Goal-Based Investing: A Decade In Review
As we all look forward to and plan for the future, let’s stop and take a look at the past decade to see what we can learn from it.
I’ve never been particularly good at New Year’s Resolutions. Coming up with a shiny new list of resolutions is always fun, but as we all know—the challenge is sticking to them. But this year, things feel different. A new decade is a fantastic opportunity to reflect on what I want for my life for the next ten years, and set goals to match my vision.
Here at Betterment, we take goals seriously. Our entire investing platform was built from the ground up on the idea of goal-based investing. Research has shown that separating your investing dollars based on the actual goals you want to reach is more effective for not just one reason, but for nine reasons.
The turn of the decade has sparked my curiosity, so I’ve set out to learn how investing goals at Betterment might have fared over the past ten years.
- If I had set aside my emergency fund in Betterment’s Safety Net goal, would my portfolio have outpaced inflation?
- If I had used a Major Purchase goal to save and plan for a down payment on a house, would I have reached my goal?
- If I had followed Betterment’s contribution advice within the Retirement goal, how would my retirement accounts be looking right now—sunny or bleak?
First, some caveats...
Our portfolio and advice changes over time, so let’s investigate the answers to these questions acting as if Betterment’s current portfolio and advice had been around in and since 2010.
Before I jump into the analysis, I want to be very explicit with some of the simplifying assumptions I’ll be making here. While Betterment launched near the beginning of this decade, our product has in no way been static. One of our core principles is iteration, and so the Betterment of today is very different than it was in 2010.
Though it would have been interesting to analyze the growth and improvement of our advice over time, I chose instead to use the goal types and advice of the current Betterment platform and apply them retroactively. The historical return data is, of course, historical, as are inputs into the model such as risk-free rate assumptions—but the actual code is what currently powers our platform.
Betterment’s recommendations and models update throughout the lifetime of our customers’ goals in order to give them better advice, and I tried to account for this throughout the analysis. Betterment’s advice for Retirement plans is adjusted for inflation and taxes, whereas other goals are projected at a pre-tax, nominal basis. Lastly, the scenarios I present below are purely hypothetical, and do not represent actual investor returns. They are certainly not promises or guarantees of future returns.
Safety Net Goal
Setting aside cash for emergencies is one of the most important components of a solid financial plan. At Betterment, our recommendation is that you keep your emergency funds invested in our Safety Net goal. With this specific goal, we invest in low-volatility assets to ensure that your portfolio isn’t at risk of a major drawdown1.
But there is also another risk to consider: inflation. If you were to keep your emergency funds in cash, the post-inflation value of the cash would naturally erode over time. In order to try to maintain your portfolio’s value while also trying to beat inflation, we invest Safety Net funds at the lowest possible risk level that still has higher expected returns than inflation—15% stocks and 85% bonds.
Let’s assume that at the beginning of the decade, we had already saved up $10,000 in cash for emergencies, and we had invested it all into Betterment’s current Safety Net portfolio of 15% stocks. Would we have outpaced inflation?
For the most part, yes, the analysis below indicates that we would have outpaced inflation. Our balance (the blue line) temporarily dips below inflation (the red line) a few times through the projection, but remains above inflation for 92% of the entire time period.
The maximum drawdown during this period is 3%, which is well below our recommended buffer of 15%. Overall, we end up with $12,900 in our Safety Net goal, which comes out to around $10,850 after adjusting for inflation.
Hypothetical Safety Net "Balance Versus Inflation"—Over the Last Ten Years
Source: Returns data from Xignite. Inflation data from the Federal Reserve. Calculations by Betterment.
Major Purchase Goal
Our Major Purchase goal is designed to help our customers plan for larger, planned expenses that we all encounter throughout our lifetimes. By setting an amount that you’d like your goal to reach by a specific target date, we can give advice on how much you’ll need to save and invest, either as a one-time deposit or through regular deposits over time. We’ll also automatically de-risk the portfolio over time to ensure that a market downturn near the end of the goal term is less likely to affect the outcome.
One possible use-case for a Major Purchase goal is for saving for a down payment on a house. My colleague Nick Holeman recently wrote a research report on the economics of buying a home, so I’ll pull some figures from there. Nick found that the average down payment on a home is around $32,500, plus an additional $5,000 of closing costs, so the target balance for our hypothetical Major Purchase goal will be $37,500.
Let’s assume that we started saving for the down payment on January 1st, 2010, and we wanted to spend the down payment funds exactly ten years later, on January 1st, 2020. If we feed these values into Betterment’s algorithm that recommends the appropriate savings amounts to reach our goal, we end up with a target savings rate of $230 per month. Let’s also assume that we log in once per year to update our recurring deposits to match Betterment’s advice.
