• KEY TAKEAWAYS
  • Achieving your financial goals is only possible if you plan effectively. Saving enough, choosing the right accounts, deciding when you can buy a house or when to retire—all of these are essential decisions even before you build an optimal portfolio.

  • Betterment offers easy-to-use financial planning tools to help you achieve your financial goals. We continue to invest in making these tools more useful and sophisticated.

  • Planning for the future requires educated guesses about economic conditions. These guesses are useful for being approximately correct, but can never be exactly correct. Reviewing your plan and goals at least annually, making adjustments as you go, is important.

When it comes to investing, it’s easy to get lost in a myriad of decisions about strategies, diversification, investment costs, or funds to buy, to name a few. These decisions are important, but their apparent complexity can obscure an even more important question: What are you trying to accomplish with your portfolio?

At Betterment, we deliver easy-to-use financial planning tools that help you design a plan to achieve your financial goals. And to that end, we continually update the tools we provide, factoring in new possible scenarios and redeveloping our assumptions as we learn about the future. In this article, we’ll outline how our model works and provide a list of updates we’ve made.

Planning For Your Future with Financial Goals

Establishing financial goals, and a plan to achieve them, is critical. This is why Betterment has been a goal-based investing service since the beginning. Goals help root your thinking about the future, and they have well-documented behavioral benefits. Your situation can change, as can your goals, so it’s essential to have flexibility in your plan, and the ability to answer key “what-if” questions. Goals help allow a financial advisor—automated or human—to give you quality advice, which adds significant value beyond the simple returns of a portfolio.

How Betterment Helps You Plan

Betterment’s online financial planning tools are designed to make it easy to set up a personalized, flexible, easy-to-track plan. Starting in our signup process, you establish your first goal and can add other goals at any time once signed up. A goal is a future spending need and will fall into one of four categories, each with different attributes and investing advice. These categories are:

  • Safety Net
  • Major Purchase
  • Retirement
  • General Investing

Once you choose a category, you provide details about the goal so that we can recommend a portfolio, a level of risk, and how to save (or withdraw, if in retirement) to help achieve the goal. Then you can use our tools to see how a one-time deposit, recurring deposits, and the time horizon change how you can achieve your goal. For more complex goals like retirement, our retirement planning tool called RetireGuide™ factors in other variables, such as the impact of Social Security or other income streams like rental real estate, your future spending, tax rates, and inflation.

Here are some examples of questions you can start to answer with Betterment’s financial planning tools:

  • How much do I need to save to put a downpayment on a house in five years?
  • When can I retire? Can I retire early?
  • How much should I save to retire at age X? What if I save more or less than that?
  • How can a poor market affect my savings plan or retirement?
  • What if Social Security isn’t around? How much do I have to save then?
  • Should I use my 401(k) or an IRA?
  • Should I use a Roth IRA / 401(k)?
  • How much should I save in my Safety Net?
  • If I save X per month, what can it be worth in 10 years?

Our tools help provide guidance on all of these questions and more. And we think they are better than most financial planning tools for two key reasons:

  1. We keep your balance updated regularly, so you know where you stand and what to do next.
  2. Changes are simple to make and applied in real time, so you can update your goals and form a better game plan.

We Plan Despite the Future’s Uncertainty

The key challenge in planning for the future is that nobody can truly forecast the future. You can’t be sure how or when your situation will change, and we can never predict how external factors like shifting markets, inflation, or tax rates will change. However, as the statistician George Box once said, “All models are wrong, but some are useful.”

As investors, our lack of ability to know the future should not mean we give up and stop planning. Instead, we should aim to identify the “useful” models Box was referring to—tools that factor in potential variability and allow you to envision how various changes are likely to affect your plan. Tools like these help you understand the range of potential outcomes, which will better inform the decisions you make today.

For example, if financial markets (and thus your portfolio) perform worse than the average we expect (a “poor market” scenario), your savings may be wholly inadequate to meet your spending needs in retirement. To help avoid this result, you could save more today to increase your projected future income, even if a poor market occurs. If you didn’t know this information in advance, it would be too late to adjust if a poor market scenario did occur.

How We Estimate Market Performance

One of the key estimates about the future we make is how your portfolio will perform in the future. As you can see from the blue shading on our Advice tab in Figure 1, there is a wide range of potential portfolio growth results, depending on if the market performs on average, poorly, or well over the time horizon of the goal.

Saving for Tesla Model S
Figure 1: Setting a major purchase goal to buy a Tesla Model S using Betterment

There are many ways to estimate future returns of a portfolio. The simplest way, used by many financial calculators, is to assume a constant average return which is typically based on historical returns of a typical benchmark, like the S&P 500 index. A common estimate is 7% for U.S. stocks. While there may be benefits to simple assumptions, this one has several problems:

  • You are not usually invested exactly like that benchmark. For example, you might hold both stocks and bonds. Different mixes of these assets in your portfolio will have different ranges of outcomes.
  • You probably have multiple financial goals, with different time horizons. For example, your retirement account should not be invested the same was as an education fund for your kids, because one is based on spending in (say) 30 years, the other in 15 years. Thus you may hold different risk portfolios for each goal which should not have the same returns assumption.
  • Using a historical estimate is very sensitive to the time horizon used to calculate it.

