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Betterment's tax-loss harvesting methodology
Betterment's tax-loss harvesting methodology Tx-loss harvesting is a sophisticated technique to get more value from your investments—but doing it well requires expertise. TABLE OF CONTENTS Navigating the “Wash Sale” rule The Betterment solution Tx-loss harvesting model calibration Best practices for TLH How we calculate the value of tax-loss harvesting Your personalized Estimated Tax Savings tool Conclusion There are many ways to get your investments to work harder for you— diversification, downside risk management, and an appropriate mix of asset classes tailored to your recommended allocation. Betterment does this automatically via its ETF portfolios. But there is another way to help you get more out of your portfolio—using investment losses to improve your after-tax returns with a method called tax-loss harvesting. In this article, we introduce Betterment’s tax-loss harvesting (TLH): a sophisticated, fully automated tool that Betterment customers can choose to enable. Betterment’s tax-loss harvesting service scans portfolios regularly for opportunities (temporary dips that result from market volatility) for opportunities to realize losses which can be valuable come tax time. While the concept of tax-loss harvesting is not new for wealthy investors, tax-loss harvesting utilizes a number of innovations that typical implementations may lack. It takes a holistic approach to tax-efficiency, seeking to optimize user-initiated transactions in addition to adding value through automated activity, such as rebalances. What is tax-loss harvesting? Capital losses can lower your tax bill by offsetting gains, but the only way to realize a loss is to sell the depreciated asset. However, in a well-allocated portfolio, each asset plays an essential role in providing a piece of total market exposure. For that reason, an investor should not want to give up potential expected returns associated with each asset just to realize a loss. At its most basic level, tax-loss harvesting is selling a security that has experienced a loss—and then buying a correlated asset (i.e. one that provides similar exposure) to replace it. The strategy has two benefits: it allows the investor to “harvest” a valuable loss, and it keeps the portfolio balanced at the desired allocation. How can it lower your tax bill? Capital losses can be used to offset capital gains you’ve realized in other transactions over the course of a year—gains on which you would otherwise owe tax. Then, if there are losses left over (or if there were no gains to offset), you can offset up to $3,000 of ordinary income for the year. If any losses still remain, they can be carried forward indefinitely. Tx-loss harvesting is primarily a tax deferral strategy, and its benefit depends entirely on individual circumstances. Over the long run, it can add value through some combination of these distinct benefits that it seeks to provide: Tax deferral: Losses harvested can be used to offset unavoidable gains in the portfolio, or capital gains elsewhere (e.g., from selling real estate), deferring the tax owed. Savings that are invested may grow, assuming a conservative growth rate of 5% over a 10-year period, a dollar of tax deferred would be worth $1.63. Even after belatedly parting with the dollar, and paying tax on the $0.63 of growth, you’re ahead. Pushing capital gains into a lower tax rate: If you’ve realized short-term capital gains (STCG) this year, they’ll generally be taxed at your highest rate. However, if you’ve harvested losses to offset them, the corresponding gain you owe in the future could be long-term capital gain (LTCG). You’ve effectively turned a gain that would have been taxed up to 50% today into a gain that will be taxed more lightly in the future (up to 30%). Converting ordinary income into long-term capital gains: A variation on the above: offsetting up to $3,000 from your ordinary income shields that amount from your top marginal rate, but the offsetting future gain will likely be taxed at the LTCG rate. Permanent tax avoidance in certain circumstances: Tax-loss harvesting provides benefits now in exchange for increasing built-in gains, subject to tax later. However, under certain circumstances (charitable donation, bequest to heirs), these gains may avoid taxation entirely. Navigating the "Wash Sale" rule Summary: Wash sale rule management is at the core of any tax-loss harvesting strategy. Unsophisticated approaches can detract from the value of the harvest or place constraints on customer cash flows in order to function. At a high level, the so-called "Wash Sale” rule disallows a loss from selling a security if a “substantially identical” security is purchased 30 days after or before the sale. The rationale is that a taxpayer should not enjoy the benefit of deducting a loss if they did not truly dispose of the security. The wash sale rule applies not just to situations when a “substantially identical” purchase is made in the same account, but also when the purchase is made in the individual’s IRA/401(k) account, or even in a spouse’s account. This broad application of the wash sale rule seeks to ensure that investors cannot utilize nominally different accounts to maintain their ownership, and still benefit from the loss. A wash sale involving an IRA/401(k) account is particularly unfavorable. Generally, a “washed” loss is postponed until the replacement is sold, but if the replacement is purchased in an IRA/401(k) account, the loss is permanently disallowed. If not managed correctly, wash sales can undermine tax-loss harvesting. Handling proceeds from the harvest is not the sole concern—any deposits made in the following 30 days (whether into the same account, or into the individual’s IRA/401(k)) also need to be allocated with care. Minimizing the wash The simplest way to avoid triggering a wash sale is to avoid purchasing any security at all for the 30 days following the harvest, keeping the proceeds (and any inflows during that period) in cash. This approach, however, would systematically keep a portion of the portfolio out of the market. More advanced strategies primarily repurchase an asset with similar exposure to the harvested security that is not “substantially identical” for purposes of the wash sale rule. In the case of an individual stock, it is clear that repurchasing stock of that same company would violate the rule. Less clear is the treatment of two index funds from different issuers (e.g., Vanguard and Schwab) that track the same index. While the IRS has not issued any guidance to suggest that such two funds are “substantially identical,” a more conservative approach when dealing with an index fund portfolio would be to repurchase a fund whose performance correlates closely with that of the harvested fund, but tracks a different index. Tx-loss harvesting is generally designed around this index-based logic and generally seeks to reduce wash sales, although it cannot avoid potential wash sales arising from transactions in tickers that track the same index where one of the tickers is not currently a primary, secondary, or tertiary ticker (as those terms are defined in this white paper). This situation could arise, for example, when other tickers are transferred to Betterment or where they were previously a primary, secondary, or tertiary ticker. Additionally, for some portfolios constructed by third parties (e.g., Vanguard, Blackrock, or Goldman Sachs), certain secondary and tertiary tickers track the same index. Certain asset classes (including those in certain Betterment-constructed portfolios and portfolios constructed by third parties, such as Vanguard, Blackrock, or Goldman Sachs) do not have tertiary tickers, such that permanently disallowed losses could occur if there were overlapping holdings in taxable and tax-advantaged accounts. Betterment’s TLH feature may also permit wash sales where the anticipated tax benefit of the overall harvest transaction sufficiently outweighs the impact of expected washed losses. Selecting a viable replacement security is just one piece of the accounting and optimization puzzle. Manually implementing a tax-loss harvesting strategy is feasible with a handful of securities, little to no cash flows, and infrequent harvests. Assets may however dip in value but potentially recover by the end of the year, therefore annual strategies or infrequent harvests may leave many losses on the table. The wash sale management and tax lot accounting necessary to support more frequent harvesting quickly becomes overwhelming in a multi-asset portfolio—especially with regular deposits, dividends, and rebalancing. In short, an effective loss harvesting algorithm should be able to maximize harvesting opportunities across a full range of volatility scenarios, without sacrificing the investor’s global asset allocation. Existing strategies and their limitations Every tax-loss harvesting strategy shares the same basic goal: to maximize a portfolio’s after-tax returns by realizing built-in losses while minimizing the negative impact of wash sales. Approaches to tax-loss harvesting differ primarily in how they handle the proceeds of the harvest to avoid a wash sale. Below are the three strategies commonly employed by manual and algorithmic implementations. After selling a security that has experienced a loss, existing strategies would likely have you: Existing strategy Problem Delay reinvesting the proceeds of a harvest for 30 days, thereby ensuring that the repurchase will not trigger a wash sale. While it’s the easiest method to implement, it has a major drawback: no market exposure. This hurts portfolio returns over the long term, and could offset any potential benefit from tax-loss harvesting. Reallocate the cash entirely into one or more different asset classes in the portfolio. This method throws off an investor’s desired asset allocation. Additionally, such purchases may block other harvests over the next 30 days by setting up potential wash sales in those other asset classes. Switch back to original security after 30 days from the replacement security. Common manual approach, also used by some automated investing services. A switchback can trigger short-term capital gains when selling the replacement security, reducing the tax benefit of the harvest. Even worse, this strategy can leave an investor owing more tax than if it did nothing. The hazards of switchbacks In the 30 days leading up to the switchback, two things can happen: the replacement security can drop further, or go up. If it goes down, the switchback will realize an additional loss. However, if it goes up, which is what any asset with a positive expected return is expected to do over any given period, the switchback will realize short-term capital gains (STCG)—kryptonite to a tax-efficient portfolio management strategy. An attempt to mitigate this risk could be setting a higher threshold based on volatility of the asset class—only harvesting when the loss is so deep that the asset is unlikely to entirely recover in 30 days. Of course, there is still no guarantee that it will not, and the price paid for this buffer is that your lower-yielding harvests will also be less frequent than they could be with a more sophisticated strategy. Examples of negative tax arbitrage Negative tax arbitrage with automatic 30-day switchback An automatic 30-day switchback can destroy the value of the harvested loss, and even increase tax owed, rather than reduce it. A substantial dip presents an excellent opportunity to sell an entire position and harvest a long-term loss. Proceeds will then be re-invested in a highly correlated replacement (tracking a different index). 30 days after the sale, the dip proved temporary and the asset class more than recovered. The switchback sale results in STCG in excess of the loss that was harvested, and actually leaves the investor owing tax, whereas without the harvest, they would have owed nothing. Due to a technical nuance in the way gains and losses are netted, the 30- day switchback can result in negative tax arbitrage, by effectively pushing existing gains into a higher tax rate. When adding up gains and losses for the year, the rules require netting of like against like first. If any long-term capital gain (LTCG) is present for the year, you must net a long-term capital loss (LTCL) against that first, and only then against any STCG. Negative tax arbitrage when unrelated long-term gains are present Now let’s assume the taxpayer realized a LTCG. If no harvest takes place, the investor will owe tax on the gain at the lower LTCG rate. However, if you add the LTCL harvest and STCG switchback trades, the rules now require that the harvested LTCL is applied first against the unrelated LTCG. The harvested LTCL gets used up entirely, exposing the entire STCG from the switchback as taxable. Instead of sheltering the highly taxed gain on the switchback, the harvested loss got used up sheltering a lower-taxed gain, creating far greater tax liability than if no harvest had taken place. In the presence of unrelated transactions, unsophisticated harvesting can effectively convert existing LTCG into STCG. Some investors regularly generate significant LTCG (for instance, by gradually diversifying out of a highly appreciated position in a single stock). It’s these investors, in fact, who would benefit the most from effective tax-loss harvesting. Negative tax arbitrage with dividends Negative tax arbitrage can result in connection with dividend payments. If certain conditions are met, some ETF distributions are treated as “qualified dividends”, taxed at lower rates. One condition is holding the security for more than 60 days. If the dividend is paid while the position is in the replacement security, it will not get this favorable treatment: under a rigid 30-day switchback, the condition can never be met. The Betterment solution Summary: Betterment’s tax-loss harvesting approaches tax-efficiency holistically, seeking to optimize transactions, including customer activity. The benefits tax-loss harvesting seeks to deliver, include: No exposure to short-term capital gains in an attempt to harvest losses. Through our proprietary Parallel Position Management (PPM) system, a dual-security asset class approach enforces preference for one security without needlessly triggering capital gains in an attempt to harvest losses, all without putting constraints on customer cash flows. No negative tax arbitrage traps associated with less sophisticated harvesting strategies (e.g., 30-day switchback), making tax-loss harvesting especially suited for those generating large long-term capital gains on an ongoing basis. Tax loss preservation logic extended to user-realized losses, not just harvested losses, automatically protecting both from the wash sale rule. In short, user withdrawals always sell any losses first. Minimize disallowed losses through overlap with a Betterment IRA/401(k). We generally use a tertiary ticker system to eliminate the possibility of permanently disallowed losses triggered by subsequent IRA/401(k) activity. This makes TLH ideal for those who invest in both taxable and tax-advantaged accounts. Harvests also take the opportunity to rebalance across all asset classes, rather than re-invest solely within the same asset class. This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and higher tax alpha. Through these innovations, tax-loss harvesting creates significant value over manually-serviced or less sophisticated algorithmic implementations. Tax-loss harvesting is accessible to investors —fully automated, effective, and at no additional cost. Parallel securities To ensure that each asset class is supported by optimal securities in both primary and alternate (secondary) positions, we screened by expense ratio, liquidity (bid-ask spread), tracking error vs. benchmark, and most importantly, covariance of the alternate with the primary.1 While there are small cost differences between the primary and alternate securities, the cost of negative tax arbitrage from tax-agnostic switching vastly outweighs the cost of maintaining a dual position within an asset class. Tax-loss harvesting features a special mechanism for coordination with IRAs/401(k)s where we pick a third (tertiary) security in each harvestable asset class where possible. While these have a higher cost than the primary and alternate, they are not expected to be utilized often, and even then, for short durations (more below in IRA/401(k) protection). However, if no suitable tertiary exists beyond the secondary used in the taxable version of the portfolio strategy, certain security groups in Betterment-constructed portfolios will not have tertiary tickers assigned in the tax-advantaged strategy. While Betterment generally constructs portfolios to minimize this risk, clients should be aware that in this scenario, rebalancing can result in wash sales, and that if the replacement purchase occurs in an IRA account, the loss is permanently disallowed. Parallel position management As demonstrated, the unconditional 30-day switchback to the primary security is problematic for a number of reasons. To fix those problems, we engineered a platform to support tax-loss harvesting, which seeks to tax-optimize user and system-initiated transactions: the Parallel Position Management (PPM) system. PPM allows each asset class to contain a primary security to represent the desired exposure while maintaining alternate and tertiary securities that are closely correlated securities, should that result in a better after-tax outcome. PPM provides several improvements over the switchback strategy. First, unnecessary gains are minimized. Second, the parallel security (could be primary or alternate) serves as a safe harbor to reduce potential wash sales—not just from harvest proceeds, but any cash inflows. Third, the mechanism seeks to protect not just harvested losses, but losses realized by the customer as well. PPM not only facilitates effective opportunities for tax-loss harvesting, but also extends maximum tax-efficiency to customer-initiated transactions. Every customer withdrawal is a potential harvest (losses are sold first). Deposits and dividends are used to rebalance your portfolio. When available cash is reinvested, it is generally routed to the parallel position that would reduce wash sales, while working toward the target allocation. PPM has a preference for the primary security when rebalancing and for all cash flow events—but always subject to tax considerations. This is how PPM behaves under various conditions: Transaction PPM behavior Withdrawals and sales from rebalancing Sales default out of the alternate position (if such a position exists), but not at the expense of triggering STCG—in that case, PPM will sell lots of the primary security first. Rebalancing will attempt to stop short of realizing STCG. Taxable gains are minimized at every decision point—STCG tax lots are the last to be sold on a user withdrawal. Deposits, buys from rebalancing, and dividend reinvestments PPM directs inflows to underweight asset classes, and within each asset class, into the primary, unless doing so incurs greater wash sale costs than buying the alternate. Harvest events TLH harvests can come out of the primary into the alternate, or vice versa, depending on which harvest has a greater expected value. After an initial harvest, it could make sense at some point to harvest back into the primary, to harvest more of the remaining primary into the alternate, or to do nothing. Wash sale management Managing cash flows across both taxable and IRA/401(k) accounts without washing realized losses is a complex problem. Tx-loss harvesting operates without constraining the way that customers prefer contributing to their portfolios. With the benefit of parallel positions, Betterment weighs wash sale implications of deposits, withdrawals and dividend reinvestment. This system protects not just harvested losses, but also losses realized through withdrawals. Minimizing wash sale through tertiary tickers in IRA/401(k) Because IRA/401(k) wash sales are particularly unfavorable—the loss is disallowed permanently—tax-loss harvesting uses a tertiary ticker system to seek to prevent losses realized in the taxable account from being washed by subsequent deposits into an IRA/401(K) where possible. Let’s look at an example of how tax-loss harvesting handles a potentially disruptive IRA inflow with a tertiary ticker when there are realized losses to protect, using real market data for a Developed Markets asset class. The customer starts with a position in VEA, the primary security, in both the taxable and IRA accounts. We harvest a loss by selling the entire taxable position, and then repurchasing the alternate security, SCHF. Loss harvested in VEA Two weeks pass, and the customer makes a withdrawal from the taxable account (the entire SCHF position, for simplicity), intending to fund the IRA. In those two weeks, the asset class dropped more, so the sale of SCHF also realized a loss. The VEA position in the IRA remains unchanged. Customer withdrawal sells SCHF at a loss A few days later, the customer contributes to his IRA, and $1,000 is allocated to the Developed Markets asset class, which already contains some VEA. Despite the fact that the customer no longer holds any VEA or SCHF in his taxable account, buying either one in the IRA would permanently wash a valuable realized loss. The Tertiary Ticker System automatically allocates the inflow into the third option for developed markets, IEFA. IRA deposit into tertiary Ticker Both losses have been preserved, and the customer now holds VEA and IEFA in his IRA, maintaining desired allocation at all times. Because no capital gains are realized in an IRA/401(k), there is no harm in switching out of the IEFA position and consolidating the entire asset class in VEA when there is no danger of a wash sale. The result: Customers using TLH who also have their IRA/401(k) assets with Betterment can know that Betterment will seek to protect valuable realized losses whenever they deposit into their IRA/401(k), whether it’s lump rollover, auto-deposits or even dividend reinvestments. Smart rebalancing Lastly, tax-loss harvesting directs the proceeds of every harvest to rebalance the entire portfolio, the same way that a Betterment account handles any incoming cash flow (deposit, dividend). For portfolios with a cash allocation, if cash is below its target allocation at the time of the TLH transaction, proceeds will first be applied to increase cash up to target, and