Director of Quantitative Investing
VP of Advice & Investing
Betterment has a singular objective: to help you make the most of your money, so that you can live better. Since our start in 2010, we have developed a range of products and services in pursuit of this objective—from advanced investing strategies to new ways of offering financial advice.
What unites each of our offerings? What is the underlying philosophy that informs how we make decisions that we hope will lead to better outcomes for our customers?
Here, we outline our fundamental investing philosophy—the philosophy that guides our portfolios’ construction, our investment optimization techniques, and our advice to Betterment customers.
Defining Betterment’s Investment Philosophy
Put simply, we at Betterment hold to the following:
Betterment uses real-world evidence and systematic decision-making to help increase the take-home value of our customers’ wealth.
When developing new investment products or advancing our current offerings, we start with a body of well-developed, robust research, then use a system of rules to remove bias and preconceptions from our decision-making process.
While we’ve formalized our investing philosophy and internal processes over time, Betterment has held to these same tenets since the beginning. We launched in 2010 with an investing strategy based on more than 50 years of advancing research in Modern Portfolio Theory. The result was a portfolio strategy composed of exchange-traded funds (ETFs) with customizable risk management. Over time, we improved the Betterment Portfolio Strategy and developed more personalized advice for each of our customers. Each advancement emerged from identifying more efficient, effective, and robust methods, and each time we’ve made a change, we’ve used a decision-making process less susceptible to bias.
In short, we strive never to be dogmatic in our approach, but rather focus on practical, evidence-backed ways of giving investment advice and building services.
What Betterment’s Philosophy Means for Investors
We believe firmly that every investor should clearly understand the underlying philosophy shaping the investing process they follow. This is true for our role as an investment advisor too. Regardless of how transparently we explain what we do, the truth is that much of your investing success depends on the choices that you, the investor, make. Betterment will always offer the advice we believe is in your best interest, but it’s often up to you to get the most out of our advice.
We set forth a set of principles that are the practical essence of Betterment’s philosophy. These principles were formed from Betterment’s review of evidence about investment decision-making and success, but as with all good principles, they’re intuitive and straightforward—steeped in common sense.
Most importantly, these principles aren’t just about us. They are tenets that you, the investor, can and should ascribe to if you wish to have a clear, coherent and realistic approach to managing your money.
Our principles for investing success are the following:
- Make a personalized plan.
- Balance cost and value.
- Maintain diversification.
- Manage taxes.
- Build in discipline.
So, what does it look like for you to embrace each of these principles? In the following sections, we’ll explain how any investor can achieve greater investing success by putting each principle into practice.
1. Make a personalized plan.
No two people have the same lives, nor do they want to achieve the same things with their lives. Making a personalized plan is about organizing your money to achieve the specific goals you value. Just as a monthly personal budget makes it easy to know what you’re spending and saving, a personalized investing plan is made up of goals aligned to future expenditures—your retirement expenses, a future car purchase, or perhaps a child’s education expenses.
A plan helps you clearly make tradeoffs in the present for the future.
While a financial advisor can help you put a plan into action, only you can do the hard work of discerning which goals are important to you, setting your expectations for future expenses, and of course, actually depositing your money into an investment account.
2. Balance cost and value.
Most financial decisions involve comparing costs with potential value. But it’s easy to focus on only one side— costs—instead of the potential value one can earn.
When deciding on investments or choosing a financial advisor, it’s important to consider both cost and value.
As concepts, value and cost are multi-dimensional. Value includes the expected after-tax growth of money, as well as the certainty of a financial plan’s success and lack of stress surrounding that outcome. We believe investors should follow a simple maxim: maximize expected take-home value. As an example, two funds may have a similar return profile, but one fund company charges more. Compare the Rydex S&P 500 Index Fund at 0.75% fees, with the Vanguard Index 500 ETF at 0.04% fees. These funds contain the exact same investment holdings, at very different prices.
Costs—when taken holistically—not only include how much you pay out of pocket, but also the income you could be earning with your own time, the value of the time you give up living life, and the stress you bear in executing the actual work. Always reduce your costs when doing so will not reduce value.
By balancing all of the types of the costs of an investment with the overall value you expect to receive, you can maximize that take-home value.
3. Maintain diversification.
Diversification, at its core, involves not being overly exposed to any single specific risk. Maintaining diversification reduces overall risk but also requires more maintenance and oversight. It also usually means giving up on extreme outcomes, both positive and negative.
The benefit of diversification is a lower risk of ruinous outcomes. While the success of any individual investment will wax and wane in unpredictable ways, diversifying across many asset classes generates a more consistent upside without the chance of any single terrible outcome ruining you by itself. It’s a way of protecting against extreme downside risk. For example, emerging markets stocks can have very high returns, but also have a risk of large losses. If you mix emerging markets with lower risk holdings like U.S. stocks, you can enjoy some of the upside, while limiting your downside.
In essence, diversification is about ensuring steady moderate outcomes rather than risking an all-or-nothing outcome that could ruin you. A diversified portfolio will never out-perform all of the different asset classes that it includes; it will always be the average of them. Over time, the lower risk but equal average benefit from diversification is a powerful engine for wealth growth.
4. Manage taxes.
Just as the income you earn is taxed by the IRS, so are the capital gains you earn by investing in securities like stocks and bonds. Taxes can change the take-home value investors earn from their investments, just as costs and market performance can. For instance, if you and another investor had the same exact investments with the same timing of your transactions, you could expect the same market returns, but, if you manage your taxes differently, you could very well keep significantly different amounts of money after taxes.
The personalized nature of taxes means that there is no one-size-fits-all solution. Investors have a wide array of tools to use: tax-advantaged accounts like IRAs, tax loss harvesting, asset location, and even selecting specific tax lots upon sale (e.g., selling the shares with the lowest gain first). But an individual’s tax situation nearly always changes (at least a little) over time. Your expected tax rate in retirement can influence the optimal tax strategy today, especially if you are using traditional IRA and 401(k)s to save. If you are charitable, donating your appreciated shares rather than giving cash can offer an increased tax benefit.
Intelligently managing taxes can—without risk—increase the value of your wealth over time, and should be a focus for all investors.
5. Build in discipline.
Investors can be more successful when they actively build discipline into their plan: i.e., when they don’t really have to think about it or exert willpower in order to execute it.
We believe that many small, consistent, steady actions compound into surprisingly impressive outcomes. The result of steady discipline over time is greater than most people expect. And yet, it’s how most people actually become wealthy. In contrast with “get-rich-quick” schemes, like speculating on lotteries, hot stocks, or options trading, steady discipline does not garner media attention or notoriety, but it is the engine of growth that purrs along quietly.
However, the more effort it takes to be disciplined, the less likely we are to succeed. Think about it: it is far harder to maintain a diet when surrounded by unhealthy food. It’s the same with our money. We must minimize the burden we impose on ourselves when trying to maintain discipline.
We believe in outsourcing some self-control and execution of our strategies to systematic implementations whenever possible. Automating savings and investment strategies like rebalancing and dividend re-investment are good examples of disciplined investing.
From Principles to Outcomes
Our investment philosophy and the principles we derive from it are meant to help you become a more successful investor. We encourage you to ascribe to these principles and take them on as your own. While no two investors’ situations are the same, you can improve your investing outcomes by following these principles that stand the test of time.
Investing is not a skill; it’s a practice. Remember that. As we, at Betterment, look to the future, we aim to be transparent and consistent about how our principles define our service. If you ever feel we are acting against our declared principles, please let us know.