Betterment makes several improvements on this method to help make our estimates more accurate:

  1. We use a return estimate for the specific portfolio you select, for each goal. For example, our estimate for a 90% stock portfolio is different than that of an 85% stock portfolio. This estimate is based on the specific asset classes that you actually hold.
  2. We consider volatility in our returns estimates. This allows us to produce the range of returns you see on the Advice tab, and also allows configuring the chance of success of our models. For example, our savings estimates assume a somewhat conservative 40th percentile outcome (60% chance of success) rather than the simple average (a 50% chance of success).
  3. The return we assume is based on risk-free rate and an asset premium. The “risk-free rate” (which is the return a risk-free asset such as a U.S. Treasury bill will return), and an equity (or bond) “risk premium” or excess return, which is how much we expect risky assets like stocks and bonds to return in addition to this risk-free rate.
  4. We assume risk-free returns vary over time. You probably know that interest rates (set by the Fed via its U.S. Treasury buying-and-selling program) are low right now, and most economists expect them to rise. The returns of each stock or bond fund in your portfolio are expected to be in addition to the safe or “risk-free” Treasury rates. So when rates rise, so should our expectations of your returns. Our projections assume these will increase from their low now to more normal rates in the future. (Learn more about this) Also, we make the typical assumption that longer-term treasuries have higher returns than short-term, due to the added interest rate risk they contain.

How We Estimate Future Tax Rates

Just like no one can predict the outcome of a presidential election, we can’t predict what tax rates in the future will be. However, we are pretty sure that certain incomes and account types will be subject to some tax, so good planning tools like Betterment’s factor in some adjustment for taxes. This is most relevant in retirement planning, where taxes affect the account types you might use (e.g., IRA or Roth IRA) and your current and future income.

How we incorporate tax rate estimates to your RetireGuide plan:

  • We use the latest federal tax data available. For federal taxes, these are known in advance and updated every Jan. 1. For state tax rates, this data is harder to come by, and we update them as soon as reasonably possible. Historically that is six to 12 months into the year. For example, given it’s early in 2017, we are still using 2016 state tax rates.
  • Tax bracket ranges are typically adjusted for inflation, so we assume that inflation by itself will not cause major changes to rate assumptions.
  • Your income will be different in the future, which affects your tax rate. We account for some income increased growth due to inflation and typical also a salary growth rate factor (see our full RetireGuide methodology for more information). We use these factors to estimate what your future rate might be.
  • We allow tax deduction and dependent overrides, which can affect your personal rate.

How We Estimate Inflation

Like tax rates, we cannot know how inflation will change through time. There are certain known historical ranges and understood targets set by fiscal policy. The most important thing is to factor in some inflation, especially for long-term goals like retirement, because we know it won’t be zero. Good tools will always do this, even if assumptions vary from tool to tool. At Betterment, by default, we currently assume a conservative 3% inflation in RetireGuide, which is higher than Fed currently targets. You can override this value in Edit Assumptions if you have a different view.

Inflation: 12-Month Average Consumer Price Index Growth

Inflation Growth Graph
Figure 2: Inflation through time, as shown by the Consumer Price Index for all consumers and all items. Seasonally adjusted. Data Source: Federal Reserve Economic Data

Our Commitment to You: Constant Improvement

Just like you should review your goals and their status periodically, our commitment to you is to keep our tools updated and as forward-thinking as possible. Our Investment Committee and team of analysts periodically review our economic, tax, and returns assumptions, as well as make improvements to the capabilities of our tools. For example, we make regular updates to our risk-free rates, especially now that rates have started to move upward. An example of how we invest in our tools is the release of RetireGuide in 2015, which was the first time we factored Social Security, inflation, and taxes into our retirement calculations. These improvements, as well as the actual performance of your account, can cause our recommendations to vary, so we recommend reviewing your goals and status at least once per year.

In order to be transparent about the changes we make, we’ll keep a log in this article of all historical changes to our models. You can also review our Projections Methodology and RetireGuide methodology documents for more model details and limitations.

Model Release Notes and Assumption Updates

Month/Year Description
May 2010 Betterment launches service with a portfolio of U.S. stocks and treasury bonds. Goal projections available with expected returns based on historical returns.
Sept. 2011 International stocks added to the portfolio, updated expected returns to include this asset class.
Nov. 2011 Multiple Goals launched.
Dec. 2012 “On/Off Track” Goal tracking advice launched. Introduced savings advice based on a more conservative 40th percentile.
Sept. 2013 New portfolio launched, with new expected returns, utilizing a risk-free curve.
2014 Risk-free rate updates: 6/2014, 10/2014
Apr. 2014 Retirement Income / safe withdrawal advice launched with conservative market outcome projections (1st percentile returns).
June 2014 Municipal bonds added to the taxable portfolio, updated taxable expected returns and risk-free rates; tax loss harvesting portfolio launched.
2015 Risk-free rate updates: 1/2015, 4/2015, 6/2015
Apr. 2014 RetireGuide launched.
2016 Risk-free rate updates: 1/2016, 4/2016, 10/2016
Jan. 2016 IRS tax rates, limits and phaseouts updated for 2016
Dec. 2016 State tax rates updated for 2016
2017 Risk-free rate updates: 3/2016
Jan. 2017 IRS tax rates, limits and phaseouts updated for 2017