only any remaining available cash is invested in securities; if cash is above its target, the excess cash above target will be invested in securities along with the harvest proceeds as part of the TLH transaction. Recognizing every harvest as a rebalancing opportunity further reduces the need for additional selling in times of volatility, further reducing tax liability. As always, fractional shares allow the inflows to be allocated with precision. Tx-loss harvesting model calibration Summary: To make harvesting decisions, tax-loss harvesting optimizes around multiple inputs, derived from rigorous Monte Carlo simulations. The decision to harvest is made when the benefit, net of cost, exceeds a certain threshold. The potential benefit of a harvest is discussed in detail below (“Results”). Unlike a 30-day switchback strategy, tax-loss harvesting does not incur the expected STCG cost of the switchback trade. Therefore, “cost” consists of three components: trading expense, execution expense, and increased cost of ownership for the replacement asset (if any). Trading costs are included in the wrap fee paid by Betterment customers. Tax-loss harvesting is engineered to factor in the other two components, configurable at the asset level, and the resulting cost approaches negligible. Bid-ask spreads for the bulk of harvestable assets are narrow. We seek funds with expense ratios for the major primary/alternate ETF pairs that are close, and in the case where a harvest back to the primary ticker is being evaluated, that difference is actually a benefit, not a cost. There are two general approaches to testing a model’s performance: historical backtesting and forward-looking simulation. Optimizing a system to deliver the best results for only past historical periods is relatively trivial, but doing so would be a classic instance of data snooping bias. Relying solely on a historical backtest of a portfolio composed of ETFs that allow for 10 to 20 years of reliable data when designing a system intended to provide 40 to 50 years of benefit would mean making a number of indefensible assumptions about general market behavior. The superset of decision variables driving tax-loss harvesting is beyond the scope of this paper—optimizing around these variables required exhaustive analysis. Tax-loss harvesting was calibrated via Betterment’s rigorous Monte Carlo simulation framework, spinning up thousands of server instances in the cloud to run through tens of thousands of forward-looking scenarios testing model performance. We have calibrated tax-loss harvesting in a way that we believe optimizes its effectiveness given expected future returns and volatility, but other optimizations could result in more frequent harvests or better results depending on actual market conditions. Best practices for tax-loss harvesting Summary: Tax-loss harvesting can add some value for most investors, but high earners with a combination of long time horizons, ongoing realized gains, and plans for some charitable disposition will reap the largest benefits. This is a good point to reiterate that tax-loss harvesting delivers value primarily due to tax deferral, not tax avoidance. A harvested loss can be beneficial in the current tax year to varying degrees, but harvesting that loss generally means creating an offsetting gain at some point in the future. If and when the portfolio is liquidated, the gain realized will be higher than if the harvest never took place. Let’s look at an example: Year 1: Buy asset A for $100. Year 2: Asset A drops to $90. Harvest $10 loss, repurchase similar Asset B for $90. Year 20: Asset B is worth $500 and is liquidated. Gains of $410 realized (sale price minus cost basis of $90) Had the harvest never happened, we’d be selling A with a basis of $100, and gains realized would only be $400 (assuming similar performance from the two correlated assets.) Harvesting the $10 loss allows us to offset some unrelated $10 gain today, but at a price of an offsetting $10 gain at some point in the future. The value of a harvest largely depends on two things. First, what income, if any, is available for offset? Second, how much time will elapse before the portfolio is liquidated? As the deferral period grows, so does the benefit—the reinvested savings from the tax deferral have more time to grow. While nothing herein should be interpreted as tax advice, examining some sample investor profiles is a good way to appreciate the nature of the benefit of tax-loss harvesting. Who benefits most? The Bottomless Gains Investor: A capital loss is only as valuable as the tax saved on the gain it offsets. Some investors may incur substantial capital gains every year from selling highly appreciated assets—other securities, or perhaps real estate. These investors can immediately use all the harvested losses, offsetting gains and generating substantial tax savings. The High Income Earner: Harvesting can have real benefits even in the absence of gains. Each year, up to $3,000 of capital losses can be deducted from ordinary income. Earners in high income tax states (such as New York or California) could be subject to a combined marginal tax bracket of up to 50%. Taking the full deduction, these investors could save $1,500 on their tax bill that year. What’s more, this deduction could benefit from positive rate arbitrage. The offsetting gain is likely to be LTCG, taxed at around 30% for the high earner—less than $1,000—a real tax savings of over $500, on top of any deferral value. The Steady Saver: An initial investment may present some harvesting opportunities in the first few years, but over the long term, it’s increasingly unlikely that the value of an asset drops below the initial purchase price, even in down years. Regular deposits create multiple price points, which may create more harvesting opportunities over time. (This is not a rationale for keeping money out of the market and dripping it in over time—tax-loss harvesting is an optimization around returns, not a substitute for market exposure.) The Philanthropist: In each scenario above, any benefit is amplified by the length of the deferral period before the offsetting gains are eventually realized. However, if the appreciated securities are donated to charity or passed down to heirs, the tax can be avoided entirely. When coupled with this outcome, the scenarios above deliver the maximum benefit of TLH. Wealthy investors have long used the dual strategy of loss harvesting and charitable giving. Even if an investor expects to mostly liquidate, any gifting will unlock some of this benefit. Using losses today, in exchange for built-in gains, offers the partial philanthropist a number of tax-efficient options later in life. Who benefits least? The Aspiring Tax Bracket Climber: Tax deferral is undesirable if your future tax bracket will be higher than your current. If you expect to achieve (or return to) substantially higher income in the future, tax-loss harvesting may be exactly the wrong strategy—it may, in fact, make sense to harvest gains, not losses. In particular, we do not advise you to use tax-loss harvesting if you can currently realize capital gains at a 0% tax rate. Graduate students, those taking parental leave, or just starting out in their careers should ask “What tax rate am I offsetting today” versus “What rate can I reasonably expect to pay in the future?” The Scattered Portfolio: Tax-loss harvesting is carefully calibrated to manage wash sales across all assets managed by Betterment, including IRA assets. However, the algorithms cannot take into account information that is not available. To the extent that a Betterment customer’s holdings (or a spouse’s holdings) in another account overlap with the Betterment portfolio, there can be no guarantee that tax-loss harvesting activity will not conflict with sales and purchases in those other accounts (including dividend reinvestments), and result in unforeseen wash sales that reverse some or all of the benefits of tax-loss harvesting. We do not recommend tax-loss harvesting to a customer who holds (or whose spouse holds) any of the ETFs in the Betterment portfolio in non-Betterment accounts. You can ask Betterment to coordinate tax-loss harvesting with your spouse’s account at Betterment. You’ll be asked for your spouse’s account information after you enable tax-loss harvesting so that we can help optimize your investments across your accounts. The Portfolio Strategy Collector: Electing different portfolio strategies for multiple Betterment goals may cause tax-loss harvesting to identify fewer opportunities to harvest losses than it might if you elect the same portfolio strategy for all of your Betterment goals. The Rapid Liquidator: What happens if all of the additional gains due to harvesting are realized over the course of a single year? In a full liquidation of a long-standing portfolio, the additional gains due to harvesting could push the taxpayer into a higher LTCG bracket, potentially reversing the benefit of tax-loss harvesting. For those who expect to draw down with more flexibility, smart automation will be there to help optimize the tax consequences. The Imminent Withdrawal: The harvesting of tax losses resets the one-year holding period that is used to distinguish between LTCG and STCG. For most investors, this isn’t an issue: by the time that they sell the impacted investments, the one-year holding period has elapsed and they pay taxes at the lower LTCG rate. This is particularly true for Betterment customers because our TaxMin feature automatically realizes LTCG ahead of STCG in response to a withdrawal request. However, if you are planning to withdraw a large portion of your taxable assets in the next 12 months, you should wait to turn on tax-loss harvesting until after the withdrawal is complete to reduce the possibility of realizing STCG. Other impacts to consider Investors with assets held in different portfolio strategies should understand how it impacts the operation of tax-loss harvesting. To learn more, please see the respective disclosures for the following Betterment and third-party portfolios: Socially Responsible Investing, Flexible portfolio, Innovative Technology, Value Tilt, Crypto ETF, Goldman Sachs Tax-Smart Bonds, Goldman Sachs Smart Beta, Target Income built with BlackRock, as well as the disclosure Betterment Advisor Solutions Model Marketplace. Clients in Advisor-designed custom portfolios through Betterment for Advisors should consult their Advisors to understand the limitations of tax-loss harvesting with respect to any custom portfolio. Additionally, as described above, electing one portfolio strategy for one or more goals in your account while simultaneously electing a different portfolio for other goals in your account may reduce opportunities for TLH to harvest losses, as TLH is calibrated to seek to reduce wash sales. Due to Betterment’s monthly cadence for billing fees for advisory services, through the liquidation of securities, tax-loss harvesting opportunities may be adversely affected for customers with particularly high stock allocations, third party portfolios, or flexible portfolios. As a result of assessing fees on a monthly cadence for a customer with only equity security exposure, which tends to be more opportunistic for tax-loss harvesting, certain securities may be sold that could have been used to tax loss harvest at a later date, thereby delaying the harvesting opportunity into the future. This delay would be due to the TLH tool’s effort to reduce instances of triggering the wash sale rule, which forbids a security from being sold only to be replaced with a “substantially similar” security within a 30-day period. Factors which will determine the actual benefit of tax-loss harvesting include, but are not limited to, market performance, the size of the portfolio, the stock exposure of the portfolio, the frequency and size of deposits into the portfolio, the availability of capital gains and income which can be offset by losses harvested, the tax rates applicable to the investor in a given tax year and in future years, the extent to which relevant assets in the portfolio are donated to charity or bequeathed to heirs, and the time elapsed before liquidation of any assets that are not disposed of in this manner. All of Betterment’s trading decisions are discretionary and Betterment may decide to limit or postpone TLH trading on any given day or on consecutive days, either with respect to a single account or across multiple accounts. tax-loss harvesting is not suitable for all investors. Nothing herein should be interpreted as tax advice, and Betterment does not represent in any manner that the tax consequences described herein will be obtained, or that any Betterment product will result in any particular tax consequence. Please consult your personal tax advisor as to whether TLH is a suitable strategy for you, given your particular circumstances. The tax consequences of tax-loss harvesting are complex and uncertain and may be challenged by the IRS. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return. Betterment assumes no responsibility for the tax consequences to any client of any transaction. See Betterment’s tax-loss harvesting disclosures for further detail. How we calculate the value of tax-loss harvesting Over 2022 and 2023, we calculated that 69% of Betterment customers who employed the strategy saw potential savings in excess of the Betterment fees charged on their taxable accounts for the year. To reach this conclusion, we first identified the accounts to consider, defined as taxable investing accounts that had a positive balance and tax-loss harvesting turned on throughout 2022 and 2023. We excluded trust accounts because their tax treatments can be highly-specific and they made up less than 1% of the data. For each account’s taxpayer, we pulled the short and long term capital gain/loss in the relevant accounts realized in 2022 and 2023 using our trading and tax records. We then divided the gain/loss into those caused by a TLH transaction and those not caused by a TLH transaction. Then, for each tax year, we calculated the short-term gains offset by taking the greater of the short-term loss realized by tax-loss harvesting and the short-term gain caused by other transactions. We did the same for long-term gain/loss. If there were any losses leftover, we calculated the amount of ordinary income that could be offset by taking the greater of the customer’s reported income and $3,000 ($1,500 if the customer is married filing separately) and then taking the greater of that number and the sum of the remaining long-term and short-term losses (after first subtracting any non-tax-loss harvesting losses from ordinary income). If there were any losses leftover in 2022 after all that, we carried those losses forward to 2023. At this point, we had for each customer the amount of short-term gains, long-term gains and ordinary income offset by tax-loss harvesting for each tax year. We then calculated the short-term and long-term capital gains rates using the federal tax brackets for 2022 and 2023 and the reported income of the taxpayer, their reported tax filing status, and their reported number of dependents. We assumed the standard deduction and conservatively did not include state capital gains taxes because some states do not have capital gains tax. We calculated the ordinary income rate including federal taxes, state taxes, and Medicare and Social Security taxes using the user’s reported income, filing status, number of dependents, assumed standard deduction, and age (assuming Medicare and Social Security taxes cease at the retirement age of 67). We then applied these tax rates respectively to the offsets to get the tax bill reduction from each type of offset and summed them up to get the total tax reduction. Then, we pulled the total fees charged to the users on the account in question that were accrued in 2022 and 2023 from our fee accrual records and compared that to the tax bill reduction. If the tax bill reduction was greater than the fees, we considered tax-loss harvesting to have indirectly paid for the fees in the account in question for the taxpayer in question. This was the case for 69% of customers. Your personalized Estimated Tax Savings tool Overview: Betterment’s TLH Estimated Tax Savings Tool is found in your online account and designed to quantify the tax-saving potential of our tax-loss harvesting (TLH) feature. By leveraging both transactional data from Betterment accounts and your self-reported demographic and financial profile information, the tool generates dynamic estimates of realized and potential tax savings. These calculations provide both current-year and cumulative ("all-time") tax savings estimates. Client-centric tax modeling: To personalize estimates, the tool takes into account client financial profile information: your self-reported annual pre-tax income, state of residence, tax filing status (e.g. individual, married filing jointly), and number of dependents. This information helps Betterment create a comprehensive tax profile, estimating your federal and state income tax rates, long-term capital gains (LTCG) rates, and applicable standard deductions. Betterment’s estimated tax savings methodology also incorporates the IRS' cap on ordinary income offsets for capital losses—$3,000 for most individuals or $1,500 if married filing separately, and also incorporates any available carryforward losses. Tax lot analysis and offsetting hierarchy: At the heart of Betterment’s estimated tax savings tool is a detailed analysis of tax-lot level trading data. Betterment tallys TLH-triggered losses (short- and long-term) from other realized capital gains or losses, grouping them by year, and calculates your potential tax benefit by offsetting losses and gains by type according to IRS rules, and allowing excess losses to offset other income types or carry forward to future years. The IRS offset order is applied: Short-term losses offset short-term gains Long-term losses offset long-term gains Remaining short-term losses offset long-term gains Remaining long-term losses offset short-term gains Remaining short-term losses offset ordinary income Remaining long-term losses offset ordinary income Any further losses are carried forward Current year estimated tax savings: Betterment calculates your current year estimated tax savings from TLH based on the IRS numbered offset list above, which is the sum of: Short-term offset represents the tax savings from subtracting your short-term harvested losses and cross-offset long-term harvested losses from current-year short-term capital gains (numbers 1 and 4 above), then multiplying by your estimated federal plus state tax rate. Long-term offset represents the savings from subtracting long-term harvested losses and cross-offset short-term harvested losses from current-year long-term capital gains (numbers 2 and 3 above), multiplied by your estimated long-term capital gains rate. Ordinary income offset captures the savings from applying any remaining harvested losses to your ordinary income up to the allowable limit (numbers 5 and 6 above), multiplied by your estimated federal plus state tax rate. Both short-term and long-term harvested losses may include banked losses from prior years that couldn’t be used at the time. These carryforward losses (number 7 above) are applied in the same way as current-year harvested losses when calculating your tax savings. For the tool, Harvested Losses are all time short- and long-term harvested losses i.e., all harvested losses to date through TLH. Savings from the Short-term offset, long-term offset, and ordinary income offset are summed to yield the current year estimated tax savings. All-time estimated tax savings : Betterment calculates your all-time estimated tax savings from TLH based on the sum of: All-time Long-term harvested losses × LTCG rate All-time Short-term harvested losses × (Federal + State tax rate) For the all-time estimated tax figure, the all-time figures used are all your harvested losses through Betterment’s TLH feature to the present date, and rather than calculate offsets, Betterment assumes that you are able to fully offset your long-term harvested losses and short-term harvested losses with gains. Therefore, we apply the long term capital gains rates and marginal ordinary income rate (which is the sum of your federal and state tax rates) by your total long-term harvested losses and short-term losses, respectively. There is no ordinary income offset in the All-Time Estimate. This simplification does not track when the loss occurred, and therefore, assumes current estimated tax rates were applicable throughout prior years. Assumptions: While this tool provides a powerful estimate of your potential tax benefits from tax-loss harvesting, it is important to understand the assumptions and limitations underlying the estimated tax savings calculations. Estimated tax savings figures presented are estimates—not guarantees—and rely on the information you’ve provided to Betterment. Actual tax outcomes may vary based on your actual tax return and situation when filing. The tool evaluates only the activity within your Betterment accounts and does not take into account any investment activity from external accounts. For the current year calculation, the tool also assumes that you have sufficient ordinary income to fully benefit from capital loss offsets, and for the all-time calculation, the tool provides a tax-dollar estimate of all harvested losses, based on type (short- or long-term) and current tax rates. Additionally, the estimated tax savings calculation simplifies the treatment of certain entities; for example, trusts, business accounts, or other specialized tax structures are not handled distinctly. State-level tax estimates exclude city tax rates and municipal taxes, which may also affect your overall tax situation. The “all-time estimate” shown reflects an approximation of the total tax impact of harvested losses to date—including benefits that have not yet been realized or claimed. While the estimate has its limitations, it provides a clear and actionable view into how tax-smart investing can add value over time. It helps show how harvested losses may lower your tax bill and boost after-tax returns—bringing transparency to a strategy that’s often hard to see in dollar terms. For many investors, it highlights the long-term financial benefits of managing taxes proactively. Conclusion Summary: Tax-loss harvesting can be an effective way to improve your investor returns without taking additional downside risk.
