Buying A Home: Down Payments, Mortgages, And Saving For Your Future
Your home may be the largest single purchase you make during your lifetime. That can make it ...Buying A Home: Down Payments, Mortgages, And Saving For Your Future Your home may be the largest single purchase you make during your lifetime. That can make it both incredibly exciting and nerve wracking. Purchasing a primary residence often falls in the grey area between a pure investment (meant to increase one’s capital) and a consumer good (meant to increase one’s satisfaction). Your home has aspects of both, and we recognize that you may purchase a home for reasons that are not strictly monetary, such as being in a particular school district or proximity to one’s family. Those are perfectly valid inputs to your purchasing decision. However, as your financial advisor, this guide will focus primarily on the financial aspects of your potential home purchase: We’ll do this by walking through the five tasks that should be done before you purchase your home. 1. Build your emergency fund. Houses are built on top of foundations to help keep them stable. Just like houses, your finances also need a stable foundation. Part of that includes your emergency fund. We recommend that, before purchasing a home, you should have a fully-funded emergency fund. Your emergency fund should be a minimum of three months’ worth of expenses. How big your emergency fund should be is a common question. By definition, emergencies are difficult to plan for. We don’t know when they will occur or how much they will cost. But we do know that life doesn’t always go smoothly, and thus that we should plan ahead for unexpected emergencies. Emergency funds are important for everyone, but especially so if you are a homeowner. When you are a renter, your landlord is likely responsible for the majority of repairs and maintenance of your building. As a homeowner, that responsibility now falls on your shoulders. Yes, owning a home can be a good investment, but it can also be an expensive endeavor. That is exactly why you should not purchase a home before having a fully-funded emergency fund. And don’t forget that your monthly expenses may increase once you purchase your new home. To determine the appropriate size for your emergency fund, we recommend using what your monthly expenses will be after you own your new home, not just what they are today. Open your Safety Net Get Started 2. Choose a fixed-rate mortgage. According to 2020 survey data by the National Association of Realtors®, 86% of home buyers took out a mortgage. This means that most people have to choose which type of mortgage is appropriate for them, and one of the key factors is deciding between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage (FRM). Betterment generally recommends choosing a fixed-rate mortgage. Here’s why: As shown below, ARMs usually—but not always—offer a lower initial interest rate than FRMs. Source: Federal Reserve Bank of St. Louis. Visualization of data by Betterment. But this lower rate comes with additional risk. With an ARM, your monthly payment can increase over time, and it is difficult to predict what those payments will be. This may make it tough to stick to a budget and plan for your other financial goals. Fixed-rate mortgages, on the other hand, lock in the interest rate for the lifetime of the loan. This stability makes budgeting and planning for your financial future much easier. Locking in an interest rate for the duration of your mortgage helps you budget and minimizes risk. Luckily, most home buyers do choose a fixed-rate mortgage. According to 2020 survey data by the National Association of Realtors®, 89% of home buyers who financed their home purchase used a fixed-rate mortgage, and this was very consistent across all age groups. Research by the Urban Institute also shows FRMs have accounted for the vast majority of mortgages over the past 2 decades. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. 3. Save For The Upfront Costs: Down Payment And Closing You’ll need more than just your emergency fund to purchase your dream home. You’ll also need a down payment and money for closing costs. Betterment recommends making a down payment of at least 20%, and setting aside about 2% of the home purchase for closing costs. A 2020 National Association of Realtors® survey shows the median down payment amount for home purchases is 12%. As the chart below shows, younger buyers tend to make smaller down payments than older buyers. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. But is making an average down payment of only 12% a wise decision? It is true that you are often allowed to purchase a home with down payments far below 20%. For example: FHA loans allow down payments as small as 3.5%. Fannie Mae allows mortgages with down payments as small as 3%. VA loans allow you to purchase a home with no down payment. However, Betterment typically advises putting down at least 20% when purchasing your home. A down payment of 20% or more can help avoid Private Mortgage Insurance (PMI). Putting at least 20% down is also a good sign you are not overleveraging yourself. Lastly, a down payment of at least 20% may help lower your interest rate. This is acknowledged by the CFPB and seems to be true when we compare interest rates of mortgages with Loan-to-Values (LTVs) below and above 80%, as shown below. Source: Federal Reserve Bank of St. Louis. Visualization of data by Betterment. Depending on your situation, it may even make sense to go above a 20% down payment. Just remember, you shouldn’t put every spare dollar you have into your home, as that will likely mean you don’t have enough liquid assets elsewhere for things such as your emergency fund and other financial goals like retirement. Closing Costs In addition to a down payment, buying a home also has significant transaction costs. These transaction costs are commonly referred to as “closing costs” or “settlement costs.” Closing costs depend on many factors, such as where you live and the price of the home. ClosingCorp, a company that specializes in closing costs and services, conducted a study that analyzed 2.9 million home purchases throughout 2020. They found that closing costs for buyers averaged 1.69% of the home’s purchase price, and ranged between states from a low of 0.71% of the home price (Missouri) up to a high of 5.90% of the home price (Delaware). The chart below shows more detail. Source: ClosingCorp, 2020 Closing Cost Trends. Visualization of data by Betterment. As a starting point, we recommend saving up about 2% of the home price (about