Often, new customers write to me and ask, what can I do to build wealth faster? It doesn’t have to be complicated. As you know, we built Betterment on the idea of efficiency, so here’s my efficient formula: four fundamental investing principles anyone can use.
There’s no surer path to building wealth than spending less and saving more. Often the only way to find out how much more you can afford to save is to go ahead and save it. Meaning: If you’re investing 10% of your income now, kick it up to 15% for 2014. You may not miss the money now, and you’ll thank yourself later. If an extra 5% seems like a stretch, start by saving another 1%.
Call it the power of +1%. If your income is $150,000 per year, and the balance in your account is $200,000, and you continue saving 10% per year, you’d end up with about $917,000 in 20 years, assuming a 5% return.
But if you increase the 10% you’re saving now by 1% each year until you reach a maximum of 16%, you could end up with $1.2 million.
2. Diversify intelligently using low-cost ETFs.
We live in a golden age of investing—for those who know how to take advantage of it. The price of diversification has fallen to an all-time low, thanks to the proliferation of low-cost exchange-traded funds (ETFs). With these more liquid instruments, investors have access to more global asset classes than ever before.
At Betterment, we use a portfolio of 12 ETFs to give our customers a globally diversified portfolio. I encourage you to read about the benefits of “Seeking the Other Kind of Alpha,” i.e. diversification. When your portfolio is properly diversified, the asset classes balance each other out, helping keep performance steadier.
3. Automate the details.
Rebalance at the right times, manage your taxes efficiently, and minimize costs. These are the hallmarks of smart investor behavior; not doing any one of these tasks can create a drag on returns—so automate them.
To put it another way, seek the optimal net investor return—net of taxes, net of behavior, net of all transaction costs. When you minimize taxes, reduce costs, and keep your asset allocation steady—features that are built into the Betterment portfolio and are automated so you don’t even have to think about them—you are likely to see higher returns over the long term.
We estimate that the Betterment advantage can add an average of 2.9% to your portfolio.
4. Stay the course.
Lastly, set your goals appropriately—whether for retirement or a near-term goal like a vacation or down payment—and then don’t futz around. Our advice algorithms are built into the Betterment method, and our product is designed using innovative behavioral finance research to help you stay the course. As the pros know: Over-trading, market timing, and other bad investor behavior often destroy DIY investors’ returns.
As you can see, there’s nothing here about options trading or shorting stocks or credit swaps. Surprised? You shouldn’t be. Building wealth is about how you behave.