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The Goldman Sachs Smart Beta portfolio methodology
The Goldman Sachs Smart Beta portfolio methodology The Goldman Sachs Smart Beta portfolio is meant for investors who seek to outperform a market-cap portfolio strategy in the long term, despite periods of underperformance. Our Smart Beta portfolio sourced from Goldman Sachs Asset Management helps meet the preference of our customers who are willing to take on additional risks to potentially outperform a market capitalization strategy. The Goldman Sachs Smart Beta portfolio strategy reflects the same underlying principles that have always guided the core Betterment portfolio strategy—investing in a globally diversified portfolio of stocks and bonds. The difference is that the Goldman Sachs Smart Beta portfolio strategy seeks higher returns by moving away from market capitalization weightings in and across equity asset classes. What is a smart beta portfolio strategy? Portfolio strategies are often described as either passive or active. Most index funds and exchange-traded funds (ETFs) are categorized as “passive” because they track the returns of the underlying market based on asset class. By contrast, many mutual funds or hedge fund strategies are considered “active” because an advisor or fund manager is actively buying and selling specific securities to attempt to beat their benchmark index. The result is a dichotomy in which a portfolio gets labeled as passive or active, and investors infer possible performance and risk based on that label. In reality, portfolio strategies reside within a plane where passive and active are just two cardinal directions. Smart beta funds, like the ones that were selected for this portfolio, seek to achieve their performance by falling somewhere in between extreme passive and active, using a set of characteristics, called “factors1,” with an objective of outperformance while managing risk. The portfolio strategy also incorporates other passive funds to achieve appropriate diversification. This alternative approach is also the reason for the name “smart beta.” An analyst comparing conventional portfolio strategies usually operates by assessing beta, which measures the sensitivity of the security to the overall market. In developing a smart beta approach, the performance of the overall market is seen as just one of many factors that affects returns. By identifying a range of factors that may drive return potential, we seek the potential to outperform the market in the long term while managing reasonable risk. When we develop and select new portfolio strategies at Betterment, we operate using five core principles of investing: Personalized planning A balance of cost and value Diversification Tax optimization Behavioral discipline The Goldman Sachs Smart Beta portfolio strategy aligns with all five of these principles, but the strategy configures cost, value, and diversification in a different way than Betterment’s Core portfolio. In order to pursue higher overall return potential, the smart beta strategy adds additional systematic risk factors that are summarized in the next section. Additionally, the strategy seeks to achieve global diversification across stocks and bonds while overweighting specific exposures to securities which may not be included in Betterment’s Core portfolio. Meanwhile, with the smart beta portfolio, we’re able to continue delivering all of Betterment’s tax-efficiency features, such as tax loss harvesting and Tax Coordination. Investing in smart beta strategies has traditionally been more expensive than a pure market cap-weighted portfolio. While the Goldman Sachs Smart Beta portfolio strategy has a far lower cost than the industry average, it is slightly more expensive than the core Betterment portfolio strategy. Because a smart beta portfolio incorporates the use of additional systematic risk factors, we typically only recommend this portfolio for investors who have a high risk tolerance and plan to save for the long term. Which “factors” drive the Goldman Sachs Smart Beta portfolio strategy? Factors are the variables that drive performance and risk in a smart beta portfolio strategy. If you think of risk as the currency you spend to achieve potential returns, factors are what determine the underlying value of that currency. We can dissect a portfolio’s return into a linear combination of factors. In academic literature and practitioner research (AQR), factors have been shown to drive historical returns. These analyses form the backbone of our advice for using the smart beta portfolio strategy. Factors reflect economically intuitive reasons and behavioral biases of investors in aggregate, all of which have been well studied in academic literature. Most of the equity ETFs used in this portfolio are Goldman Sachs ActiveBetaTM, which are Goldman Sach’s factor-based smart beta equity funds. Stocks are scored according to four factors where the highest scoring companies have greater weighting. The weights are then constrained to be in-line with the market. These factors include: Good Value When a company has solid earnings (after-tax net income), but has a relatively low price (i.e., there’s a relatively low demand by the universe of investors), its stock is considered to have good value. Allocating to stocks based on this factor gives investors exposure to companies that have high growth potential but have been overlooked by other investors. High Quality High-quality companies demonstrate sustainable profitability over time. By investing based on this factor, the portfolio includes exposure to companies with strong fundamentals (e.g., strong and stable revenue and earnings) and potential for consistent returns. Low Volatility Stocks with low volatility tend to avoid extreme swings up or down in price. What may seem counterintuitive is that these stocks also tend to have higher returns than high volatility stocks. This is recognized as a persistent anomaly among academic researchers because the higher the volatility of the asset, the higher its return should be (according to standard financial theory). Low-volatility stocks are often overlooked by investors, as they usually don’t increase in value substantially when the overall market is trending higher. In contrast, investors seem to have a systematic preference for high-volatility stocks based on the data and, as a result, the demand increases these stocks’ prices and therefore reduces their future returns. Strong Momentum Stocks with strong momentum have recently been trending strongly upward in price. It is well documented that stocks tend to trend for some time, and investing in these types of stocks allows you to take advantage of these trends. It’s important to define the momentum factor with precision since securities can also exhibit reversion to the mean—meaning that “what goes up must come down.” The Goldman Sachs Smart Beta portfolio also targets a small operational cash allocation in taxable accounts, health savings accounts, and individual retirement accounts (IRAs). How can these factors lead to future outperformance? In specific terms, the factors that drive the smart beta portfolio strategy—while having varying performance year-to-year relative to their market cap benchmark—have potential to outperform their respective benchmarks when combined. You can see an example of this in the chart of yearly factor returns for US large cap stocks below. You’ll see that the ranking of the four factor indexes varies over time, rotating outperformance over the S&P 500 Index in nearly all of the years. Performance Ranking of Smart Beta Indices vs. S&P 500 Why invest in a smart beta portfolio? As we’ve explained above, we generally only advise using Betterment’s choice smart beta strategy if you’re looking for a more tactical strategy that seeks to outperform a market-cap portfolio strategy in the long term despite potential periods of underperformance. For investors who fall into such a scenario, our analysis, supported by academic and practitioner literature, shows that the four factors above may provide higher return potential than a portfolio that uses market weighting as its only factor. While each factor weighted in the smart beta portfolio strategy has specific associated risks, some of these risks have low or negative correlation, which allow for the portfolio design to offset constituent risks and control the overall portfolio risk. Of course, these risks and correlations are based on historical analysis, and no advisor could guarantee their outlook for the future. An investor who elects the Goldman Sachs Smart Beta portfolio strategy should understand that the potential losses of this strategy can be greater than those of market benchmarks. In the year of the dot-com collapse of 2000, for example, when the S&P 500 dropped by 10%, the S&P 500 Momentum Index lost 21%. Given the systematic risks involved, we believe the evidence that shows that smart beta factors may lead to higher expected return potential relative to market cap benchmarks, and thus, we are proud to offer the portfolio for customers with long investing horizons. 1Factors, as applied in investing, can mean different things. In the context of asset allocation, factors are drivers of return within broader asset classes used as a lens to uncover return potential and minimize risk. The Goldman Sachs Smart Beta portfolios examine market capitalization, rates, emerging markets, credit, equity style, commodities and momentum to seek to avoid taking unnecessary risk while pursuing the best opportunities to drive portfolio returns.
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How Betterment manages risks in your portfolio
How Betterment manages risks in your portfolio Betterment’s tools can keep you on track with the best chance of reaching your goals. Investing always involves some level of risk. But you should always have control over how much risk you take on. When your goals are decades away, it's easier to invest in riskier assets. The closer you get to reaching your goals, the more you may want to play it safe. Betterment’s tools can help manage risk and keep you on track toward your goals. In this guide, we’ll: Explain how Betterment provides allocation advice Talk about determining your personal risk level Walk through some of Betterment’s automated tools that help you manage risk Take a look at low-risk portfolios The key to managing your risk: asset allocation Risk is inherent to investing, and to some degree risk is good. High risk, high reward, right? What’s important is how you manage your risk. You want your investments to grow as the market fluctuates. One major way investors manage risk is through diversification. You’ve likely heard the old cliche, “Don’t put all your eggs in one basket.” This is the same reasoning investors use. We diversify our investments, putting our eggs in various baskets, so to speak. This way if one investment fails, we don’t lose everything. But how do you choose which baskets to put your eggs in? And how many eggs do you put in those baskets? Investors have a name for this process: asset allocation. Asset allocation involves splitting up your investment dollars across several types of financial assets (like stocks and bonds). Together these investments form your portfolio. A good portfolio will have your investment dollars in the right baskets: protecting you from extreme loss when the markets perform poorly, yet leaving you open to windfalls when the market does well. If that sounds complicated, there’s good news: Betterment will automatically recommend how to allocate your investments based on your individual goals. How Betterment provides allocation advice At Betterment, our recommendations start with your financial goals. Each of your financial goals—whether it’s a vacation or retirement—gets its own allocation of stocks and bonds. Next we look at your investment horizon, a fancy term for “when you need the money and how you’ll withdraw it.” It’s like a timeline. How long will you invest for? Will you take it out all at once, or a little bit at a time? For a down payment goal, you might withdraw the entire investment after 10 years once you’ve hit your savings mark. But when you retire, you’ll probably withdraw from your retirement account gradually over the course of years. What if you don’t have a defined goal? If you’re investing without a timeline or target amount, we’ll use your age to set your investment horizon with a default target date of your 65th birthday. We’ll assume you’ll withdraw from it like a retirement account, but maintain a slightly riskier portfolio even when you hit the target date, since you haven’t decided when you'll liquidate those investments. But you’re not a “default” person. So why would you want a default investment plan? That’s why you should have a goal. When we know your goal and time horizon, we can determine the best risk level by assessing possible outcomes across a range of bad to average markets. Our projection model includes many possible futures, weighted by how likely we believe each to be. By some standards, we err on the side of caution with a fairly conservative allocation model. Our mission is to help you get to your goal through steady saving and appropriate allocation, rather than taking on unnecessary risk. How much risk should you take on? Your investment horizon is one of the most important factors in determining your risk level. The more time you have to reach your investing goals, the more risk you can afford to safely take. So generally speaking, the closer you are to reaching your goal, the less risk your portfolio should be exposed to. This is why we use the Betterment auto-adjust—a glide path (aka formula) used for asset allocation that becomes more conservative as your target date approaches. We adjust the recommended allocation and portfolio weights of the glide path based on your specific goal and time horizon. Want to take a more aggressive approach? More conservative? That’s totally ok. You’re in control. You always have the final say on your allocation, and we can show you the likely outcomes. Our quantitative approach helps us establish a set of recommended risk ranges based on your goals. If you choose to deviate from our risk guidance, we’ll provide you with feedback on the potential implications. Take more risk than we recommend, and we’ll tell you we believe your approach is “too aggressive” given your goal and time horizon. Even if you care about the downsides less than the average outcome, we’ll still caution you against taking on more risk, because it can be very difficult to recover from losses in a portfolio flagged as “too aggressive.” On the other hand, if you choose a lower risk level than our “conservative” band, we'll label your choice “very conservative.” A downside to taking a lower risk level is you may need to save more. You should choose a level of risk that’s aligned with your ability to stay the course. An allocation is only optimal if you’re able to commit to it in both good markets and bad ones. To ensure you’re comfortable with the short-term risk in your portfolio, we present both extremely good and extremely poor return scenarios for your selection over a one-year period. How Betterment automatically optimizes your risk An advantage of investing with Betterment is that our technology works behind the scenes to automatically manage your risk in a variety of ways, including auto-adjusted allocation and rebalancing. Auto-adjusted allocation For most goals, the ideal allocation will change as you near your goal. Our automated tools aim to make those adjustments as efficient and tax-friendly as possible. Deposits, withdrawals, and dividends can help us guide your portfolio toward the target allocation, without having to sell any assets. If we do need to sell any of your investments, our tax-smart technology is designed to minimize the potential tax impact. First we look for shares that have losses. These can offset other taxes. Then we sell shares with the smallest embedded gains (and smallest potential taxes). Rebalancing Over time, individual assets in a diversified portfolio move up and down in value, drifting away from the target weights that help achieve proper diversification. The difference between your target allocation and the actual weights in your current ETF portfolio is called portfolio drift. We define portfolio drift as the total absolute deviation of each super asset class from its target, divided by two. These super asset classes are US Bonds, International Bonds, Emerging Markets Bonds, US Stocks, International Stocks, and Emerging Markets Stocks. For Betterment-constructed portfolios that include a cash allocation, drift in the cash allocation is measured alongside super asset class drift. (Separately, Betterment-managed custom portfolios evaluate drift at the security group level. For reference, security groups are groupings of tickers that include a primary ticker, and may include secondary and/or tertiary tickers designed to help avoid wash sales and allow for tax-loss harvesting opportunities). A high drift may expose you to more (or less) risk than you intended when you set the target allocation. Betterment automatically monitors your account for rebalancing opportunities to reduce drift. There are several different methods depending on the circumstances: First, in response to cash flows such as deposits, withdrawals, and dividend reinvestments, Betterment buys underweight holdings and sells overweight holdings. This reactive rebalancing generally occurs when cash flows going into or out of the portfolio are already happening. We use inflows (like deposits and dividend reinvestments) to buy asset classes that are under-weight. This reduces the need to sell, which in turn reduces potential capital gains taxes. And we use outflows (like withdrawals) by seeking to first sell asset classes that are overweight. Second, if cash flows are not sufficient to keep a client’s portfolio drift within its applicable drift tolerance (such parameters as disclosed in Betterment’s Form ADV), automated rebalancing sells overweight holdings in order to buy underweight ones, aligning the portfolio more closely with its target allocation. This proactive rebalancing reshuffles assets that are already in the portfolio, and requires a minimum portfolio balance (clients can review the estimated balance at www.betterment.com/legal/portfolio-minimum). The rebalancing algorithm is also calibrated to avoid frequent small rebalance transactions and to seek tax efficient outcomes, such as helping to reduce wash sales and minimizing short-term capital gains. Allocation change rebalancing occurs when you change your target allocation. This sells securities and could possibly realize capital gains, but we still utilize our tax minimization algorithm to help reduce the tax impact. We’ll let you know the potential tax impact before you confirm your allocation change. Once you confirm it, we’ll rebalance to your new target with minimized drift. When Betterment rebalances a portfolio with a cash allocation, the rebalancing algorithm will first seek to bring the portfolio's cash allocation back to its target before investing in securities. If cash is below its target allocation, rebalancing will first use available funds (e.g., deposits, dividends, and/or proceeds from selling overweight holdings) to increase cash up to target, and only any remaining available cash is invested in securities; conversely, if cash is above its target allocation, the excess cash above target will be invested in securities as a part of the rebalancing transaction. If you are an Advised client, rebalancing in your account may function differently depending on the customizations your Advisor has selected for your portfolio. We recommend reaching out to your Advisor for further details. For more information, please review our rebalancing disclosures. How Betterment reduces risk in portfolios Investments like short-term US treasuries can help reduce risk in portfolios. At a certain point, however, including assets such as these in a portfolio no longer improves returns for the amount of risk taken. For Betterment, this point is our 60% stock portfolio. Portfolios with a stock allocation of 60% or more don’t incorporate these exposures. We include our U.S. Ultra-Short Income ETF and our U.S. Short-Term Treasury Bond ETF in the portfolio at stock allocations below 60% for both the IRA and taxable versions of the Betterment Core portfolio strategy. If your portfolio includes no stocks (meaning you allocated 100% of your portfolio’s investments to bonds), we can take the hint. You likely don’t want to worry about market volatility. So in that case, we recommend that you invest everything in these ETFs. At 0% stocks, a Betterment Core portfolio generally consists of 60% U.S. short-term treasury bonds, 20% U.S. short-term high quality bonds, and 20% inflation protected bonds.* Increase the stock allocation in your portfolio, and we’ll decrease the allocation to these exposures. Reach the 60% stock allocation threshold, and we’ll remove these funds from the recommended portfolio. At that allocation, they decrease expected returns given the desired risk of the overall portfolio. Short-term U.S. treasuries generally have lower volatility (any price swings are quite mild) and smaller drawdowns (shorter, less significant periods of loss). The same can be said for short-term high quality bonds, but they are slightly more volatile. It’s also worth noting that these asset classes don’t always go down at exactly the same time. By combining these asset classes, we’re able to produce a portfolio with a higher potential yield while maintaining relatively lower volatility. As with other assets, the returns for assets such as high quality bonds include both the possibility of price returns and income yield. Generally, price returns are expected to be minimal, with the primary form of returns coming from the income yield. The yields you receive from the ETFs in Betterment’s 0% stocks portfolio are the actual yields of the underlying assets after fees. Since we’re investing directly in funds that are paying prevailing market rates, you can feel confident that the yield you receive is fair and in line with prevailing rates. Work toward your financial goals without risking it all Choosing an investment portfolio is a personal decision, but it doesn’t have to be a difficult one. At Betterment, our goal is to help you feel confident that you’re always taking an appropriate amount of risk. We’ll help you select a portfolio with the risk level that’s right for you, and you can rest assured that our automated services are built to manage it efficiently. *Target investments, actual holdings will vary.
