 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 “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 a security, 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. 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. 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. While Betterment was initially built to use FIFO as the default method, we’ve 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, Betterment’s algorithm first determines what security or securities to sell in order to reduce drift in the portfolio, bringing the portfolio closer to its target allocation as a part of the transaction. Once the algorithm has identified which security to sell, it needs to make a choice as to which specific tax lots of that holding will be sold. For example, if the algorithm identifies a client’s portfolio should sell VTI, and the portfolio holds 10 shares of VTI purchased at different times with different cost basis, it next needs to determine which of the 10 shares of VTI to sell that will minimize taxes on the transaction. This second choice, which specifies tax lots to sell, follows a set of rules which we call TaxMin. This method is more granular in its approach and will aim to improve the tax impact for most transactions, as compared to FIFO. How does the TaxMin method work? 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) generally results in a lower tax liability in the long run. Accordingly, 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. Generally, the algorithm is designed to we sell shares in a way that is intended to prioritize realizing available losses (which can mean that we can prioritize selling tax lots with a long-term loss or a short-term loss, depending on which loss type would result in minimizing taxes for the particular transaction), and when losses are not available, evaluating which securities can be sold with the lowest capital gains (similarly, which can prioritize tax lots with only short-term capital gains over those with long-term capital gains). If the identified security to sell has both short-term capital gains and long-term capital gains, Betterment’s system will generally prioritize realizing the long-term capital gains first, and if needed, followed by short-term capital gains. generating short-term capital losses, then long-term capital losses, followed by long-term capital gains and then lastly, short-term capital gains. In short, the algorithm targets selling tax looks through each category before moving to the next, but within each category, lots with the highest cost basis in order to minimize taxes on the overall transaction are targeted first. In the case of a gain, the higher the cost 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 cost basis, the bigger the loss (which can be beneficial, since losses can be used to offset gains). 1 TaxMin is designed to generally minimize taxes because it prioritizes selling tax lots at a loss before it sells tax lots at a gain. However, for certain groups – investors in relatively low income tax brackets, especially those who expect to be subject to higher tax rates in the future, and those who can recognize capital gains at a 0% tax rate – it may be more beneficial to prioritize selling assets at a gain in the short run. Investors with different individual tax circumstances should consider whether other offerings might provide more tax efficiency in these scenarios. Also, clients should be aware that when a client 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. 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.) 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.

