Betterment's cash analysis analyzes the timing and amount of money flowing out of the checking account you’ve linked to your Betterment account.
We then identify whether you have extra cash in your linked bank account that might earn a higher yield in a different account, such as Betterment’s Smart Saver account.
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Most American adults face some sort of cash management problem. Maybe you face a tight budget and need to control expenses; or maybe you have extra income and want to know the best use for that cash; or perhaps your income fluctuates from month to month and you’re looking to maintain a relatively constant amount of cash in your checking account.
You can imagine a cash management problem by thinking of a bathroom sink filled with warm water. You can control the level of water in the sink by turning off the faucet or by letting some of the water drain out. To extend the analogy, no one has an unlimited amount of water in their faucets (income), and it can get tricky to manage the stopper effectively to keep just enough water in the sink (expenses).
As a financial advisor, Betterment aims to help people better understand their cash flows to make more effective decisions for their money. It’s part of our core philosophy: Every person should have a personalized financial plan, and to get there, you often need a more solid understanding of your day-to-day money needs.
At a high level, we offer two things to help Betterment customers manage their cash.
- We analyze the timing and amount of money flowing out of the checking account you’ve linked to your Betterment account.
- We identify whether you have extra cash in your linked bank account that might earn a higher yield in a different account, such as Betterment’s Smart Saver account.
In this methodology, we’ll describe our process for analyzing how money flows out of your checking account, and how we arrive at our recommendation on whether you have any extra cash in your account.
How We Analyze Your Checking Account
At Betterment, we allow you to link one checking account to deposit and withdraw money from your Betterment accounts for several reasons. For starters, it helps us prevent fraud by giving customers just one door to move money through. It also allows us to start helping you manage your cashflow (without collecting information on all your possible accounts) by analyzing your checking transactions to make a recommendation on how much extra cash you may have.
We analyze your checking account through a connection enabled by our partner, Quovo. We take in transaction information from your checking account, organize the information, and then make a forecast on your future expenses. We’ll walk through that process below.
Organizing Your Checking Account Transaction Information
The key to analyzing cashflows effectively is to organize the transactions in your checking account. With the assistance of Quovo, we categorize every withdrawal (including debits and ACH transfers) from your checking account into what we call an expense stream. You can think of expense streams as roughly equivalent to line items in a household budget. You may buy groceries more than once in a month, but each time you buy groceries, that expense belongs in the same stream as the other grocery expenses. Similarly, if you make a mortgage payment monthly, then all twelve mortgage payments constitute a distinct expense stream.
We categorize all expenses that show up in your checking account into specific expense streams, based on the transaction memo, the similarity of transactions’ dollar amounts, and the regularity with which transactions occur.
It’s worth noting that expense streams inevitably change over time. New streams are likely to emerge as your expenses evolve and existing expense streams are similarly may become obsolete. In addition, Betterment only analyzes expense streams that are debited from your checking account, so expenses made through a credit card are analyzed as an aggregated credit card expense stream, not as individual expense streams. For those with multiple checking accounts, it’s important to keep in mind that we only analyze the one checking account linked to Betterment.
Since we partner with Quovo to help us gather this information from your checking account, we will seek to update our analysis as Quovo provides more robust information. As these changes occur, we’ll work to improve our analysis to make stronger predictions.
Predicting Future Expenses Based on Past Expenses
Once we’ve organized expenses into expense streams, we broadly group expense streams into two categories: Regular expense streams and irregular expense streams. Regular expense streams have a known frequency (daily, weekly, monthly, etc.) and a predictable transaction amount. Irregular expense streams have no definable frequency and variable transaction amounts. We make a forecast of your future expenses by looking back at both types of expense streams, making a prediction for each expense stream type, then adding those predictions together.
As we’ll show later, we use this forecast to provide you with a recommendation on how much extra cash you may be holding in your checking account.
Predicting Regular Expense Streams
As explained above, regular expense streams either have a defined frequency or repeat at intervals with little variation. For any given expense stream with an undefined frequency to qualify as a regular expense, the ratio of the volatility between the timing of transactions and the average time between transactions must be very low.