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The hidden cost of holding too much cash
The hidden cost of holding too much cash How to size up your actual cash needs, and find a high-potential home for the rest Key takeaways Cash is great for short-term needs, but inflation steadily eats away at its value over time. Size up those short-term needs like paying the bills and providing a safety net. Then consider investing your excess cash for the long run to make your money work harder. Cash feels safe, but that sense of safety comes at a cost: inflation steadily eats away at the value of your money over time. Take recent history as a harsh example. Since 2021, cash has lost roughly 20% of its purchasing power due to inflation. Parking your money in a high-yield cash account can help ease the blow, but interest rates ebb and flow. Savers may very well find themselves with lower yields in the near future and more cash than suits their needs. So let’s start there: exactly which needs is cash best suited for, and how much do you really need on hand? Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. The average American’s calls for cash Inflation risks aside, cash has the advantage of being highly “liquid,” meaning it’s easy to access at a moment’s notice. This makes it ideal for short-term needs like paying the bills, providing a safety net, and purchasing big-ticket items. Let’s put some hypothetical numbers to these to help quantify the average American’s cash needs. Paying the bills — The average American household, based on the latest available numbers from 2024, spends roughly $6,500 a month. Providing a safety net — Most advisors (including us) recommend an emergency fund with at least three months' worth of expenses ($19,500 using the average monthly spend above). Your spending levels may differ, but for the average American, that calls for about $26,000 in cash, plus any more needed for major purchases. Saving for a home and/or car purchase, for example, will change your calculus. If you're more risk averse, then consider adding a little more buffer. Try a six-month emergency fund. If you’re a freelancer and your income fluctuates a lot, consider nine months. Beyond that, however, you're paying a premium for cash not earmarked for a specific purpose, and the cost is two-fold. Your money, as mentioned earlier, is very likely losing value each day. Not the big swings of the stock market, but a slow yet steady leak. You're missing out on the potential gains of the market. And the historical difference in yields between cash and stocks is stark, to say the least. Global stocks, as represented by the MSCI World Index, have generated nearly a 9% annual return since 1988. Even the highest-yield cash accounts come nowhere near that. So once you've identified your excess cash, where do you go from there? Take a big leap forward on your long-term goals And say hello to investing by way of a lump sum deposit. It can feel like a leap of faith. Like diving into the deep end instead of slowly wading in. And it feels that way for a good reason—all investing comes with risk. But when you have extra cash lying around, historical and simulated market data suggests that investing it all at once outperforms spreading it out, even when accounting for market volatility. Spreading out your deposits over time is called dollar cost averaging, and it’s generally a good fit for investing your regular cash flow, not lump sums you already have on hand. But savvy savers can employ both strategies—they dollar cost average their income as it comes in, and they invest excess dollars or cash windfalls in lump sums. Because in the end, both serve the same goal of building long-term wealth. -
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Three ways to put your bonus to work
Three ways to put your bonus to work Here's how to work with your urge to splurge, while still moving your money goals forward. Key takeaways Bonuses can help you take a big leap forward with your money goals. But if a spending spree sounds tempting, consider splitting your bonus 50/50 between “present-day” you and “future” you. Saving your bonus via a 401(k) and/or IRA can unlock special tax advantages. Stashing it in a high-yield cash account can help build your emergency fund or save for a near-term goal. Year-end bonuses are a blessing. And while there’s no guarantee you’ll get one—just ask Clark Griswold—if you do, they can have the power to supercharge your savings goals. So while you wait for that bonus cash, read up on three ways to handle small cash windfalls such as these. Go 50/50: Treat yourself now and save for the future Let’s address the elephant in the room: A lot of us spend the bulk of our bonuses. But there’s a psychological workaround to this temptation: Think of yourself as two people. There’s “present-day” you, flush with cash and eyeing a few items on your wish list. Then there’s “future” you and all of their dreams for major purchases or financial freedom. Since both of you can rightly lay claim to your bonus, the only fair thing to do is split it 50-50. So go ahead: Splurge guilt-free with one half of your bonus, and save the other half. Tax-savvy saving: Use your bonus to get a tax break A lot of companies withhold taxes on bonuses at the IRS-recommended rate of 22%. Less commonly, some companies lump it in with your regular paycheck, and your regular withholding rate applies. Either way, and contrary to popular belief, bonuses aren’t taxed at a higher rate. But seeing your bonus shrink due to any amount of taxes is still rough. Thankfully, you may able to minimize your tax hit with the help of a tax-advantaged retirement account: Boost your 401(k) contributions. In some cases, companies allow employees to make 401(k) contributions with their bonuses. If that’s the case for you, consider funneling “future” you’s half of your bonus into your traditional or Roth 401(k), up to the IRS limits. Traditional for a tax break now, Roth for a tax break later. Max out your IRA. Depending on how much income you make, you may be eligible to take advantage of the tax perks of a traditional or Roth IRA. Better yet, you have until Tax Day of 2026 to max out your 2025 IRA! Stash the cash: Start earning interest today Tax breaks aren’t the end-all, be-all, of course. In some scenarios, saving your bonus in a high-yield cash account like our Cash Reserve account might take priority. If you lack an emergency fund, for example, or if you’re planning for a major purchase in the near future. Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. However you save or invest your bonus, rest easy knowing you’re striking a good balance between today and tomorrow. Unless your bonus came in the form of jelly, in which case you’re on your own, Clark. -
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Three steps to size up your emergency fund
Three steps to size up your emergency fund Strive for at least three months of expenses while taking these factors into consideration. Imagine losing your job, totaling your car, or landing in the hospital. How quickly would your mind turn from the shock of the event itself to worrying about paying your bills? If you’re anything like the majority of Americans recently surveyed by Bankrate, finances would add insult to injury pretty fast: Only around 2 in 5 Americans would pay for an emergency from their savings In these scenarios, an emergency fund can not only help you avoid taking on high-interest debt or backtracking on other money goals, it can give you one less thing to worry about in trying times. So how much should you have saved, and where should you put it? Follow these three steps. 1. Tally up your monthly living expenses — or use our shortcut. Coming up with this number isn’t always easy. You may have dozens of regular expenses falling into one of a few big buckets: Food Housing Transportation Medical When you create an Emergency Fund goal at Betterment, we automatically estimate your monthly expenses based on two factors from your financial profile: Your self-reported household annual income Your zip code’s estimated cost of living You’re more than welcome to use your own dollar figure, but don’t let math get in the way of getting started. 2. Decide how many months make sense for you We recommend having at least three months’ worth of expenses in your emergency fund. A few scenarios that might warrant saving more include: You support others with your income Your job security is iffy You don’t have steady income You have a serious medical condition But it really comes down to how much will help you sleep soundly at night. According to Bankrate’s survey, nearly ⅔ of people say that total is six months or more. Whatever amount you land on, we’ll suggest a monthly recurring deposit to help you get there. We’ll also project a four-year balance based on your initial and scheduled deposits and your expected return and volatility. Why four years? We believe that’s a realistic timeframe to save at least three months of living expenses through recurring deposits. If you can get there quicker and move on to other money goals, even better! 3. Pick a place to keep your emergency fund We recommend keeping your emergency fund in one of two places: cash—more specifically a low-risk, high-yield cash account—or a bond-heavy investing account. A low-risk, high-yield cash account like our Cash Reserve may not always keep pace with inflation, but it comes with no investment risk. Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. An investing account is better suited to keep up with inflation but is relatively riskier. Because of this volatility, we currently suggest adding a 30% buffer to your emergency fund’s target amount if you stick with the default stock/bond allocation. There also may be tax implications should you withdraw funds. Your decision will again come down to your comfort level with risk. If the thought of seeing your emergency fund’s value dip, even for a second, gives you heartburn, you might consider sticking with a cash account. Or you can always hedge and split your emergency fund between the two. There’s no wrong answer here! Remember to go with the (cash) flow There’s no final answer here either. Emergency funds naturally ebb and flow over the years. Your monthly expenses could go up or down. You might have to withdraw (and later replace) funds. Or you simply might realize you need a little more saved to feel secure. Revisit your numbers on occasion—say, once a year or anytime you get a raise or big new expense like a house or baby—and rest easy knowing you’re tackling one of the most important financial goals out there.
Investing
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Betterment's Socially Responsible Investing portfolios methodology
Betterment's Socially Responsible Investing portfolios methodology Learn how we construct 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 empowerment) 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. Betterment's SRI portfolios also target a small operational cash allocation in taxable accounts, health savings accounts, and individual retirement accounts (IRAs). 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 Social Equity Mandate ETFs managed with the aim of obtaining exposures in investments that seek to advance vulnerable, disadvantaged, or underserved social groups. The Gender Equity Mandate also contributes to fulfilling this broader mandate. 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 diversity and veteran impact 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. 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, US High Quality bonds, and US Mortgage-Backed Securities. 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 more than 47% lower than Betterment’s 100% stock Core portfolio as of March 12, 2025*. *Target investments, actual holdings will vary. 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, social equity, and shareholder engagement. The Social Impact portfolio was designed to give investors exposure to investments which promote social empowerment 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 empowerment with sufficient liquidity relative to their size in the portfolio. How does the Social Impact portfolio help promote social empowerment? 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 the following ETFs: SPDR SSGA Gender Diversity Index ETF (SHE) Academy Veteran Impact ETF(VETZ) Goldman Sachs JUST U.S. Large Cap Equity ETF (JUST) 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. VETZ, the Academy Veteran Impact ETF, is a US Bond ETF and is the first publicly traded ETF to primarily invest in loans to U.S. service members, military veterans, their survivors, and veteran-owned businesses. A majority of the underlying assets consist of loans to veterans or their families. The fund primarily invests in Mortgage-Backed Securities that are guaranteed by government-sponsored enterprises, such as Ginnie Mae, Fannie Mae, and Freddie Mac. The fund also invests in pools of small business loans backed by the Small Business Administration (SBA). JUST, Goldman Sachs JUST U.S. Large Cap Equity ETF, invests in U.S. companies promoting positive change on key social issues, such as worker wellbeing, customer privacy, environmental impact, and community strength, based on the values of the American public as identified by JUST Capital’s polling. Investment in socially responsible ETFs varies by portfolio allocation; not all allocations include the specific ETFs listed above. 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 to 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 March 31, 2025 indicate that SRI income returns at certain risk levels have been lower than those of the 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 March 31, 2025. 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 March 2025. 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 the investing landscape continues to evolve. -
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Betterment's tax-loss harvesting methodology
Betterment's tax-loss harvesting methodology Tx-loss harvesting is a sophisticated technique to get more value from your investments—but doing it well requires expertise. TABLE OF CONTENTS Navigating the “Wash Sale” rule The Betterment solution Tx-loss harvesting model calibration Best practices for TLH How we calculate the value of tax-loss harvesting Your personalized Estimated Tax Savings tool Conclusion There are many ways to get your investments to work harder for you— diversification, downside risk management, and an appropriate mix of asset classes tailored to your recommended allocation. Betterment does this automatically via its ETF portfolios. But there is another way to help you get more out of your portfolio—using investment losses to improve your after-tax returns with a method called tax-loss harvesting. In this article, we introduce Betterment’s tax-loss harvesting (TLH): a sophisticated, fully automated tool that Betterment customers can choose to enable. Betterment’s tax-loss harvesting service scans portfolios regularly for opportunities (temporary dips that result from market volatility) for opportunities to realize losses which can be valuable come tax time. While the concept of tax-loss harvesting is not new for wealthy investors, tax-loss harvesting utilizes a number of innovations that typical implementations may lack. It takes a holistic approach to tax-efficiency, seeking to optimize user-initiated transactions in addition to adding value through automated activity, such as rebalances. What is tax-loss harvesting? Capital losses can lower your tax bill by offsetting gains, but the only way to realize a loss is to sell the depreciated asset. However, in a well-allocated portfolio, each asset plays an essential role in providing a piece of total market exposure. For that reason, an investor should not want to give up potential expected returns associated with each asset just to realize a loss. At its most basic level, tax-loss harvesting is selling a security that has experienced a loss—and then buying a correlated asset (i.e. one that provides similar exposure) to replace it. The strategy has two benefits: it allows the investor to “harvest” a valuable loss, and it keeps the portfolio balanced at the desired allocation. How can it lower your tax bill? Capital losses can be used to offset capital gains you’ve realized in other transactions over the course of a year—gains on which you would otherwise owe tax. Then, if there are losses left over (or if there were no gains to offset), you can offset up to $3,000 of ordinary income for the year. If any losses still remain, they can be carried forward indefinitely. Tx-loss harvesting is primarily a tax deferral strategy, and its benefit depends entirely on individual circumstances. Over the long run, it can add value through some combination of these distinct benefits that it seeks to provide: Tax deferral: Losses harvested can be used to offset unavoidable gains in the portfolio, or capital gains elsewhere (e.g., from selling real estate), deferring the tax owed. Savings that are invested may grow, assuming a conservative growth rate of 5% over a 10-year period, a dollar of tax deferred would be worth $1.63. Even after belatedly parting with the dollar, and paying tax on the $0.63 of growth, you’re ahead. Pushing capital gains into a lower tax rate: If you’ve realized short-term capital gains (STCG) this year, they’ll generally be taxed at your highest rate. However, if you’ve harvested losses to offset them, the corresponding gain you owe in the future could be long-term capital gain (LTCG). You’ve effectively turned a gain that would have been taxed up to 50% today into a gain that will be taxed more lightly in the future (up to 30%). Converting ordinary income into long-term capital gains: A variation on the above: offsetting up to $3,000 from your ordinary income shields that amount from your top marginal rate, but the offsetting future gain will likely be taxed at the LTCG rate. Permanent tax avoidance in certain circumstances: Tax-loss harvesting provides benefits now in exchange for increasing built-in gains, subject to tax later. However, under certain circumstances (charitable donation, bequest to heirs), these gains may avoid taxation entirely. Navigating the "Wash Sale" rule Summary: Wash sale rule management is at the core of any tax-loss harvesting strategy. Unsophisticated approaches can detract from the value of the harvest or place constraints on customer cash flows in order to function. At a high level, the so-called "Wash Sale” rule disallows a loss from selling a security if a “substantially identical” security is purchased 30 days after or before the sale. The rationale is that a taxpayer should not enjoy the benefit of deducting a loss if they did not truly dispose of the security. The wash sale rule applies not just to situations when a “substantially identical” purchase is made in the same account, but also when the purchase is made in the individual’s IRA/401(k) account, or even in a spouse’s account. This broad application of the wash sale rule seeks to ensure that investors cannot utilize nominally different accounts to maintain their ownership, and still benefit from the loss. A wash sale involving an IRA/401(k) account is particularly unfavorable. Generally, a “washed” loss is postponed until the replacement is sold, but if the replacement is purchased in an IRA/401(k) account, the loss is permanently disallowed. If not managed correctly, wash sales can undermine tax-loss harvesting. Handling proceeds from the harvest is not the sole concern—any deposits made in the following 30 days (whether into the same account, or into the individual’s IRA/401(k)) also need to be allocated with care. Minimizing the wash The simplest way to avoid triggering a wash sale is to avoid purchasing any security at all for the 30 days following the harvest, keeping the proceeds (and any inflows during that period) in cash. This approach, however, would systematically keep a portion of the portfolio out of the market. More advanced strategies primarily repurchase an asset with similar exposure to the harvested security that is not “substantially identical” for purposes of the wash sale rule. In the case of an individual stock, it is clear that repurchasing stock of that same company would violate the rule. Less clear is the treatment of two index funds from different issuers (e.g., Vanguard and Schwab) that track the same index. While the IRS has not issued any guidance to suggest that such two funds are “substantially identical,” a more conservative approach when dealing with an index fund portfolio would be to repurchase a fund whose performance correlates closely with that of the harvested fund, but tracks a different index. Tx-loss harvesting is generally designed around this index-based logic and generally seeks to reduce wash sales, although it cannot avoid potential wash sales arising from transactions in tickers that track the same index where one of the tickers is not currently a primary, secondary, or tertiary ticker (as those terms are defined in this white paper). This situation could arise, for example, when other tickers are transferred to Betterment or where they were previously a primary, secondary, or tertiary ticker. Additionally, for some portfolios constructed by third parties (e.g., Vanguard, Blackrock, or Goldman Sachs), certain secondary and tertiary tickers track the same index. Certain asset classes (including those in certain Betterment-constructed portfolios and portfolios constructed by third parties, such as Vanguard, Blackrock, or Goldman Sachs) do not have tertiary tickers, such that permanently disallowed losses could occur if there were overlapping holdings in taxable and tax-advantaged accounts. Betterment’s TLH feature may also permit wash sales where the anticipated tax benefit of the overall harvest transaction sufficiently outweighs the impact of expected washed losses. Selecting a viable replacement security is just one piece of the accounting and optimization puzzle. Manually implementing a tax-loss harvesting strategy is feasible with a handful of securities, little to no cash flows, and infrequent harvests. Assets may however dip in value but potentially recover by the end of the year, therefore annual strategies or infrequent harvests may leave many losses on the table. The wash sale management and tax lot accounting necessary to support more frequent harvesting quickly becomes overwhelming in a multi-asset portfolio—especially with regular deposits, dividends, and rebalancing. In short, an effective loss harvesting algorithm should be able to maximize harvesting opportunities across a full range of volatility scenarios, without sacrificing the investor’s global asset allocation. Existing strategies and their limitations Every tax-loss harvesting strategy shares the same basic goal: to maximize a portfolio’s after-tax returns by realizing built-in losses while minimizing the negative impact of wash sales. Approaches to tax-loss harvesting differ primarily in how they handle the proceeds of the harvest to avoid a wash sale. Below are the three strategies commonly employed by manual and algorithmic implementations. After selling a security that has experienced a loss, existing strategies would likely have you: Existing strategy Problem Delay reinvesting the proceeds of a harvest for 30 days, thereby ensuring that the repurchase will not trigger a wash sale. While it’s the easiest method to implement, it has a major drawback: no market exposure. This hurts portfolio returns over the long term, and could offset any potential benefit from tax-loss harvesting. Reallocate the cash entirely into one or more different asset classes in the portfolio. This method throws off an investor’s desired asset allocation. Additionally, such purchases may block other harvests over the next 30 days by setting up potential wash sales in those other asset classes. Switch back to original security after 30 days from the replacement security. Common manual approach, also used by some automated investing services. A switchback can trigger short-term capital gains when selling the replacement security, reducing the tax benefit of the harvest. Even worse, this strategy can leave an investor owing more tax than if it did nothing. The hazards of switchbacks In the 30 days leading up to the switchback, two things can happen: the replacement security can drop further, or go up. If it goes down, the switchback will realize an additional loss. However, if it goes up, which is what any asset with a positive expected return is expected to do over any given period, the switchback will realize short-term capital gains (STCG)—kryptonite to a tax-efficient portfolio management strategy. An attempt to mitigate this risk could be setting a higher threshold based on volatility of the asset class—only harvesting when the loss is so deep that the asset is unlikely to entirely recover in 30 days. Of course, there is still no guarantee that it will not, and the price paid for this buffer is that your lower-yielding harvests will also be less frequent than they could be with a more sophisticated strategy. Examples of negative tax arbitrage Negative tax arbitrage with automatic 30-day switchback An automatic 30-day switchback can destroy the value of the harvested loss, and even increase tax owed, rather than reduce it. A substantial dip presents an excellent opportunity to sell an entire position and harvest a long-term loss. Proceeds will then be re-invested in a highly correlated replacement (tracking a different index). 