Betterment's Socially Responsible Investing portfolios methodology

Betterment's tax-loss harvesting methodology

Betterment's fund selection methodology

Betterment's fund selection methodology Mar 20, 2025 8:00:00 AM When constructing a portfolio, Betterment focuses on exchange-traded funds (ETFs) with generally low costs and high liquidity. In the following piece, we detail Betterment’s investment selection methodology, including: Why ETFs Cost of Ownership (CO) Mitigating market impact Actively-managed investments Conclusion 1. Why ETFs? When constructing a portfolio, Betterment focuses on exchange-traded funds (“ETFs”) with generally low costs and high liquidity. An ETF is essentially a basket which contains underlying securities, such as stocks and bonds, and generally come in two different flavors: passive (or index tracking) and active. By design, passive index ETFs closely track their benchmarks—such as the S&P 500. On the other hand, active ETFs represent a group of hand-selected securities decided upon by a portfolio manager with the intention of beating a benchmark. Additionally, ETFs have certain structural advantages when compared to mutual funds. These include: A. Clear goals and mandates Betterment generally selects ETFs that have mandates to passively track broad-market benchmark indexes. A passive mandate explicitly restricts the fund administrator to the singular goal of replicating a benchmark rather than making active investment decisions in an effort to beat the fund’s underlying benchmark. We largely favor such transparency and lower idiosyncratic market risk, yet some asset classes may benefit from fundamental research-driven security selection, and in some instances, Betterment employs the use of active ETFs managed by experienced external portfolio management teams (more on that below). B. Intraday availability ETFs are transactable during all open market hours just like any other stock. As such, they are heavily traded by the full spectrum of equity market participants including market makers, short-term traders, buy-and-hold investors, and fund administrators themselves creating and redeeming units as needed (or increasing or decreasing the supply of ETFs based on market demand). This diverse trading activity leads to most ETFs carrying low liquidity premiums (or lower costs to transact due to competition from readily available market participants pushing prices downward) and equity-like transaction times irrespective of the underlying holdings of each fund. This generally makes ETFs fairly liquid, which makes them cheaper and easier to trade on-demand for activities like creating a new portfolio or rebalancing an existing one. C. Low-fee structures Because most benchmarks update constituents (i.e., the specific stocks and related weights that make up a broad-market index) fairly infrequently, passive index-tracking ETFs also register lower annual turnover (or the rate a fund tends to transact its holdings) and thus fewer associated costs are passed through to investors. In addition, ETFs are generally managed by their administrators as a single share class that holds all assets as a single entity. This structure naturally lends itself as a defense against administrators practicing fee discrimination across the spectrum of available investors. With only one share class, ETFs are investor-type agnostic. The result is that ETF administrators provide the same exposures and low fees to the entire spectrum of potential buyers. Where actively-managed ETFs are utilized in Betterment portfolios, fees and expenses remain a critical aspect of our decision making.Our selection process will favor active over passive when we strongly believe the value added by an active manager outweighs its likely higher expense ratio.. D. Tax efficiency In the case when a fund (irrespective of its specific structure) sells holdings that have experienced capital appreciation, the capital gains generated from those sales must, by law, be accrued and distributed to shareholders by year-end in the form of distributions. These distributions increase tax liabilities for all of the fund’s shareholders. With respect to these distributions, ETFs offer a significant tax advantage for shareholders over mutual funds. Because mutual funds are not exchange traded, the only available counterparty available for a buyer or seller is the fund administrator. When a shareholder in a mutual fund wishes to liquidate their holdings in the fund, the fund’s administrator must sell securities in order to generate the cash required to satisfy the redemption request. These redemption-driven sales generate capital gains that lead to distributions for not just the redeeming investor, but all shareholders in the fund. Mutual funds thus effectively socialize the fund’s tax liability to all shareholders, leading to passive, long-term investors having to help pay a tax bill for all intermediate (and potentially short-term) shareholder transactions. Because ETFs are exchange-traded, the entire market serves as potential counterparties to a buyer or seller. When a shareholder in an ETF wishes to liquidate their holdings in the fund, they simply sell their shares to another investor just like that of a single company’s equity shares. The resulting transaction would only generate a capital gain or loss for the seller and not all investors in the fund. In addition, ETFs enjoy a slight advantage when it comes to taxation on dividends paid out to investors. After the passing of the Jobs and Growth Tax Relief Reconciliation Act of 2003, certain qualified dividend payments from corporations to investors are only subject to the lower long-term capital gains tax rather than standard income tax (which is still in force for ordinary, non-qualified dividends). Qualified dividends have to be paid by a domestic corporation (or foreign corporation listed on a domestic stock exchange) and must be held by both the investor and the fund for 61 of the 120 days surrounding the dividend payout date. As a result of active mutual funds’ higher turnover, a higher percentage of dividends paid out to their investors violate the holding period requirement and increase investor tax profiles. E. Investment flexibility The maturation and growth of the global ETF market over the past few decades has led to the development of an immense spectrum of products covering different asset classes, markets, styles, and geographies. The result is a robust market of potential portfolio components which are versatile, extremely liquid, and easily substitutable. Despite all the advantages of ETFs, it is still important to note that not all ETFs are exactly alike or equally beneficial to an investor. Betterment’s investment selection process seeks to select ETFs that provide exposure to the desired asset classes. For certain asset classes where markets are more efficient, we seek to achieve these asset class exposures through passively managed ETFs due to its cost-effectiveness. Alternatively, where Betterment utilizes active management, we conduct rigorous analysis and due diligence to best understand the trade-off of benchmark deviation for potential performance benefit. The cornerstone of Betterment’s approach to investment selection is our “Cost of Ownership” or CO, allowing us to effectively rank and select ETFs based upon their fees to hold and cost to trade. 