Once we’ve identified regular expense streams, we make a prediction about future expenses by adding together the weighted average expenses of each of these streams for the forecast horizon, controlling for the frequency of transactions in an expense stream and the instances of expense streams ending.
We stop including a regular expense stream with a defined frequency in our forecast if the last transaction in the stream occurred:
- More than two months ago if the expense stream frequency is monthly
- More than 30 days ago if daily
- More than 5 weeks ago if weekly
- More than 3 two-week periods (6 weeks) ago if biweekly
- More than 3 half-month periods (1.5 months) if frequency is semi-monthly
We’ll continue to refine these cut-off points as we evaluate and improve our algorithm.
We stop including regular expense streams that have a low variance but no defined frequency in the forecast if the last transaction in the stream occurred beyond a certain threshold. We define this threshold as more than 1.5 standard deviations above the average for the time between expenses in the stream.
Predicting Irregular Expense Streams
We analyze irregular expense streams separately. This is because, if the time that elapses between expenses is too great, making a forecast using a weighted average (as we do with regular expense streams) is likely to be less accurate than combining all such irregular streams into one time series and then forecasting it on its own.
We make a prediction about future expenses for irregular expense streams by combining all irregular expense streams as if they are one expense stream in a daily time series. We then filter out very large, one-off expenses. Irregular expenses that are over the greater of $5,000 or the 99th percentile of all expenses are considered large, one-off expenses and are removed. If multiple expenses occur on the same day, we add all of those expenses together. Each day with no expenses is given an expense amount of $0.
To make the forecast, we average the last year of the combined, filtered expenses and scale by the upper and lower bounds of the forecast period (21 days or 35 days).
Aggregating the Predictions into a Single Forecast
The final step is adding our predictions of regular and irregular expenses together to arrive at an estimate of total expenses. Our predictions are made on a regular basis, which means that they may change from day to day.
How We Define Extra Cash in Checking Accounts
To estimate how much extra cash you may be holding in your checking account, we use the expense streams analysis and prediction process explained above to define a target balance for your checking account in the future. Because the goal of our analysis is to continually give you smart feedback on your balance, the target balance isn’t static advice; it evolves as our prediction about your cash needs evolve.
To arrive at our target balance for determining how much extra cash you have, our technology simultaneously makes two predictions:
- How much cash we predict you’ll need for the next 21 days (three weeks).
- How much cash we predict you’ll need for the next 35 days (five weeks).
The difference between the current balance in your checking account and your target balance (the balance we predict you’ll need for the next 35 days) is what we consider extra cash, which we recommend moving to an account where you could generate higher earnings.
If your current balance falls between the 21-day prediction and 35-day prediction, then we provide you with a message to use your own judgment as to whether you have extra cash based on your knowledge of your cashflow expectations. If your balance falls below the 21-day prediction, then we suggest that you may want to check in on your balance to see if you can cover your expenses, given what we know about you. This analysis will be updated regularly, as long as your checking account remains linked to Betterment. So, our advice on your extra cash will refresh regularly. It is important to note that this information is not gathered or adjusted in real time. Quovo aims to provide current checking account balance that is no more than 24 hours old, so you should be aware that deposits and withdrawals won’t be reflected immediately in your cash analysis.
While there are an array of cash savings solutions to choose from, we tie this analysis to Smart Saver, Betterment’s low-risk investing account designed to help earn a high yield. It is important to note we assume that a cash solution is the appropriate use for any extra cash in your checking account and does not consider whether that money might better be used for investing, or for another purpose, such as paying down debt.
Evolving How We Help You Manage Cash
As described in this methodology, we aim to provide smart feedback when we think you have extra cash that could be earning you more value if it were in a higher yield account. You can think of this methodology as a starting point for helping you manage your cashflow. By adding to our analysis and refining our prediction capabilities, we’re working to help you manage your cash more effectively over time.
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