30 days after the sale, the dip proved temporary and the asset class more than recovered. The switchback sale results in STCG in excess of the loss that was harvested, and actually leaves the investor owing tax, whereas without the harvest, they would have owed nothing. Due to a technical nuance in the way gains and losses are netted, the 30- day switchback can result in negative tax arbitrage, by effectively pushing existing gains into a higher tax rate. When adding up gains and losses for the year, the rules require netting of like against like first. If any long-term capital gain (LTCG) is present for the year, you must net a long-term capital loss (LTCL) against that first, and only then against any STCG. Negative tax arbitrage when unrelated long-term gains are present Now let’s assume the taxpayer realized a LTCG. If no harvest takes place, the investor will owe tax on the gain at the lower LTCG rate. However, if you add the LTCL harvest and STCG switchback trades, the rules now require that the harvested LTCL is applied first against the unrelated LTCG. The harvested LTCL gets used up entirely, exposing the entire STCG from the switchback as taxable. Instead of sheltering the highly taxed gain on the switchback, the harvested loss got used up sheltering a lower-taxed gain, creating far greater tax liability than if no harvest had taken place. In the presence of unrelated transactions, unsophisticated harvesting can effectively convert existing LTCG into STCG. Some investors regularly generate significant LTCG (for instance, by gradually diversifying out of a highly appreciated position in a single stock). It’s these investors, in fact, who would benefit the most from effective tax-loss harvesting. Negative tax arbitrage with dividends Negative tax arbitrage can result in connection with dividend payments. If certain conditions are met, some ETF distributions are treated as “qualified dividends”, taxed at lower rates. One condition is holding the security for more than 60 days. If the dividend is paid while the position is in the replacement security, it will not get this favorable treatment: under a rigid 30-day switchback, the condition can never be met. The Betterment solution Summary: Betterment’s tax-loss harvesting approaches tax-efficiency holistically, seeking to optimize transactions, including customer activity. The benefits tax-loss harvesting seeks to deliver, include: No exposure to short-term capital gains in an attempt to harvest losses. Through our proprietary Parallel Position Management (PPM) system, a dual-security asset class approach enforces preference for one security without needlessly triggering capital gains in an attempt to harvest losses, all without putting constraints on customer cash flows. No negative tax arbitrage traps associated with less sophisticated harvesting strategies (e.g., 30-day switchback), making tax-loss harvesting especially suited for those generating large long-term capital gains on an ongoing basis. Tax loss preservation logic extended to user-realized losses, not just harvested losses, automatically protecting both from the wash sale rule. In short, user withdrawals always sell any losses first. Minimize disallowed losses through overlap with a Betterment IRA/401(k). We generally use a tertiary ticker system to eliminate the possibility of permanently disallowed losses triggered by subsequent IRA/401(k) activity. This makes TLH ideal for those who invest in both taxable and tax-advantaged accounts. Harvests also take the opportunity to rebalance across all asset classes, rather than re-invest solely within the same asset class. This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and higher tax alpha. Through these innovations, tax-loss harvesting creates significant value over manually-serviced or less sophisticated algorithmic implementations. Tax-loss harvesting is accessible to investors —fully automated, effective, and at no additional cost. Parallel securities To ensure that each asset class is supported by optimal securities in both primary and alternate (secondary) positions, we screened by expense ratio, liquidity (bid-ask spread), tracking error vs. benchmark, and most importantly, covariance of the alternate with the primary.1 While there are small cost differences between the primary and alternate securities, the cost of negative tax arbitrage from tax-agnostic switching vastly outweighs the cost of maintaining a dual position within an asset class. Tax-loss harvesting features a special mechanism for coordination with IRAs/401(k)s where we pick a third (tertiary) security in each harvestable asset class where possible. While these have a higher cost than the primary and alternate, they are not expected to be utilized often, and even then, for short durations (more below in IRA/401(k) protection). However, if no suitable tertiary exists beyond the secondary used in the taxable version of the portfolio strategy, certain security groups in Betterment-constructed portfolios will not have tertiary tickers assigned in the tax-advantaged strategy. While Betterment generally constructs portfolios to minimize this risk, clients should be aware that in this scenario, rebalancing can result in wash sales, and that if the replacement purchase occurs in an IRA account, the loss is permanently disallowed. Parallel position management As demonstrated, the unconditional 30-day switchback to the primary security is problematic for a number of reasons. To fix those problems, we engineered a platform to support tax-loss harvesting, which seeks to tax-optimize user and system-initiated transactions: the Parallel Position Management (PPM) system. PPM allows each asset class to contain a primary security to represent the desired exposure while maintaining alternate and tertiary securities that are closely correlated securities, should that result in a better after-tax outcome. PPM provides several improvements over the switchback strategy. First, unnecessary gains are minimized. Second, the parallel security (could be primary or alternate) serves as a safe harbor to reduce potential wash sales—not just from harvest proceeds, but any cash inflows. Third, the mechanism seeks to protect not just harvested losses, but losses realized by the customer as well. PPM not only facilitates effective opportunities for tax-loss harvesting, but also extends maximum tax-efficiency to customer-initiated transactions. Every customer withdrawal is a potential harvest (losses are sold first). Deposits and dividends are used to rebalance your portfolio. When available cash is reinvested, it is generally routed to the parallel position that would reduce wash sales, while working toward the target allocation. PPM has a preference for the primary security when rebalancing and for all cash flow events—but always subject to tax considerations. This is how PPM behaves under various conditions: Transaction PPM behavior Withdrawals and sales from rebalancing Sales default out of the alternate position (if such a position exists), but not at the expense of triggering STCG—in that case, PPM will sell lots of the primary security first. Rebalancing will attempt to stop short of realizing STCG. Taxable gains are minimized at every decision point—STCG tax lots are the last to be sold on a user withdrawal. Deposits, buys from rebalancing, and dividend reinvestments PPM directs inflows to underweight asset classes, and within each asset class, into the primary, unless doing so incurs greater wash sale costs than buying the alternate. Harvest events TLH harvests can come out of the primary into the alternate, or vice versa, depending on which harvest has a greater expected value. After an initial harvest, it could make sense at some point to harvest back into the primary, to harvest more of the remaining primary into the alternate, or to do nothing. Wash sale management Managing cash flows across both taxable and IRA/401(k) accounts without washing realized losses is a complex problem. Tx-loss harvesting operates without constraining the way that customers prefer contributing to their portfolios. With the benefit of parallel positions, Betterment weighs wash sale implications of deposits, withdrawals and dividend reinvestment. This system protects not just harvested losses, but also losses realized through withdrawals. Minimizing wash sale through tertiary tickers in IRA/401(k) Because IRA/401(k) wash sales are particularly unfavorable—the loss is disallowed permanently—tax-loss harvesting uses a tertiary ticker system to seek to prevent losses realized in the taxable account from being washed by subsequent deposits into an IRA/401(K) where possible. Let’s look at an example of how tax-loss harvesting handles a potentially disruptive IRA inflow with a tertiary ticker when there are realized losses to protect, using real market data for a Developed Markets asset class. The customer starts with a position in VEA, the primary security, in both the taxable and IRA accounts. We harvest a loss by selling the entire taxable position, and then repurchasing the alternate security, SCHF. Loss harvested in VEA Two weeks pass, and the customer makes a withdrawal from the taxable account (the entire SCHF position, for simplicity), intending to fund the IRA. In those two weeks, the asset class dropped more, so the sale of SCHF also realized a loss. The VEA position in the IRA remains unchanged. Customer withdrawal sells SCHF at a loss A few days later, the customer contributes to his IRA, and $1,000 is allocated to the Developed Markets asset class, which already contains some VEA. Despite the fact that the customer no longer holds any VEA or SCHF in his taxable account, buying either one in the IRA would permanently wash a valuable realized loss. The Tertiary Ticker System automatically allocates the inflow into the third option for developed markets, IEFA. IRA deposit into tertiary Ticker Both losses have been preserved, and the customer now holds VEA and IEFA in his IRA, maintaining desired allocation at all times. Because no capital gains are realized in an IRA/401(k), there is no harm in switching out of the IEFA position and consolidating the entire asset class in VEA when there is no danger of a wash sale. The result: Customers using TLH who also have their IRA/401(k) assets with Betterment can know that Betterment will seek to protect valuable realized losses whenever they deposit into their IRA/401(k), whether it’s lump rollover, auto-deposits or even dividend reinvestments. Smart rebalancing Lastly, tax-loss harvesting directs the proceeds of every harvest to rebalance the entire portfolio, the same way that a Betterment account handles any incoming cash flow (deposit, dividend). For portfolios with a cash allocation, if cash is below its target allocation at the time of the TLH transaction, proceeds will first be applied to increase cash up to target, and only any remaining available cash is invested in securities; if cash is above its target, the excess cash above target will be invested in securities along with the harvest proceeds as part of the TLH transaction. Recognizing every harvest as a rebalancing opportunity further reduces the need for additional selling in times of volatility, further reducing tax liability. As always, fractional shares allow the inflows to be allocated with precision. Tx-loss harvesting model calibration Summary: To make harvesting decisions, tax-loss harvesting optimizes around multiple inputs, derived from rigorous Monte Carlo simulations. The decision to harvest is made when the benefit, net of cost, exceeds a certain threshold. The potential benefit of a harvest is discussed in detail below (“Results”). Unlike a 30-day switchback strategy, tax-loss harvesting does not incur the expected STCG cost of the switchback trade. Therefore, “cost” consists of three components: trading expense, execution expense, and increased cost of ownership for the replacement asset (if any). Trading costs are included in the wrap fee paid by Betterment customers. Tax-loss harvesting is engineered to factor in the other two components, configurable at the asset level, and the resulting cost approaches negligible. Bid-ask spreads for the bulk of harvestable assets are narrow. We seek funds with expense ratios for the major primary/alternate ETF pairs that are close, and in the case where a harvest back to the primary ticker is being evaluated, that difference is actually a benefit, not a cost. There are two general approaches to testing a model’s performance: historical backtesting and forward-looking simulation. Optimizing a system to deliver the best results for only past historical periods is relatively trivial, but doing so would be a classic instance of data snooping bias. Relying solely on a historical backtest of a portfolio composed of ETFs that allow for 10 to 20 years of reliable data when designing a system intended to provide 40 to 50 years of benefit would mean making a number of indefensible assumptions about general market behavior. The superset of decision variables driving tax-loss harvesting is beyond the scope of this paper—optimizing around these variables required exhaustive analysis. Tax-loss harvesting was calibrated via Betterment’s rigorous Monte Carlo simulation framework, spinning up thousands of server instances in the cloud to run through tens of thousands of forward-looking scenarios testing model performance. We have calibrated tax-loss harvesting in a way that we believe optimizes its effectiveness given expected future returns and volatility, but other optimizations could result in more frequent harvests or better results depending on actual market conditions. Best practices for tax-loss harvesting Summary: Tax-loss harvesting can add some value for most investors, but high earners with a combination of long time horizons, ongoing realized gains, and plans for some charitable disposition will reap the largest benefits. This is a good point to reiterate that tax-loss harvesting delivers value primarily due to tax deferral, not tax avoidance. A harvested loss can be beneficial in the current tax year to varying degrees, but harvesting that loss generally means creating an offsetting gain at some point in the future. If and when the portfolio is liquidated, the gain realized will be higher than if the harvest never took place. Let’s look at an example: Year 1: Buy asset A for $100. Year 2: Asset A drops to $90. Harvest $10 loss, repurchase similar Asset B for $90. Year 20: Asset B is worth $500 and is liquidated. Gains of $410 realized (sale price minus cost basis of $90) Had the harvest never happened, we’d be selling A with a basis of $100, and gains realized would only be $400 (assuming similar performance from the two correlated assets.) Harvesting the $10 loss allows us to offset some unrelated $10 gain today, but at a price of an offsetting $10 gain at some point in the future. The value of a harvest largely depends on two things. First, what income, if any, is available for offset? Second, how much time will elapse before the portfolio is liquidated? As the deferral period grows, so does the benefit—the reinvested savings from the tax deferral have more time to grow. While nothing herein should be interpreted as tax advice, examining some sample investor profiles is a good way to appreciate the nature of the benefit of tax-loss harvesting. Who benefits most? The Bottomless Gains Investor: A capital loss is only as valuable as the tax saved on the gain it offsets. Some investors may incur substantial capital gains every year from selling highly appreciated assets—other securities, or perhaps real estate. These investors can immediately use all the harvested losses, offsetting gains and generating substantial tax savings. The High Income Earner: Harvesting can have real benefits even in the absence of gains. Each year, up to $3,000 of capital losses can be deducted from ordinary income. Earners in high income tax states (such as New York or California) could be subject to a combined marginal tax bracket of up to 50%. Taking the full deduction, these investors could save $1,500 on their tax bill that year. What’s more, this deduction could benefit from positive rate arbitrage. The offsetting gain is likely to be LTCG, taxed at around 30% for the high earner—less than $1,000—a real tax savings of over $500, on top of any deferral value. The Steady Saver: An initial investment may present some harvesting opportunities in the first few years, but over the long term, it’s increasingly unlikely that the value of an asset drops below the initial purchase price, even in down years. Regular deposits create multiple price points, which may create more harvesting opportunities over time. (This is not a rationale for keeping money out of the market and dripping it in over time—tax-loss harvesting is an optimization around returns, not a substitute for market exposure.) The Philanthropist: In each scenario above, any benefit is amplified by the length of the deferral period before the offsetting gains are eventually realized. However, if the appreciated securities are donated to charity or passed down to heirs, the tax can be avoided entirely. When coupled with this outcome, the scenarios above deliver the maximum benefit of TLH. Wealthy investors have long used the dual strategy of loss harvesting and charitable giving. Even if an investor expects to mostly liquidate, any gifting will unlock some of this benefit. Using losses today, in exchange for built-in gains, offers the partial philanthropist a number of tax-efficient options later in life. Who benefits least? The Aspiring Tax Bracket Climber: Tax deferral is undesirable if your future tax bracket will be higher than your current. If you expect to achieve (or return to) substantially higher income in the future, tax-loss harvesting may be exactly the wrong strategy—it may, in fact, make sense to harvest gains, not losses. In particular, we do not advise you to use tax-loss harvesting if you can currently realize capital gains at a 0% tax rate. Graduate students, those taking parental leave, or just starting out in their careers should ask “What tax rate am I offsetting today” versus “What rate can I reasonably expect to pay in the future?” The Scattered Portfolio: Tax-loss harvesting is carefully calibrated to manage wash sales across all assets managed by Betterment, including IRA assets. However, the algorithms cannot take into account information that is not available. To the extent that a Betterment customer’s holdings (or a spouse’s holdings) in another account overlap with the Betterment portfolio, there can be no guarantee that tax-loss harvesting activity will not conflict with sales and purchases in those other accounts (including dividend reinvestments), and result in unforeseen wash sales that reverse some or all of the benefits of tax-loss harvesting. We do not recommend tax-loss harvesting to a customer who holds (or whose spouse holds) any of the ETFs in the Betterment portfolio in non-Betterment accounts. You can ask Betterment to coordinate tax-loss harvesting with your spouse’s account at Betterment. You’ll be asked for your spouse’s account information after you enable tax-loss harvesting so that we can help optimize your investments across your accounts. The Portfolio Strategy Collector: Electing different portfolio strategies for multiple Betterment goals may cause tax-loss harvesting to identify fewer opportunities to harvest losses than it might if you elect the same portfolio strategy for all of your Betterment goals. The Rapid Liquidator: What happens if all of the additional gains due to harvesting are realized over the course of a single year? In a full liquidation of a long-standing portfolio, the additional gains due to harvesting could push the taxpayer into a higher LTCG bracket, potentially reversing the benefit of tax-loss harvesting. For those who expect to draw down with more flexibility, smart automation will be there to help optimize the tax consequences. The Imminent Withdrawal: The harvesting of tax losses resets the one-year holding period that is used to distinguish between LTCG and STCG. For most investors, this isn’t an issue: by the time that