2. Cost of Ownership (CO) The Cost of Ownership (“CO”) is Betterment’s fund scoring method, used to rate funds for inclusion in the Betterment portfolio. CO takes into account an ETF’s transactional costs as well as costs associated with holding funds. In addition to CO, Betterment also considers certain other qualitative factors of ETFs, particularly when Betterment considers the use of actively-managed funds. Qualitative factors may include, but are not limited to whether the ETF fulfills a desired portfolio mandate and/or exposure and due diligence interviews with portfolio management teams. CO is determined by two components, a fund’s cost-to-trade and cost-to-hold. The first, cost-to-trade, represents the cost associated with trading in and out of funds during the course of regular investing activities, such as rebalancing, cash inflows or withdrawals, and tax loss harvesting. Betterment defines the the cost-to-trade as the bid-ask spread, or the difference between the price at which you can buy a security and the price at which you can sell the same security at any given time. The second component, cost-to-hold, is represented by the ETF’s expense ratio, or the fund expenses imposed by an ETF administrator. Let’s review the specific inputs to each component in more detail: Cost-to-Trade: Bid-Ask spread Bid-Ask spread: Generally market transactions are associated with two prices: the price at which people are willing to sell a security, and the price others are willing to pay to buy it. The difference between these two numbers is known as the bid-ask spread, and can be expressed in currency or percentage terms. For example, a trader may be happy to sell a share at $100.02, but only wishes to buy it at $99.98. The bid-ask currency spread here is $.04, which coincidentally also represents a bid-ask percentage of 0.04%. In this example, if you were to buy a share, and immediately sell it, you’d end up with 0.04% less due to the spread. This is how traders and market makers make money—by providing liquid access to markets for small margins. Generally, heavily-traded securities with more competitive counterparties willing to transact will carry lower bid-ask spreads. Unlike the expense ratio, the degree to which you care about bid-ask spread likely depends on how actively you trade. Buy-and-hold investors typically care about it less compared to active traders, because they will accrue significantly fewer transactions over their intended investment horizons. Minimizing these costs is beneficial to building an efficient portfolio which is why Betterment attempts to select ETFs with narrower bid-ask spreads. Cost-to-Hold: Expense ratio Expense ratio: An expense ratio is the set percentage of the price of a single share paid by shareholders to the fund administrators every year. ETFs often collect these fees from the dividends passed through from the underlying assets to holders of the security, which result in lower total returns to shareholders. Finding cost of ownership We calculate CO as the sum of the above components: CO = "Cost-to-Trade" + "Cost-to-Hold" Where Cost-to-trade = 0.5 * bid-ask spread As mentioned above, cost-to-trade estimates the costs associated with buying and selling funds in the open market. This amount is weighted to appropriately represent the aggregate investing activities of the average Betterment client in terms of cash flows, rebalances, and tax loss harvests. Additionally, we utilize ½ of the bid-ask spread in our calculations as this mid-point is generally what customers realize in terms of trade costs. The cost-to-hold represents our expectations of the annual costs an investor will incur from owning a fund as defined by the fund’s expense ratio In many cases, cost-to-hold, which includes an ETF’s expense ratio, will be the dominant factor in the total cost calculations. Of course, one can’t hold a security without first purchasing it, so we must also account for transaction costs, which we accomplish with our cost-to-trade component. 3. Minimizing market impact Market impact, or the change in price caused by an investor buying or selling a fund, is incorporated into Betterment’s total cost number through the cost-to-trade component. This is specifically through the interaction of bid-ask spreads. However, we do review and monitor other trading-related metrics not represented specifically in the CO calculation when evaluating our universe of investable funds. Additional metrics include whether the ETF has relatively high levels of existing assets under management and average daily traded volumes. This helps to ensure that Betterment’s trading activity and holdings will not dominate the security’s natural market efficiency, which could either drive the price of the ETF up or down when trading. ETFs without an appropriate level of assets or daily trade volume might lead to a situation where Betterment’s activity on behalf of clients moves the existing market for the security. In an attempt to avoid potentially negative effects upon our investors, we generally do not consider ETFs with smaller asset bases and limited trading activity unless some other extenuating factor is present. 4. Actively-managed investments Compared to passive investments which track a broad-market index, actively-managed ones seek to outperform their benchmark index by selecting and weighting securities based on a fundamental company research or market outlook. Betterment believes that certain markets may favor active management, and therefore, are less efficient than others, resulting in an opportunity where value may be added through actively-managed investments Given this, Betterment believes that a rigorous due diligence process can help identify favorable active managers who have developed a time-tested research-driven investment process. Additionally, while active management may have the potential to add return potential, Betterment continues to hold true to its Core portfolio construction philosophy, prioritizing cost-efficiency. This results in the continued evaluation of any actively-managed investment strategies we utilize with their ability to beat the benchmark vs. their, typically, higher expense ratio. Conclusion As with any investment, ETFs are subject to market risk, including the possible loss of principal. The value of any portfolio will fluctuate with the value of the underlying securities. ETFs may trade for less than their net asset value (NAV). There is always a risk that an ETF will not meet its stated objective on any given trading day. Betterment reviews its investment selection analysis on a periodic basis to assess: the validity of existing selections, potential changes by fund administrators (raising or lowering expense ratios), and changes in specific ETF market factors,including tighter bid-ask spreads). Additionally, Betterment undertakes qualitative due diligence to enhance our selection process for actively-managed investments. Finally, at the core of our portfolio construction process, we are constantly considering the tax implications of portfolio selection changes and estimates the net benefit of transitioning between investment vehicles for our clients.

