How Betterment Works During Volatile Markets

It can be difficult to ride out a market downturn when you can see it affecting your investment portfolio. We have automated features in place to address volatile markets when they occur.

Chart going up and down next to a bullseye arrow

Volatile markets can make even the most experienced investor worry about their investment accounts. A sharp drop in your portfolio’s value is never fun. It might leave some investors wanting to take immediate action.

Because we passively invest here at Betterment, taking action based on market movements is not required on your part, and doing so can actually lower your returns. An internal study found that customers who change their allocation as a result of market changes are often likely to underperform customers who don’t make such unnecessary changes.

When volatility does hit—and it will—we have several automated features that can help keep you on track towards your financial goals even in times of uncertainty.

Automatic Allocation Adjustments

Many financial advisors, including Betterment, will help you choose an asset allocation that is suitable for each of your financial goals.

When you initially set up a goal with us, we will ask you how long you’ll be investing for and what amount of money you’re aiming towards. This information helps us choose the appropriate asset allocation for you not only for right now, but for the future as well.

For most goals, the asset allocation will automatically get less risky as you get closer to your goal’s end date, by following a “glide-path”.

Chart showing how allocation changes over time for major purchase goalThis reduction in risk as your goal’s end date gets closer is based on Betterment research into potential negative outcomes, or downside risk. If you’re only investing for a short time period, it’s a good idea to invest in low-risk assets, because you likely won’t have enough time to earn back value if a large market drop occurs.

Over long time horizons, including stocks in your allocation is likely to lead to a higher final balance, even in poor market scenarios. Since 1871, the lowest average annual return over any 30-year period for the S&P 500 was still 5% from 1903 to 1933, a period that includes World War I and ends in the middle of the Great Depression (data from Robert Shiller; calculations by Betterment.) Even during one of the most tumultuous 30-year periods in American history, adding stocks to your allocation would have left you better off than leaving your money on the sidelines.

Portfolio Rebalancing

The allocation that we choose for you is our best estimate of the combination of assets that will help you reach your goal by the date you’re aiming for. But, unless each asset you invest in has the same exact returns, normal stock market fluctuations will cause your actual allocation to drift away from the allocation you started with.

We call this process portfolio drift, and though a small amount of drift is perfectly normal—and a mathematical certainty—a large amount of drift could expose your portfolio to unwanted risks.

Example: If you initially split your investment 50/50 between stocks and bonds, and in the subsequent month stocks return 10% while bonds stay at the same price, your actual allocation at the end of that month could be around 52% stocks and 48% bonds.

A period of sustained volatility could be especially harmful to your portfolio if your portfolio drift is left unchecked. To help minimize this risk, we automatically rebalance your portfolio whenever your portfolio drift exceeds a certain threshold.

We generally use any cash inflows, like deposits or dividends, and outflows, like withdrawals, to help rebalance your portfolio. When money comes in, we can buy assets from asset classes your portfolio is underweight in. When money is going out, we can sell assets from asset classes your portfolio is overweight in. This cash flow based rebalancing method helps keep your portfolio risk in check while reducing the need to sell investments, and potentially realize capital gains, to rebalance.

If rebalancing does require selling investments in a taxable account, the specific shares to be sold are selected tax-efficiently, using our TaxMin method, ensuring that no short-term gains will be realized in your account during the rebalance, as these are particularly tax-inefficient.

Tax Loss Harvesting

Tax loss harvesting is the practice of selling an investment that has experienced a loss. By realizing, or "harvesting" a loss, you are able to offset taxes on both gains and income. The sold investment is replaced by a similar one, maintaining an optimal asset allocation and expected returns.

Tax loss harvesting is a feature that may benefit you most when the market is volatile. After all, if there are no losses in your account, we cannot harvest any losses. In fact, we found that the periods where tax loss harvesting would have provided the most hypothetical value was in the period following the dot-com bubble as well as the financial crisis of 2008.

You can use any harvested losses to reduce capital gains you’ve realized through other investments in the same tax year. This can reduce your tax bill, especially if you have a lot of short-term capital gains, which are taxed at a higher rate than long-term capital gains.

If you’ve harvested more losses than you have in realized capital gains, you can use up to $3,000 in losses to reduce your taxable income. Any unused losses from the current tax year can be carried over indefinitely and used in subsequent years.

Updated Advice

When you set up your goals, we’ll offer advice on how much you should be depositing in order to reach your goal. Large swings in the market can change our deposit advice, because different deposit amounts are now needed.

Fortunately, if your account drops in value due to large market swings, our recommended monthly deposit advice will increase to help keep you on track.

Likewise, a large increase in your account value caused by strong market performance will mean you can decrease your monthly deposits and still reach your goal, though an added margin of safety doesn’t hurt.

We’ll Be Right There With You

Hopefully you’re no longer worried about the next market downturn. You know that Betterment is working for you through all the ups and downs, because we have built-in features that help you ride out inevitable volatile markets. Set up your account today and let us ride out the next market downturn with you.