they sell the impacted investments, the one-year holding period has elapsed and they pay taxes at the lower LTCG rate. This is particularly true for Betterment customers because our TaxMin feature automatically realizes LTCG ahead of STCG in response to a withdrawal request. However, if you are planning to withdraw a large portion of your taxable assets in the next 12 months, you should wait to turn on tax-loss harvesting until after the withdrawal is complete to reduce the possibility of realizing STCG. Other impacts to consider Investors with assets held in different portfolio strategies should understand how it impacts the operation of tax-loss harvesting. To learn more, please see the respective disclosures for the following Betterment and third-party portfolios: Socially Responsible Investing, Flexible portfolio, Innovative Technology, Value Tilt, Crypto ETF, Goldman Sachs Tax-Smart Bonds, Goldman Sachs Smart Beta, Target Income built with BlackRock, as well as the disclosure Betterment Advisor Solutions Model Marketplace. Clients in Advisor-designed custom portfolios through Betterment for Advisors should consult their Advisors to understand the limitations of tax-loss harvesting with respect to any custom portfolio. Additionally, as described above, electing one portfolio strategy for one or more goals in your account while simultaneously electing a different portfolio for other goals in your account may reduce opportunities for TLH to harvest losses, as TLH is calibrated to seek to reduce wash sales. Due to Betterment’s monthly cadence for billing fees for advisory services, through the liquidation of securities, tax-loss harvesting opportunities may be adversely affected for customers with particularly high stock allocations, third party portfolios, or flexible portfolios. As a result of assessing fees on a monthly cadence for a customer with only equity security exposure, which tends to be more opportunistic for tax-loss harvesting, certain securities may be sold that could have been used to tax loss harvest at a later date, thereby delaying the harvesting opportunity into the future. This delay would be due to the TLH tool’s effort to reduce instances of triggering the wash sale rule, which forbids a security from being sold only to be replaced with a “substantially similar” security within a 30-day period. Factors which will determine the actual benefit of tax-loss harvesting include, but are not limited to, market performance, the size of the portfolio, the stock exposure of the portfolio, the frequency and size of deposits into the portfolio, the availability of capital gains and income which can be offset by losses harvested, the tax rates applicable to the investor in a given tax year and in future years, the extent to which relevant assets in the portfolio are donated to charity or bequeathed to heirs, and the time elapsed before liquidation of any assets that are not disposed of in this manner. All of Betterment’s trading decisions are discretionary and Betterment may decide to limit or postpone TLH trading on any given day or on consecutive days, either with respect to a single account or across multiple accounts. tax-loss harvesting is not suitable for all investors. Nothing herein should be interpreted as tax advice, and Betterment does not represent in any manner that the tax consequences described herein will be obtained, or that any Betterment product will result in any particular tax consequence. Please consult your personal tax advisor as to whether TLH is a suitable strategy for you, given your particular circumstances. The tax consequences of tax-loss harvesting are complex and uncertain and may be challenged by the IRS. You and your tax advisor are responsible for how transactions conducted in your account are reported to the IRS on your personal tax return. Betterment assumes no responsibility for the tax consequences to any client of any transaction. See Betterment’s tax-loss harvesting disclosures for further detail. How we calculate the value of tax-loss harvesting Over 2022 and 2023, we calculated that 69% of Betterment customers who employed the strategy saw potential savings in excess of the Betterment fees charged on their taxable accounts for the year. To reach this conclusion, we first identified the accounts to consider, defined as taxable investing accounts that had a positive balance and tax-loss harvesting turned on throughout 2022 and 2023. We excluded trust accounts because their tax treatments can be highly-specific and they made up less than 1% of the data. For each account’s taxpayer, we pulled the short and long term capital gain/loss in the relevant accounts realized in 2022 and 2023 using our trading and tax records. We then divided the gain/loss into those caused by a TLH transaction and those not caused by a TLH transaction. Then, for each tax year, we calculated the short-term gains offset by taking the greater of the short-term loss realized by tax-loss harvesting and the short-term gain caused by other transactions. We did the same for long-term gain/loss. If there were any losses leftover, we calculated the amount of ordinary income that could be offset by taking the greater of the customer’s reported income and $3,000 ($1,500 if the customer is married filing separately) and then taking the greater of that number and the sum of the remaining long-term and short-term losses (after first subtracting any non-tax-loss harvesting losses from ordinary income). If there were any losses leftover in 2022 after all that, we carried those losses forward to 2023. At this point, we had for each customer the amount of short-term gains, long-term gains and ordinary income offset by tax-loss harvesting for each tax year. We then calculated the short-term and long-term capital gains rates using the federal tax brackets for 2022 and 2023 and the reported income of the taxpayer, their reported tax filing status, and their reported number of dependents. We assumed the standard deduction and conservatively did not include state capital gains taxes because some states do not have capital gains tax. We calculated the ordinary income rate including federal taxes, state taxes, and Medicare and Social Security taxes using the user’s reported income, filing status, number of dependents, assumed standard deduction, and age (assuming Medicare and Social Security taxes cease at the retirement age of 67). We then applied these tax rates respectively to the offsets to get the tax bill reduction from each type of offset and summed them up to get the total tax reduction. Then, we pulled the total fees charged to the users on the account in question that were accrued in 2022 and 2023 from our fee accrual records and compared that to the tax bill reduction. If the tax bill reduction was greater than the fees, we considered tax-loss harvesting to have indirectly paid for the fees in the account in question for the taxpayer in question. This was the case for 69% of customers. Your personalized Estimated Tax Savings tool Overview: Betterment’s TLH Estimated Tax Savings Tool is found in your online account and designed to quantify the tax-saving potential of our tax-loss harvesting (TLH) feature. By leveraging both transactional data from Betterment accounts and your self-reported demographic and financial profile information, the tool generates dynamic estimates of realized and potential tax savings. These calculations provide both current-year and cumulative ("all-time") tax savings estimates. Client-centric tax modeling: To personalize estimates, the tool takes into account client financial profile information: your self-reported annual pre-tax income, state of residence, tax filing status (e.g. individual, married filing jointly), and number of dependents. This information helps Betterment create a comprehensive tax profile, estimating your federal and state income tax rates, long-term capital gains (LTCG) rates, and applicable standard deductions. Betterment’s estimated tax savings methodology also incorporates the IRS' cap on ordinary income offsets for capital losses—$3,000 for most individuals or $1,500 if married filing separately, and also incorporates any available carryforward losses. Tax lot analysis and offsetting hierarchy: At the heart of Betterment’s estimated tax savings tool is a detailed analysis of tax-lot level trading data. Betterment tallys TLH-triggered losses (short- and long-term) from other realized capital gains or losses, grouping them by year, and calculates your potential tax benefit by offsetting losses and gains by type according to IRS rules, and allowing excess losses to offset other income types or carry forward to future years. The IRS offset order is applied: Short-term losses offset short-term gains Long-term losses offset long-term gains Remaining short-term losses offset long-term gains Remaining long-term losses offset short-term gains Remaining short-term losses offset ordinary income Remaining long-term losses offset ordinary income Any further losses are carried forward Current year estimated tax savings: Betterment calculates your current year estimated tax savings from TLH based on the IRS numbered offset list above, which is the sum of: Short-term offset represents the tax savings from subtracting your short-term harvested losses and cross-offset long-term harvested losses from current-year short-term capital gains (numbers 1 and 4 above), then multiplying by your estimated federal plus state tax rate. Long-term offset represents the savings from subtracting long-term harvested losses and cross-offset short-term harvested losses from current-year long-term capital gains (numbers 2 and 3 above), multiplied by your estimated long-term capital gains rate. Ordinary income offset captures the savings from applying any remaining harvested losses to your ordinary income up to the allowable limit (numbers 5 and 6 above), multiplied by your estimated federal plus state tax rate. Both short-term and long-term harvested losses may include banked losses from prior years that couldn’t be used at the time. These carryforward losses (number 7 above) are applied in the same way as current-year harvested losses when calculating your tax savings. For the tool, Harvested Losses are all time short- and long-term harvested losses i.e., all harvested losses to date through TLH. Savings from the Short-term offset, long-term offset, and ordinary income offset are summed to yield the current year estimated tax savings. All-time estimated tax savings : Betterment calculates your all-time estimated tax savings from TLH based on the sum of: All-time Long-term harvested losses × LTCG rate All-time Short-term harvested losses × (Federal + State tax rate) For the all-time estimated tax figure, the all-time figures used are all your harvested losses through Betterment’s TLH feature to the present date, and rather than calculate offsets, Betterment assumes that you are able to fully offset your long-term harvested losses and short-term harvested losses with gains. Therefore, we apply the long term capital gains rates and marginal ordinary income rate (which is the sum of your federal and state tax rates) by your total long-term harvested losses and short-term losses, respectively. There is no ordinary income offset in the All-Time Estimate. This simplification does not track when the loss occurred, and therefore, assumes current estimated tax rates were applicable throughout prior years. Assumptions: While this tool provides a powerful estimate of your potential tax benefits from tax-loss harvesting, it is important to understand the assumptions and limitations underlying the estimated tax savings calculations. Estimated tax savings figures presented are estimates—not guarantees—and rely on the information you’ve provided to Betterment. Actual tax outcomes may vary based on your actual tax return and situation when filing. The tool evaluates only the activity within your Betterment accounts and does not take into account any investment activity from external accounts. For the current year calculation, the tool also assumes that you have sufficient ordinary income to fully benefit from capital loss offsets, and for the all-time calculation, the tool provides a tax-dollar estimate of all harvested losses, based on type (short- or long-term) and current tax rates. Additionally, the estimated tax savings calculation simplifies the treatment of certain entities; for example, trusts, business accounts, or other specialized tax structures are not handled distinctly. State-level tax estimates exclude city tax rates and municipal taxes, which may also affect your overall tax situation. The “all-time estimate” shown reflects an approximation of the total tax impact of harvested losses to date—including benefits that have not yet been realized or claimed. While the estimate has its limitations, it provides a clear and actionable view into how tax-smart investing can add value over time. It helps show how harvested losses may lower your tax bill and boost after-tax returns—bringing transparency to a strategy that’s often hard to see in dollar terms. For many investors, it highlights the long-term financial benefits of managing taxes proactively. Conclusion Summary: Tax-loss harvesting can be an effective way to improve your investor returns without taking additional downside risk. -
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The Goldman Sachs Smart Beta portfolio methodology
The Goldman Sachs Smart Beta portfolio methodology The Goldman Sachs Smart Beta portfolio is meant for investors who seek to outperform a market-cap portfolio strategy in the long term, despite periods of underperformance. Our Smart Beta portfolio sourced from Goldman Sachs Asset Management helps meet the preference of our customers who are willing to take on additional risks to potentially outperform a market capitalization strategy. The Goldman Sachs Smart Beta portfolio strategy reflects the same underlying principles that have always guided the core Betterment portfolio strategy—investing in a globally diversified portfolio of stocks and bonds. The difference is that the Goldman Sachs Smart Beta portfolio strategy seeks higher returns by moving away from market capitalization weightings in and across equity asset classes. What is a smart beta portfolio strategy? Portfolio strategies are often described as either passive or active. Most index funds and exchange-traded funds (ETFs) are categorized as “passive” because they track the returns of the underlying market based on asset class. By contrast, many mutual funds or hedge fund strategies are considered “active” because an advisor or fund manager is actively buying and selling specific securities to attempt to beat their benchmark index. The result is a dichotomy in which a portfolio gets labeled as passive or active, and investors infer possible performance and risk based on that label. In reality, portfolio strategies reside within a plane where passive and active are just two cardinal directions. Smart beta funds, like the ones that were selected for this portfolio, seek to achieve their performance by falling somewhere in between extreme passive and active, using a set of characteristics, called “factors1,” with an objective of outperformance while managing risk. The portfolio strategy also incorporates other passive funds to achieve appropriate diversification. This alternative approach is also the reason for the name “smart beta.” An analyst comparing conventional portfolio strategies usually operates by assessing beta, which measures the sensitivity of the security to the overall market. In developing a smart beta approach, the performance of the overall market is seen as just one of many factors that affects returns. By identifying a range of factors that may drive return potential, we seek the potential to outperform the market in the long term while managing reasonable risk. When we develop and select new portfolio strategies at Betterment, we operate using five core principles of investing: Personalized planning A balance of cost and value Diversification Tax optimization Behavioral discipline The Goldman Sachs Smart Beta portfolio strategy aligns with all five of these principles, but the strategy configures cost, value, and diversification in a different way than Betterment’s Core portfolio. In order to pursue higher overall return potential, the smart beta strategy adds additional systematic risk factors that are summarized in the next section. Additionally, the strategy seeks to achieve global diversification across stocks and bonds while overweighting specific exposures to securities which may not be included in Betterment’s Core portfolio. Meanwhile, with the smart beta portfolio, we’re able to continue delivering all of Betterment’s tax-efficiency features, such as tax loss harvesting and Tax Coordination. Investing in smart beta strategies has traditionally been more expensive than a pure market cap-weighted portfolio. While the Goldman Sachs Smart Beta portfolio strategy has a far lower cost than the industry average, it is slightly more expensive than the core Betterment portfolio strategy. Because a smart beta portfolio incorporates the use of additional systematic risk factors, we typically only recommend this portfolio for investors who have a high risk tolerance and plan to save for the long term. Which “factors” drive the Goldman Sachs Smart Beta portfolio strategy? Factors are the variables that drive performance and risk in a smart beta portfolio strategy. If you think of risk as the currency you spend to achieve potential returns, factors are what determine the underlying value of that currency. We can dissect a portfolio’s return into a linear combination of factors. In academic literature and practitioner research (AQR), factors have been shown to drive historical returns. These analyses form the backbone of our advice for using the smart beta portfolio strategy. Factors reflect economically intuitive reasons and behavioral biases of investors in aggregate, all of which have been well studied in academic literature. Most of the equity ETFs used in this portfolio are Goldman Sachs ActiveBetaTM, which are Goldman Sach’s factor-based smart beta equity funds. Stocks are scored according to four factors where the highest scoring companies have greater weighting. The weights are then constrained to be in-line with the market. These factors include: Good Value When a company has solid earnings (after-tax net income), but has a relatively low price (i.e., there’s a relatively low demand by the universe of investors), its stock is considered to have good value. Allocating to stocks based on this factor gives investors exposure to companies that have high growth potential but have been overlooked by other investors. High Quality High-quality companies demonstrate sustainable profitability over time. By investing based on this factor, the portfolio includes exposure to companies with strong fundamentals (e.g., strong and stable revenue and earnings) and potential for consistent returns. Low Volatility Stocks with low volatility tend to avoid extreme swings up or down in price. What may seem counterintuitive is that these stocks also tend to have higher returns than high volatility stocks. This is recognized as a persistent anomaly among academic researchers because the higher the volatility of the asset, the higher its return should be (according to standard financial theory). Low-volatility stocks are often overlooked by investors, as they usually don’t increase in value substantially when the overall market is trending higher. In contrast, investors seem to have a systematic preference for high-volatility stocks based on the data and, as a result, the demand increases these stocks’ prices and therefore reduces their future returns. Strong Momentum Stocks with strong momentum have recently been trending strongly upward in price. It is well documented that stocks tend to trend for some time, and investing in these types of stocks allows you to take advantage of these trends. It’s important to define the momentum factor with precision since securities can also exhibit reversion to the mean—meaning that “what goes up must come down.” The Goldman Sachs Smart Beta portfolio also targets a small operational cash allocation in taxable accounts, health savings accounts, and individual retirement accounts (IRAs). How can these factors lead to future outperformance? In specific terms, the factors that drive the smart beta portfolio strategy—while having varying performance year-to-year relative to their market cap benchmark—have potential to outperform their respective benchmarks when combined. You can see an example of this in the chart of yearly factor returns for US large cap stocks below. You’ll see that the ranking of the four factor indexes varies over time, rotating outperformance over the S&P 500 Index in nearly all of the years. Performance Ranking of Smart Beta Indices vs. S&P 500 Why invest in a smart beta portfolio? As we’ve explained above, we generally only advise using Betterment’s choice smart beta strategy if you’re looking for a more tactical strategy that seeks to outperform a market-cap portfolio strategy in the long term despite potential periods of underperformance. For investors who fall into such a scenario, our analysis, supported by academic and practitioner literature, shows that the four factors above may provide higher return potential than a portfolio that uses market weighting as its only factor. While each factor weighted in the smart beta portfolio strategy has specific associated risks, some of these risks have low or negative correlation, which allow for the portfolio design to offset constituent risks and control the overall portfolio risk. Of course, these risks and correlations are based on historical analysis, and no advisor could guarantee their outlook for the future. An investor who elects the Goldman Sachs Smart Beta portfolio strategy should understand that the potential losses of this strategy can be greater than those of market benchmarks. In the year of the dot-com collapse of 2000, for example, when the S&P 500 dropped by 10%, the S&P 500 Momentum Index lost 21%. Given the systematic risks involved, we believe the evidence that shows that smart beta factors may lead to higher expected return potential relative to market cap benchmarks, and thus, we are proud to offer the portfolio for customers with long investing horizons. 1Factors, as applied in investing, can mean different things. In the context of asset allocation, factors are drivers of return within broader asset classes used as a lens to uncover return potential and minimize risk. The Goldman Sachs Smart Beta portfolios examine market capitalization, rates, emerging markets, credit, equity style, commodities and momentum to seek to avoid taking unnecessary risk while pursuing the best opportunities to drive portfolio returns.
