Betterment's portfolio is designed to help customers achieve the optimal expected returns at every level of risk from their investments.
Next, we use a variety of strategies—including automation—to make sure investors keep as much of those returns as possible.
Remember when you got your first paycheck? That was probably the first moment when you saw the sizable difference between what you earned and what you actually took home.
There’s a parallel to investing here. Often, there is a gap between the amount your portfolio earns (your investment returns) – and what actually lands into your pocket (your investor returns). But unlike the withholdings from your paycheck, that investment gap is something you can mitigate.
Betterment is designed to help you keep those investor returns that can be—and often are—gobbled up by excessive fees, poor investor behavior (i.e. market timing or uncompensated risk from poor diversification), and other inefficiencies like poor tax strategies.
In fact, that’s the fundamental reason Betterment exists: To offer you a better, more effective and ultimately more rewarding way to invest.
While this number depends greatly on how you choose to invest elsewhere, we estimate that you can potentially keep an additional 2.66% of your investor returns each year by using Betterment.
Additional Returns with Betterment
This chart is for illustrative purposes only and is hypothetical only. It does not represent results of actual trading using client assets. It serves to demonstrate the dollar impact compounded over time of the potential individual additional returns attributable to each of index investing, automatic rebalancing and better behavior in excess of the returns generated by a hypothetical portfolio not containing these three features.
We discuss below how we derived the potential individual additional returns attributable to index investing, automatic rebalancing and better behavior. These three items may not operate independently from each other. You should carefully consider the processes, data, assumptions, and limitations we reference in the studies in this article. Among other things, the studies included in this article cover different time periods, investments, and other important items.
Past performance does not guarantee future results, and the likelihood of investment outcomes are hypothetical in nature. Please note that hypothetical results are calculated and developed with the benefit of hindsight and have inherent limitations. These hypothetical results are based on historical studies, and may be sensitive to the time periods in which they occurred. Further, there is a potential for loss as well as gain that the hypothetical information portrayed does not display. Actual Betterment customers may experience different results from those shown.
* To calculate this number, we evaluated the effect of each potential additional return category on the above-described portfolio. Portfolio performance is calculated by compounding on a monthly basis. We then added the output from the three separate analyses together.
First, we start with the basic concept of index investing, rather than active management.
Innovative research by Rick Ferri, CFA, founder of Portfolio Solutions, and Betterment’s Alex Benke, CFP, published in the peer-reviewed Journal of Indexes in January 2014, demonstrated that over a 15-year period, a portfolio composed of index funds outperformed a portfolio of active funds 83% of the time.
Using the same data, we found that the index-fund portfolio outperformed active funds by 1.01% on an annualized basis.
Index investing is growing in popularity, but the vast majority of investments in the U.S. are still in actively managed funds. Research from Deutsche Bank showed that active mutual funds had market share of 76.2% in 2013, down from more than 95% in 1998. We select only low-cost index-tracking ETFs, making the Betterment portfolio the right vehicle to capture the average 1.01% advantage found in Ferri and Benke’s data.1
You can view the full whitepaper here.
Smart, automated rebalancing
Another benefit to investing with Betterment is smart, automated rebalancing – a key ingredient for optimal portfolio performance. When portfolios drift, it usually means you are taking on risk that you had not planned to take and that could hurt your performance over time. Rebalancing puts you back on the efficient frontier. Our sophisticated approach to rebalancing uses your portfolio’s dividends and other deposits to rebalance by buying underweight assets and uses withdrawals to sell overweight assets. If rebalancing in a taxable account requires selling shares, our TaxMin service attempts to minimize the taxes incurred.
One study found that rebalancing increased returns by about 0.40%.2 The primary benefit of rebalancing, however, is that it controls risk in your portfolio and can significantly reduce measures of risk – volatility and the expected maximum drawdown.
Lastly, we have built specific behavioral guardrails and nudges which help you be a better investor (sometimes despite yourself!)
Over the last decade, much research has been devoted to the role of behavior in investing. It turns out that bad behavior (like trying to time the market or reacting to temporary market news) hurts returns – a lot. We’ve put a lot of thought into helping you avoid that kind of behavior penalty. On average, a Betterment customer kept an extra 1.25% of returns as compared to an average investor, our analysis showed.
So when you add up the total potential Betterment advantage to you, it’s quantifiably better.
1We performed our analysis using Ferri and Benke’s underlying dataset compared an all-index fund portfolio to 5,000 portfolios of randomly selected, comparable actively managed funds over a 16-year period (1997 to 2012).
2Swensen, David, Unconventional Success, 2005, pp. 195-96. The 0.40% was calculated using investment portfolios from TIAA-CREF participant data from year-end 1992 to year-end 2002. The finding that rebalancing improves raw returns is sensitive to the time period studied and the performance of assets during that period. Past performance does not guarantee future results, and the likelihood of investment outcomes are hypothetical in nature.
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