See what's in store for our annual portfolio updates

See what's in store for our annual portfolio updates Jan 31, 2025 10:00:00 AM Tweaks to Core, Value Tilt, SRI, and Innovative Tech are coming soon. When you pay someone to manage your investing, it's good to know exactly what you're paying for. In one sense, you’re paying for how your shares are bought, sold, and held. Our sophisticated spins on strategies like asset location, for example, can help minimize your taxes and maximize your returns. Then there's the collections of investments themselves, and making sure these portfolios keep up with market conditions. We do this in part by regularly adjusting our portfolios' asset allocations, or the specific weights of asset classes (i.e., stocks and bonds) and subasset classes (large cap stocks, long-term bonds, etc.). Let's quickly walk through our approach to portfolio management, or feel free to skip ahead to preview the upcoming changes. How we evaluate and manage our portfolios It all starts with sizing up asset classes. We run a rigorous, data-driven process to form long-term expectations for both the returns and the risk levels of various classes. From there, we simulate thousands of paths for the market, and average the optimal asset allocations to build more robust portfolio weights. This “Monte Carlo” technique is ideal when random variables are everywhere, such as capital markets. Lastly, it’s important to reiterate that while things like interest rate shifts and federal fiscal policy can drive short-term market volatility, we manage our portfolios based on long-term outlooks. We keep an eye on the short-term, but we don’t chase trends. This year's updates, in a nutshell For starters, we're updating a handful of portfolios, ones we build and manage ourselves. We offer a few others managed by partners like Goldman Sachs and BlackRock—you can check out those allocations in the Betterment app or on our website. This year’s updates, which are much smaller in scope and scale than last year’s, will encompass these portfolios: Core Value Tilt All three Socially Responsible Investing portfolios Innovative Technology Select Betterment Premium-exclusive portfolios Here's what's changing. More U.S. exposure While we don't advise going all-in on American markets, the forecasted risk-adjusted return for the U.S. remains strong in the long run (think: decades) relative to international markets. So similar to last year’s portfolio updates, we’re dialing down the international exposure for most portfolios. Those portfolios will see: Small increases in U.S. stock and bond allocations Small decreases in international emerging market stocks and bonds Small decreases in international developed market bonds More short-term corporate bonds The biggest change this year will be felt by portfolios with larger bond allocations. We expect U.S. short-term, high-quality corporate bonds to offer higher yields without undue increases in long-term risk, so we’re increasing the exposure to them while decreasing the weight of short-term U.S. Treasuries. The yields on these types of treasury bonds, which mature in a year or less, tend to fall right along with interest rates, and a lower interest rate environment is still expected in the long run. New innovation ETF Separately, we’re diversifying the Innovative Technology portfolio by adding a new actively-managed fund. This new ETF builds on themes like AI and biotech while adding more exposure to large-cap stocks and the Information Technology sector (hardware, software, etc.) as a whole. Sit back and enjoy the switch The great thing about technology like ours is that it makes implementing updated portfolios simple. Our automated rebalancing will tax-efficiently transition customers’ portfolios to the new target weights over time. It’s yet another example of how we make it easy to be invested.

Betterment's asset location methodology

Betterment Investing Team

Betterment Investing Team

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