Planning
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Debt doesn't have to keep you caged—here's how to save your way out
Debt doesn't have to keep you caged—here's how to save your way out Paying down debt and building your savings aren't mutually exclusive—here's a simple framework for juggling both at once. Key takeaways Getting your financial footing early in your career has never been easy, but today’s high-debt, low-hire job economy adds to the struggles. But you don't need to be debt-free before you start saving. They can run on parallel tracks. Some debt can sit on the backburner while you put your money to work elsewhere. It all hinges on how high of an interest rate a loan carries. Quick number crunching beats a high-maintenance budget. Size up your cash flow, then direct your discretionary spending with a few guiding principles. Between college, cars, and credit cards, debt is a simple fact of life for a lot of us, especially those early in their careers. But waiting until you’re debt-free to start saving means missing out on one of your biggest advantages as a saver: time. So let’s reset expectations. With a clearer picture of your cash flow, you can chip away at debt, find your financial footing, and start enjoying some meaningful financial freedoms all at the same time First: Figure out what you're working with Do you really need a budget? We’d say yes, but it doesn’t need to be a detailed spreadsheet or elaborate app. Crunch a few numbers, then get on with it. Because before you can decide where your money goes, you need to know how much you have to direct in the first place. Start with your take-home pay, what lands in your account after taxes. Then subtract bare necessities like: Housing — your total costs will vary depending on whether you rent or own Utilities — electricity, internet, phone, etc. Transportation — car payment, insurance, gas, or transit Groceries — actual at-home food spending, not delivery Health insurance — assuming you're not on a parent's plan What's left is your discretionary income. For a lot of people in their 20s, that number is smaller than they'd like. That's okay. Even a little is enough to get started. From there, split what's left into two buckets: Freedom fund — for saving, debt paydown, and building toward bigger goals (more on this below) Fun fund — for shame-free spending like going out, trips, whatever makes your life feel like your life If you have a decent chunk of discretionary spending to work with, a 50/50 split between these two buckets is a solid starting point. If things are tight, lean toward the freedom fund for now. This is your money's first real job—not just covering expenses, but starting to build something. Then: Build your freedom fund Financial freedom comes in many shapes and sizes, but the most impactful aren't always the most exciting. So when setting up your freedom fund, it’s often best to focus first on preventing backsliding. 1. Cover your minimum payments and capture any employer match Missing minimum debt payments can lead to late fees, credit score dings, and balances that quickly balloon—small problems that become expensive ones quickly. If your employer offers a 401(k) match, contribute enough to get it. That match is treated as part of your total compensation. Leaving it on the table is like giving yourself a pay cut. 2. Attack high-interest debt while building a starter emergency fund Not all debts are created equal. Those with higher interest rates—roughly 8% or higher based on the current rate environment and market forecasts—can snowball fast. So paying them down aggressively is often the higher-ROI move. Lower-interest debt, on the other hand, is less of an emergency. You don't need to pour every available dollar into paying it off. Steady, on-time payments can be enough while you work toward other goals. At the same time, consider building a small cash cushion as you go. Without one, a single surprise bill can send you right back to square one. Even $500 in a high-yield cash account makes a meaningful difference. Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. 3. Start designing the life you want This is where the line between your freedom and fun funds starts to blur. You’ve laid the foundation with the previous two steps, now you can dream big with moves that make sense a few years out or beyond. Sometimes that’s a literal move—to your own place, or a new city—or stepping away from work for a while for your mental wellbeing. Eventually, it can mean working less for the money, and more for the meaning. Because as your nest egg grows, you may very well feel empowered to pass on jobs that don’t align with your values. Either way, these types of long-term goals are better-suited for low-cost, globally-diversified investing, and apps like Betterment make it easier than ever to get started. A good-enough system beats the perfect plan When you’re just starting out, you’re often working with less than you’d like. But you can still build momentum by starting small and staying consistent. You don't need to have it all figured out. You just need a clear enough picture of your cash flow and a few sensible priorities to work from. Cover your minimums. Build a small cushion. And put what's left to work. The rest will follow. -
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How to course correct when you simply can't stay the course
How to course correct when you simply can't stay the course De-risking during market volatility can be costly. Here’s how to do it without breaking the bank. The best course of action during market volatility is often inaction. That’s because selling riskier assets at a loss locks in those losses. It foregoes their potential for future growth, and it might also trigger capital gains taxes in the process. But if taking some sort of action feels necessary, then modestly reducing your overall risk exposure can be a reasonable alternative. Consider dialing down your existing stock allocation by a few percentage points, or lower the costs of recalibrating by using your future deposits instead. Either way, the solution may be the same: sprinkling in more bonds. Consider bonds to calm your investing nerves When people talk about diversification, equities like international stocks get most of the attention. But no less important in the role of managing risk are bonds. These are the loans given to governments and companies by investors, and while they're not completely risk-free (no asset is), the relatively-modest interest they tend to pay out can feel like a windfall when stock values are plunging. They won’t negate all of the volatility of stocks, but they can help smooth things out and preserve capital. This is why all of our recommended allocations include holding at least some bonds. You can easily dial the bond allocation up or down in our portfolios such as Core. And we also offer two portfolios comprised primarily of bonds, each one designed for a different use case: Target Income built with BlackRock, designed to help you limit market volatility, preserve wealth, and generate income. The Goldman Sachs Tax-Smart Bonds portfolio, designed for high-income individuals seeking a higher after-tax yield compared to a cash account. Don’t forget about the role of cash One of the best ways to mitigate your overall financial risk is by shoring up your emergency fund, which may include a high-yield cash account like our Cash Reserve. Imagine losing your income stream, and how much time you'd want to get back on your feet. A good place to start is 3-6 months' worth of your essential expenses, but your right amount is whatever helps you sleep more soundly at night. Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. Steadying the ship during unsteady times As we mentioned up front, right-sizing your risk during downturns isn’t always cheap. But there are ways to minimize the costs. Lowering your risk profile incrementally is one of them, and stretching out your safety net is another. Either way, it’s okay to recalibrate your risk tolerance from time-to-time, and you can do it wisely with Betterment. -
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Free financial advice, for the busiest season of your life
Free financial advice, for the busiest season of your life For households with $100k+ at Betterment, our advisory fee includes complimentary live chat with a licensed financial specialist. Key takeaways Mid-career comes with competing financial priorities, but you don't have to figure out the order alone. Households with $100k or more at Betterment unlock free access to live chat with a licensed financial specialist. Not AI, not a bot—a real person. Higher earners often leave money behind by staying in "default mode.” Use live chat to size up advanced strategies like asset location, backdoor Roth IRAs, and tax-loss harvesting. Transferring investments from outside Betterment can be a simple way to reach $100k and unlock live chat, while also bringing more of your financial life under one roof. If life is one long series of challenges, those in their 30s or 40s are somewhere in the messy middle of it all. Maybe you just bought a house, or you're trying to. Maybe there's a kid on the way, an expensive wedding behind you, and a college fund somewhere on the horizon. Your income is real now, your finances are getting complicated fast, and the old advice ("just max out your IRA") stopped covering it a while ago. The good news? You don't have to untangle everything by yourself. Households with $100k or more at Betterment now have free access to live chat with a licensed financial specialist—someone who can look at your specific situation and help you figure out what to do next. So let's set the table for your first conversation. Too many goals, not enough dollars? You’ve got a lot going on, so much that your cash flow can’t cover everything. Free live chat can help you quickly prioritize and start knocking out money goals. Because the sooner you start, the sooner you can start enjoying the financial freedom that comes with stacking milestones. Here’s a sampling of the life goals we can help you sort through: Buying a home. Whether you're ready to make an offer or still saving for a down payment, a home purchase reshapes your whole financial picture. A $100k Betterment balance not only lets you size up your strategy with the help of a specialist, it can score you a discounted rate on a mortgage. Building (or rebuilding) an emergency fund. Life has a way of getting expensive at the worst moments. Three to six months of accessible cash is the foundation everything else sits on. At the same time, it’s also possible to overdo it. So size up exactly how much cash you need to sleep better at night, and what to do with the rest. Saving for your kid's college. This one isn’t a pass-fail proposition. Saving even a little, especially while your kids are little, can lighten their financial load when college or trade school come knocking. The question is where to save, and how this goal fits against everything else you're juggling. Charitable giving. The great thing about building the foundation for long-term wealth is it empowers you to give with an abundance mindset. And by donating and replacing appreciated shares instead of dollars, you can effectively reset the tax bill on a slice of your taxable investing as an added bonus. Move beyond the basics of investing Once your finances mature a little, you hit a different category of question. Not "Am I saving?" but "Am I set up the right way?" This is where a lot of investors quietly wonder if they're missing something. And often, they are—not because they've done anything wrong, but because default settings don't always age well. A few advanced settings worth exploring include: Asset location (aka Tax Coordination). It's not just what you invest in, it's where you hold it. You may now have a mix of account types (tax-deferred, tax-exempt, and/or taxable), and strategically dividing up your portfolio between them can meaningfully reduce the potential tax drag on your returns over time. Backdoor Roth contributions. Make more money, and the tax benefits of a traditional IRA will quickly phase out. Make a little more, and the same goes for Roth IRAs. But there’s a perfectly legit workaround that high earners use to get money into a Roth anyway. It takes a couple of steps, so live chatting with our team (and a tax advisor) is highly recommended. Tax-loss harvesting. When your taxable investments dip below their initial purchase price, you can jump on the opportunity to “harvest” the theoretical loss and potentially snag similar benefits as tax-deferred accounts. None of these are hacks. They're just what a well-kept portfolio and automated investing can look like once you've moved past the basics. Help has entered the chat If your household has more than $100k at Betterment, you've reached the point where some money questions are worth asking out loud—and you can do exactly that, for free, with a licensed financial specialist via live chat. Not a chatbot. Not an FAQ page. A real human who can act as a sounding board, take a look at how you're set up, and tell you honestly whether anything deserves a second look. Think of it as a gut-check from someone who's seen a lot of portfolios. The kind of conversation where you can ask: Is a backdoor Roth right for me? How can I grow my charitable giving right along with my wealth? Does my particular mix of assets and accounts make sense? If you're already at $100k, you're already in—simply open a new support chat and select “Talk to a financial specialist.” And if you're not quite there, transferring existing investments from external accounts can be a straightforward way to get there. It can mean bringing more of your financial life under one roof, with the fuller picture in view. So consider transferring your investments to Betterment, and get a second set of eyes for your nest egg.
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How Betterment manages risks in your portfolio
How Betterment manages risks in your portfolio true Betterment’s tools can keep you on track with the best chance of reaching your goals. Investing always involves some level of risk. But you should always have control over how much risk you take on. When your goals are decades away, it's easier to invest in riskier assets. The closer you get to reaching your goals, the more you may want to play it safe. Betterment’s tools can help manage risk and keep you on track toward your goals. In this guide, we’ll: Explain how Betterment provides allocation advice Talk about determining your personal risk level Walk through some of Betterment’s automated tools that help you manage risk Take a look at low-risk portfolios The key to managing your risk: asset allocation Risk is inherent to investing, and to some degree risk is good. High risk, high reward, right? What’s important is how you manage your risk. You want your investments to grow as the market fluctuates. One major way investors manage risk is through diversification. You’ve likely heard the old cliche, “Don’t put all your eggs in one basket.” This is the same reasoning investors use. We diversify our investments, putting our eggs in various baskets, so to speak. This way if one investment fails, we don’t lose everything. But how do you choose which baskets to put your eggs in? And how many eggs do you put in those baskets? Investors have a name for this process: asset allocation. Asset allocation involves splitting up your investment dollars across several types of financial assets (like stocks and bonds). Together these investments form your portfolio. A good portfolio will have your investment dollars in the right baskets: protecting you from extreme loss when the markets perform poorly, yet leaving you open to windfalls when the market does well. If that sounds complicated, there’s good news: Betterment will automatically recommend how to allocate your investments based on your individual goals. How Betterment provides allocation advice At Betterment, our recommendations start with your financial goals. Each of your financial goals—whether it’s a vacation or retirement—gets its own allocation of stocks and bonds. Next we look at your investment horizon, a fancy term for “when you need the money and how you’ll withdraw it.” It’s like a timeline. How long will you invest for? Will you take it out all at once, or a little bit at a time? For a down payment goal, you might withdraw the entire investment after 10 years once you’ve hit your savings mark. But when you retire, you’ll probably withdraw from your retirement account gradually over the course of years. What if you don’t have a defined goal? If you’re investing without a timeline or target amount, we’ll use your age to set your investment horizon with a default target date of your 65th birthday. We’ll assume you’ll withdraw from it like a retirement account, but maintain a slightly riskier portfolio even when you hit the target date, since you haven’t decided when you'll liquidate those investments. But you’re not a “default” person. So why would you want a default investment plan? That’s why you should have a goal. When we know your goal and time horizon, we can determine the best risk level by assessing possible outcomes across a range of bad to average markets. Our projection model includes many possible futures, weighted by how likely we believe each to be. By some standards, we err on the side of caution with a fairly conservative allocation model. Our mission is to help you get to your goal through steady saving and appropriate allocation, rather than taking on unnecessary risk. How much risk should you take on? Your investment horizon is one of the most important factors in determining your risk level. The more time you have to reach your investing goals, the more risk you can afford to safely take. So generally speaking, the closer you are to reaching your goal, the less risk your portfolio should be exposed to. This is why we use the Betterment auto-adjust—a glide path (aka formula) used for asset allocation that becomes more conservative as your target date approaches. We adjust the recommended allocation and portfolio weights of the glide path based on your specific goal and time horizon. Want to take a more aggressive approach? More conservative? That’s totally ok. You’re in control. You always have the final say on your allocation, and we can show you the likely outcomes. Our quantitative approach helps us establish a set of recommended risk ranges based on your goals. If you choose to deviate from our risk guidance, we’ll provide you with feedback on the potential implications. Take more risk than we recommend, and we’ll tell you we believe your approach is “too aggressive” given your goal and time horizon. Even if you care about the downsides less than the average outcome, we’ll still caution you against taking on more risk, because it can be very difficult to recover from losses in a portfolio flagged as “too aggressive.” On the other hand, if you choose a lower risk level than our “conservative” band, we'll label your choice “very conservative.” A downside to taking a lower risk level is you may need to save more. You should choose a level of risk that’s aligned with your ability to stay the course. An allocation is only optimal if you’re able to commit to it in both good markets and bad ones. To ensure you’re comfortable with the short-term risk in your portfolio, we present both extremely good and extremely poor return scenarios for your selection over a one-year period. How Betterment automatically optimizes your risk An advantage of investing with Betterment is that our technology works behind the scenes to automatically manage your risk in a variety of ways, including auto-adjusted allocation and rebalancing. Auto-adjusted allocation For most goals, the ideal allocation will change as you near your goal. Our automated tools aim to make those adjustments as efficient and tax-friendly as possible. Deposits, withdrawals, and dividends can help us guide your portfolio toward the target allocation, without having to sell any assets. If we do need to sell any of your investments, our tax-smart technology is designed to minimize the potential tax impact. First we look for shares that have losses. These can offset other taxes. Then we sell shares with the smallest embedded gains (and smallest potential taxes). Rebalancing Over time, individual assets in a diversified portfolio move up and down in value, drifting away from the target weights that help achieve proper diversification. The difference between your target allocation and the actual weights in your current ETF portfolio is called portfolio drift. We define portfolio drift as the total absolute deviation of each super asset class from its target, divided by two. These super asset classes are US Bonds, International Bonds, Emerging Markets Bonds, US Stocks, International Stocks, and Emerging Markets Stocks. For Betterment-constructed portfolios that include a cash allocation, drift in the cash allocation is measured alongside super asset class drift. (Separately, Betterment-managed custom portfolios evaluate drift at the security group level. For reference, security groups are groupings of tickers that include a primary ticker, and may include secondary and/or tertiary tickers designed to help avoid wash sales and allow for tax-loss harvesting opportunities). A high drift may expose you to more (or less) risk than you intended when you set the target allocation. Betterment automatically monitors your account for rebalancing opportunities to reduce drift. There are several different methods depending on the circumstances: First, in response to cash flows such as deposits, withdrawals, and dividend reinvestments, Betterment buys underweight holdings and sells overweight holdings. This reactive rebalancing generally occurs when cash flows going into or out of the portfolio are already happening. We use inflows (like deposits and dividend reinvestments) to buy asset classes that are under-weight. This reduces the need to sell, which in turn reduces potential capital gains taxes. And we use outflows (like withdrawals) by seeking to first sell asset classes that are overweight. Second, if cash flows are not sufficient to keep a client’s portfolio drift within its applicable drift tolerance (such parameters as disclosed in Betterment’s Form ADV), automated rebalancing sells overweight holdings in order to buy underweight ones, aligning the portfolio more closely with its target allocation. This proactive rebalancing reshuffles assets that are already in the portfolio, and requires a minimum portfolio balance (clients can review the estimated balance at www.betterment.com/legal/portfolio-minimum). The rebalancing algorithm is also calibrated to avoid frequent small rebalance transactions and to seek tax efficient outcomes, such as helping to reduce wash sales and minimizing short-term capital gains. Allocation change rebalancing occurs when you change your target allocation. This sells securities and could possibly realize capital gains, but we still utilize our tax minimization algorithm to help reduce the tax impact. We’ll let you know the potential tax impact before you confirm your allocation change. Once you confirm it, we’ll rebalance to your new target with minimized drift. When Betterment rebalances a portfolio with a cash allocation, the rebalancing algorithm will first seek to bring the portfolio's cash allocation back to its target before investing in securities. If cash is below its target allocation, rebalancing will first use available funds (e.g., deposits, dividends, and/or proceeds from selling overweight holdings) to increase cash up to target, and only any remaining available cash is invested in securities; conversely, if cash is above its target allocation, the excess cash above target will be invested in securities as a part of the rebalancing transaction. If you are an Advised client, rebalancing in your account may function differently depending on the customizations your Advisor has selected for your portfolio. We recommend reaching out to your Advisor for further details. For more information, please review our rebalancing disclosures. How Betterment reduces risk in portfolios Investments like short-term US treasuries can help reduce risk in portfolios. At a certain point, however, including assets such as these in a portfolio no longer improves returns for the amount of risk taken. For Betterment, this point is our 60% stock portfolio. Portfolios with a stock allocation of 60% or more don’t incorporate these exposures. We include our U.S. Ultra-Short Income ETF and our U.S. Short-Term Treasury Bond ETF in the portfolio at stock allocations below 60% for both the IRA and taxable versions of the Betterment Core portfolio strategy. If your portfolio includes no stocks (meaning you allocated 100% of your portfolio’s investments to bonds), we can take the hint. You likely don’t want to worry about market volatility. So in that case, we recommend that you invest everything in these ETFs. At 0% stocks, a Betterment Core portfolio generally consists of 60% U.S. short-term treasury bonds, 20% U.S. short-term high quality bonds, and 20% inflation protected bonds.