With those assumptions in mind, we can explore how the balance of our Major Purchase goal would have evolved over time. The chart below plots the hypothetical balance over the course of the past decade (blue line), compared to the desired end target amount (red line) and the cumulative deposits into the Major Purchase goal (green line).
We see that we do end up reaching our goal, and even slightly early—in early 2019, rather than at the end of 2019.
Hypothetical Major Purchase Goal Balance—Over the Last Ten Years
Source: Return data from Xignite. Calculations by Betterment.
Another way to assess the outcome of following the Major Purchase advice is to look at how much we cumulatively had to deposit in order to reach the target amount.
If we had chosen not to invest our cash at all and given up the opportunity to potentially receive investment returns, our total cumulative deposits would of course be a flat $37,500—the original target amount for our Major Purchase goal.
With the Major Purchase goal, the total cumulative deposits necessary to reach our goal would have been $29,804, which is around 21% less than if we hadn’t invested at all. In other words, committing to Betterment’s deposit advice over the ten year period would have earned us enough returns to allow us to save less towards our down payment, yet end up with the same target amount.
The chart below shows the effect investing through the past decade would have had on our goal. The bar in red is the sum of all deposits into the goal over the past decade based on Betterment’s recommendations, and the blue area shows the additional balance gained from investing.
Hypothetical Final Major Purchase "Balance Versus Total Deposits"
Source: Returns data from Xignite. Calculations by Betterment.
In total, we need about $7,700 less to reach our target amount when using the Major Purchase goal as opposed to not investing it at all. That’s not a bad outcome for the five minutes of work per year that it takes to log in and check up on your deposit advice within your Betterment account.
Saving for retirement is one of the most common ways that our customers use Betterment, and we have a wide range of tools to make that journey easier. These include advice on how much to save, how to choose the right accounts, and how much predicted spending power you’ll have in retirement based on our projections.
For the Retirement goal, I was curious to see the effect that market conditions of the past decade would have had on the retirement-readiness of a customer nearing their retirement date. I assumed that the customer was 55 years old at the start of the decade, and planning on retiring at age 65.
I also assumed the customer wants to be able to withdraw enough money from their account to have $20,000 per year (after paying a 15% long-term capital gains tax) for 20 years after their retirement date to supplement their social security. Based on these inputs and an estimated inflation of 2%, Betterment estimates that the customer would need around $382,000 at retirement, according to the customer’s projection graph.
I further assumed that our customer had saved 2/3 of that desired balance at the start of the decade, and that the customer logs in once per year to update their automated deposits according to Betterment’s advice, as the balance in the account changes.
Based on these assumptions and market data from the past decade, we can calculate the actual amount that the customer could withdraw in retirement. The chart below shows that due to favorable market conditions, our customer is actually able to withdraw around $20,500 per year in retirement, which is roughly 2.5% more than they initially planned.
Hypothetical Retirement "Spending Power Versus Target Spending Power"
Source: Betterment data.
If 2.5% seems like a very small increase after what has been a historically strong decade for markets, you are not alone—I was also initially surprised.
The answer lies in the U.S. Treasury yield markets. Treasury securities are often seen as being some of the most risk-free assets in U.S. markets. At the beginning of the decade, 30-year Treasury rates were around 4.63%2, meaning investors could lock in very high risk-free rates by investmenting in those instruments, or other instruments whose rates are primarily driven by Treasury rates.
As of December 2nd, 2019, the 30-year Treasury rate is 2.28%, so investors have a much lower rate on their risk-free investments. The chart below shows the yield curve at the beginning of the decade (blue) and at the end of the decade (red).
Yield Curve at the Beginning and End of the Decade
The decrease in long-term rates has a large effect on retirees with a fixed-income heavy portfolio. Luckily, Betterment’s advice updates with changes in not just the equity and bond markets, but also because of Treasury rates—so our hypothetical investor did not lose any spending power in retirement due to activity in the Treasury rate markets.
On To The Next Decade
While no one will ever be able to predict what the markets will do over the next decade, and future market returns are unlikely to match the past, looking backwards can often help us feel empowered to plan for the future.
As we usher in the new decade, I hope you’ll join me in thinking about what your goals are for the next ten years, and start planning for how you can make them a reality.
1 Drawdown is an investing term that measures how much an investing balance decreases from its all-time high. In simple terms, you can think of maximum drawdown as the largest loss you might have endured during a period if you invested at exactly the worst time.
2 Data from the Federal Reserve. Please note that clicking the previous link will download a CSV file of historical rates to your computer.