* Increase the stock allocation in your portfolio, and we’ll decrease the allocation to these exposures. Reach the 60% stock allocation threshold, and we’ll remove these funds from the recommended portfolio. At that allocation, they decrease expected returns given the desired risk of the overall portfolio. Short-term U.S. treasuries generally have lower volatility (any price swings are quite mild) and smaller drawdowns (shorter, less significant periods of loss). The same can be said for short-term high quality bonds, but they are slightly more volatile. It’s also worth noting that these asset classes don’t always go down at exactly the same time. By combining these asset classes, we’re able to produce a portfolio with a higher potential yield while maintaining relatively lower volatility. As with other assets, the returns for assets such as high quality bonds include both the possibility of price returns and income yield. Generally, price returns are expected to be minimal, with the primary form of returns coming from the income yield. The yields you receive from the ETFs in Betterment’s 0% stocks portfolio are the actual yields of the underlying assets after fees. Since we’re investing directly in funds that are paying prevailing market rates, you can feel confident that the yield you receive is fair and in line with prevailing rates. Work toward your financial goals without risking it all Choosing an investment portfolio is a personal decision, but it doesn’t have to be a difficult one. At Betterment, our goal is to help you feel confident that you’re always taking an appropriate amount of risk. We’ll help you select a portfolio with the risk level that’s right for you, and you can rest assured that our automated services are built to manage it efficiently. *Target investments, actual holdings will vary. -
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How To Plan Your Taxes When Investing
How To Plan Your Taxes When Investing true Tax planning should happen year round. Here are some smart moves to consider that can help you save money now—and for years to come. Editor’s note: We’re about to dish on taxes and investing in length, but please keep in mind Betterment isn’t a tax advisor, nor should any information here be considered tax advice. Please consult a tax professional for advice on your specific situation. In 1 minute No one wants to pay more taxes than they have to. But as an investor, it’s not always clear how your choices change what you may ultimately owe to the IRS. Consider these strategies that can help reduce your taxes, giving you more to spend or invest as you see fit. Max out retirement accounts: The more you invest in your IRA and/or 401(k), the more tax benefits you receive. So contribute as much as you’re able to. Consider tax loss harvesting: When your investments lose value, you have the opportunity to reduce your tax bill. Selling depreciated assets lets you deduct the loss to offset other investment gains or decrease your taxable income. You can do this for up to $3,000 worth of losses every year, and additional losses can count toward future years. Rebalance your portfolio with cash flows: To avoid realizing gains before you may need to, try to rebalance your portfolio without selling any existing investments. Instead, use cash flows, including new deposits and dividends, to adjust your portfolio’s allocation. Consider a Roth conversion: You can convert all or some of traditional IRA into a Roth IRA at any income level and at any time. You’ll pay taxes upfront, but when you retire, your withdrawals are tax free. It’s worth noting that doing so is a permanent change, and it isn’t right for everyone. We recommend consulting a qualified tax advisor before making the decision. Invest your tax refund: Tax refunds can feel like pleasant surprises, but in reality they represent a missed opportunity. In practice, they mean you’ve been overpaying Uncle Sam throughout the year, and only now are you getting your money back. If you can, make up for this lost time by investing your refund right away. Donate to charity: Giving to causes you care about provides tax benefits. Donate in the form of appreciated investments instead of cash, and your tax-deductible donation can also help you avoid paying taxes on capital gains. In 5 minutes Taxes are complicated. It’s no wonder so many people dread tax season. But if you only think about them at the start of the year or when you look at your paycheck, you could be missing out. As an investor, you can save a lot more in taxes by being strategic with your investments throughout the year. In this guide, we’ll: Explain how you can save on taxes with strategic investing Examine specific tips for tax optimization Consider streamlining the process via automation Max out retirement accounts every year Retirement accounts such as IRAs and 401(k)s come with tax benefits. The more you contribute to them, the more of those benefits you enjoy. Depending on your financial situation, it may be worth maxing them out every year. The tax advantages of 401(k)s and IRAs come in two flavors: Roth and traditional. Contributions to Roth accounts are made with post-tax dollars, meaning Uncle Sam has already taken a cut. Contributions to traditional accounts, on the other hand, are usually made with pre-tax dollars. These two options effectively determine whether you pay taxes on this money now or later. So, which is better, Roth or Traditional? The answer depends on how much money you expect to live on during retirement. If you think you’ll be in a higher tax bracket when you retire (because you’ll be withdrawing more than you currently make each month), then paying taxes now with a Roth account can keep more in your pocket. But if you expect to be in the same or lower tax bracket when you retire, then pushing your tax bill down the road via a Traditional retirement account may be the better route. Use tax loss harvesting throughout the year Some of your assets will decrease in value. That’s part of investing. But tax loss harvesting is designed to allow you to use losses in your taxable (i.e. brokerage) investing accounts to your advantage. You gain a tax deduction by selling assets at a loss. That deduction can offset other investment gains or decrease your taxable income by up to $3,000 every year. And any losses you don’t use rollover to future years. Traditionally, you’d harvest these losses at the end of the year as you finalize your deductions. But then you could miss out on other losses throughout the year. Continuously monitoring your portfolio lets you harvest losses as they happen. This could be complicated to do on your own, but automated tools make it easy. At Betterment, we offer Tax Loss Harvesting at no extra cost. Once you determine if Tax Loss Harvesting is right for you (Betterment will ask you a few questions to help you determine this), all you have to do is enable it, and this feature looks for opportunities regularly, seeking to help increase your after-tax returns. Keep in mind, however, that everyone’s tax situation is different—and Tax Loss Harvesting may not be suitable for yours. In general, we don’t recommend it if: Your future tax bracket will be higher than your current tax bracket. You can currently realize capital gains at a 0% tax rate. You’re planning to withdraw a large portion of your taxable assets in the next 12 months. You risk causing wash sales due to having substantially identical investments elsewhere. Rebalance your portfolio with cash flows As the market ebbs and flows, your portfolio can drift from its target allocation. One way to rebalance your portfolio is by selling assets, but that can cost you in taxes. A more efficient method for rebalancing is to use cash flows like new deposits and dividends you’ve earned. This can help keep your allocation on target while keeping taxes to a minimum. Betterment can automate this process, automatically monitoring your portfolio for rebalancing opportunities, and efficiently rebalancing your portfolio throughout the year once your account has reached the balance threshold. Consider getting out of high-cost investments Sometimes switching to a lower-cost investment firm means having to sell investments, which can trigger taxes. But over time, high-fee investments could cost you more than you’d pay in taxes to move to a lower cost money manager. For example, if selling a fund will cost you $1,000 in taxes, but you will save $500 per year in fees, you can break even in just two years. If you plan to be invested for longer than that, switching can be a savvy investment move. Consider a Roth conversion The IRS limits who can contribute to a Roth IRA based on income. But there’s no income limit for converting your traditional IRA into a Roth IRA. It’s not for everyone, and it does come with some potential pitfalls, but you have good reasons to consider it. A Roth conversion could: Lower the taxable portion of the conversion due to after-tax contributions made previously Lower your tax rates Put you in a lower tax bracket than normal due to retirement or low-income year Provide tax-free income in retirement or for a beneficiary Provide an opportunity to use an AMT (alternative minimum tax) credit carryover Provide an opportunity to use an NOL (net operating loss) carryover If you decide to convert your IRA, don’t wait until December—you’d miss out on 11 months of potential tax-free growth. Generally, the earlier you do your conversion the better. That said, Roth conversions are permanent, so be certain about your decision before making the change. It’s worth speaking with a qualified tax advisor to determine whether a Roth conversion is right for you. Invest your tax refund It might feel nice to receive a tax refund, but it usually means you’ve been overpaying your taxes throughout the year. That’s money you could have been investing! If you get a refund, consider investing it to make up for lost time. Depending on the size of your refund, you may want to resubmit your Form W-4 to your employer to adjust the amount of taxes withheld from each future paycheck. The IRS offers a Tax Withholding Estimator to help you get your refund closer to $0. Then you could increase your 401(k) contribution by that same amount. You won’t notice a difference in your paycheck, but it can really add up in your retirement account. Donate to charity It’s often said that it’s better to give than to receive. This is doubly true when charitable giving provides tax benefits in addition to the feeling of doing good. You can optimize your taxes while supporting your community or giving to causes you care about. To donate efficiently, consider giving away appreciated investments instead of cash. Then you avoid paying taxes on capital gains, and the gift is still tax deductible. You’ll have to itemize your deductions above the standard deduction, so you may want to consider “bunching” two to five years’ worth of charitable contributions. Betterment’s Charitable Giving can help streamline the donation process by automatically identifying the most appreciated long-term investments and partnering directly with highly-rated charities across a range of causes. -
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How Betterment’s tech helps you manage your money
How Betterment’s tech helps you manage your money true Our human experts harness the power of technology to help you reach your financial goals. Here’s how. When you’re trying to make the most of your money and plan for the future, there are some things humans simply can’t do as well as algorithms. The big idea: Here at Betterment, we’re all about automated investing—using technology with human experts at the helm—to manage your money smarter and help you meet your financial goals. How does it work? Robo-advisors use algorithms and automation to quickly and efficiently optimize your investments. They do the heavy lifting behind the scenes, managing all the data analysis and adapting investment expertise to fit your circumstances. All you need to do is fill in the gaps with details about your financial goals. The result: you spend less time managing your finances and more time enjoying your life, while Betterment focuses on your specific reasons for saving, adjusting your risk based on your timeline and target amount. Plus, robo-advisors cost less to operate. While the specific fees vary from one robo-advisor to the next, they all tend to be a fraction of what it costs to work with a traditional investment manager, meaning more of your money stays invested. Learn more about how much it costs to save, spend and invest with Betterment. A winning combination of human expertise and technology: Automation is what Betterment is known for. But our team of financial experts is our secret sauce. They research, prototype, and implement all the advice and activity that you see in your account. Our algorithms and tools are built on the expertise of traders, quantitative researchers, tax experts, CFP® professionals, behavioral scientists, and more. Four big benefits (just for starters): We put your dividends back to work: We automatically reinvest available dividends, even purchasing fractions of shares on your behalf, so you don’t miss out on potential market returns. A focus on the future: Nobody knows the future. And that makes financial planning tough. Your situation can change at any time but our tools and advice can help you see how various changes could affect your goals. We show you a range of potential outcomes so you can make more informed decisions. Anticipating taxes: We may not be able to predict future tax rates, but we can be pretty sure that certain incomes and account types will be subject to some taxes. This becomes especially relevant in retirement planning, where taxes affect which account types are most valuable to you. Factoring in inflation: We don’t know how inflation will change, but we can reference known historical ranges, as well as targets set by fiscal policy. The most important thing is to factor in some inflation because we know it won’t be zero. We currently assume a 2% inflation rate in our retirement planning advice and in our safe withdrawal advice, which is what the Fed currently targets. Additional advice is always available: At Betterment, we automate what we can and complement our automated advice with access to our financial planning experts through our Premium plan, which offers unlimited calls and emails with our team of CFP® professionals. You can also schedule a call with an advisor to assist with a rollover or help with your initial account setup. Whether you need a one-time consultation or ongoing support, you can always discuss your unique financial situations with one of our licensed financial professionals Managing your money with Betterment: Our mission is to empower you to make the most of your money, so you can live better. Sometimes the best way to do that is with human creativity and critical thought. Sometimes it’s with machine automation and precision. Usually, it takes a healthy dose of both. -
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Three steps to size up your emergency fund
Three steps to size up your emergency fund true Strive for at least three months of expenses while taking these factors into consideration. Imagine losing your job, totaling your car, or landing in the hospital. How quickly would your mind turn from the shock of the event itself to worrying about paying your bills? If you’re anything like the majority of Americans recently surveyed by Bankrate, finances would add insult to injury pretty fast: Only around 2 in 5 Americans would pay for an emergency from their savings In these scenarios, an emergency fund can not only help you avoid taking on high-interest debt or backtracking on other money goals, it can give you one less thing to worry about in trying times. So how much should you have saved, and where should you put it? Follow these three steps. 1. Tally up your monthly living expenses — or use our shortcut. Coming up with this number isn’t always easy. You may have dozens of regular expenses falling into one of a few big buckets: Food Housing Transportation Medical When you create an Emergency Fund goal at Betterment, we automatically estimate your monthly expenses based on two factors from your financial profile: Your self-reported household annual income Your zip code’s estimated cost of living You’re more than welcome to use your own dollar figure, but don’t let math get in the way of getting started. 2. Decide how many months make sense for you We recommend having at least three months’ worth of expenses in your emergency fund. A few scenarios that might warrant saving more include: You support others with your income Your job security is iffy You don’t have steady income You have a serious medical condition But it really comes down to how much will help you sleep soundly at night. According to Bankrate’s survey, nearly ⅔ of people say that total is six months or more. Whatever amount you land on, we’ll suggest a monthly recurring deposit to help you get there. We’ll also project a four-year balance based on your initial and scheduled deposits and your expected return and volatility. Why four years? We believe that’s a realistic timeframe to save at least three months of living expenses through recurring deposits. If you can get there quicker and move on to other money goals, even better! 3. Pick a place to keep your emergency fund We recommend keeping your emergency fund in one of two places: cash—more specifically a low-risk, high-yield cash account—or a bond-heavy investing account. A low-risk, high-yield cash account like our Cash Reserve may not always keep pace with inflation, but it comes with no investment risk. Cash Reserve offered by Betterment LLC and requires a Betterment Securities brokerage account. Betterment is not a bank. FDIC insurance provided by Program Banks, subject to certain conditions. Learn more. An investing account is better suited to keep up with inflation but is relatively riskier. Because of this volatility, we currently suggest adding a 30% buffer to your emergency fund’s target amount if you stick with the default stock/bond allocation. There also may be tax implications should you withdraw funds. Your decision will again come down to your comfort level with risk. If the thought of seeing your emergency fund’s value dip, even for a second, gives you heartburn, you might consider sticking with a cash account. Or you can always hedge and split your emergency fund between the two. There’s no wrong answer here! Remember to go with the (cash) flow There’s no final answer here either. Emergency funds naturally ebb and flow over the years. Your monthly expenses could go up or down. You might have to withdraw (and later replace) funds. Or you simply might realize you need a little more saved to feel secure. Revisit your numbers on occasion—say, once a year or anytime you get a raise or big new expense like a house or baby—and rest easy knowing you’re tackling one of the most important financial goals out there.