the national average) for closing costs. But of course, if your state tends to be much higher or lower than that, you should plan accordingly. In total, that means that you should generally save at least 20% of the home price to go towards a down payment, and around 2% for estimated closing costs. With Betterment, you can open a Major Purchase goal and save for your downpayment and closing costs using either a cash portfolio or investing portfolio, depending on your risk tolerance and when you think you’ll buy your home. 4. Think Long-Term We mentioned the closing costs for buyers above, but remember: There are also closing costs when you sell your home. These closing costs mean it may take you a while to break even on your purchase, and that selling your home soon after is more likely to result in a financial loss. That’s why Betterment doesn’t recommend buying a home unless you plan to own that home for at least 4 years, and ideally longer. Unfortunately, closing costs for selling your home tend to be even higher than when you buy a home. Zillow, Bankrate, NerdWallet, The Balance and Opendoor all estimate them at around 8% to 10% of the home price. Betterment’s research analyzed closing costs for both buying and selling, the opportunity costs of potentially investing that money, and more. It shows that the average expected breakeven time is about 4 years as shown below. Of course, this will depend on many factors, but is helpful as a general guide. Thus, if you do not plan to own your home for at least 4 years, you should think carefully on whether buying a home is a smart move at this point in your life. Source: Betterment, Is Buying A Home A Good Investment? Visualization of data by Betterment. Luckily, it appears that most home buyers stay in their homes beyond our 4-year rule of thumb. The chart below is built from 2020 survey data by the National Association of Realtors®. It shows how long individuals of various age groups stayed in their previous homes before selling them. Across all age groups, the median length of time was 10 years, which is more than double our 4-year rule of thumb. That’s excellent. However, we can see that younger buyers, on average, come in well below the 10-year median, which indicates they are more at risk of not breaking even on their home purchases. Source: National Association of Realtors®, 2020 Home Buyers and Sellers Generational Trends. Visualization of data by Betterment. Some things you can do to help ensure you stay in your home long enough to at least break even include: If you’re buying a home in an area you don’t know very well, consider renting in the neighborhood first to make sure you actually enjoy living there. Think ahead and make sure the home makes sense for you 4 years from now, not just you today. Are you planning on having kids soon? Might your elderly parents move in with you? How stable is your job? All of these are good questions to consider. Don’t rush your home purchase. Take your time and think through this very large decision. The phrase “measure twice, cut once” is very applicable to home purchases. 5. Calculate Your Monthly Affordability The upfront costs are just one component of home affordability. The other is the ongoing monthly costs. Betterment recommends building a financial plan to determine how much home you can afford while still achieving your other financial goals. But if you don’t have a financial plan, we recommend not exceeding a debt-to-income (DTI) ratio of 36%. In other words, you take your monthly debt payments (including your housing costs), and divide them by your gross monthly income. Lenders often use this as one factor when it comes to approving you for a mortgage. Debt Income Ratios There are lots of rules in terms of what counts as income and what counts as debt. These rules are all outlined in parts of Fannie Mae’s Selling Guide and Freddie Mac’s Seller/Servicer Guide. While the above formula is just an estimate, it is helpful for planning purposes. In certain cases Fannie Mae and Freddie Mac will allow debt-to-income ratios as high as 45%-50%. But just because you can get approved for that, doesn’t mean it makes financial sense to do so. Keep in mind that the lender’s concern is your ability to repay the money they lent you. They are far less concerned with whether or not you can also afford to retire or send your kids to college. The debt to income ratio calculation also doesn’t factor in income taxes or home repairs, both of which can be significant. This is all to say that using DTI ratios to calculate home affordability may be an okay starting point, but they fail to capture many key inputs for calculating how much you personally can afford. We’ll outline our preferred alternative below, but if you do choose to use a DTI ratio, we recommend using a maximum of 36%. That means all of your debts—including your housing payment—should not exceed 36% of your gross income. In our opinion, the best way to determine how much home you can afford is to build a financial plan. That way, you can identify your various financial goals, and calculate how much you need to be saving on a regular basis to achieve those goals. With the confidence that your other goals are on-track, any excess cash flow can be used towards monthly housing costs. Think of this as starting with your financial goals, and then backing into home affordability, instead of the other way around. Wrapping Things Up If owning a home is important to you, you can use the five steps in this guide to help you make a wiser purchasing decision. Have an emergency fund of at least three months’ worth of expenses to help with unexpected maintenance and emergencies. Choose a fixed-rate mortgage to help keep your budget stable. Save for a minimum 20% down payment to avoid PMI, and plan for paying ~2% in closing costs. Don’t buy a home unless you plan to own it for at least 4 years. Otherwise, you are not likely to break even after you factor in the various costs of homeownership. Build a financial plan to determine your monthly affordability, but as a starting point, don’t exceed a debt-to-income ratio of 36%. If you’d like help saving towards a down payment or building a financial plan, sign up for Betterment today. Save for your home with Betterment Get Started
You Can Now Skip Individual Recurring Deposits
Managing your Betterment auto-deposits just got easier. Now you can skip any individual ...You Can Now Skip Individual Recurring Deposits Managing your Betterment auto-deposits just got easier. Now you can skip any individual auto-deposit in just a few easy steps. It gives me great joy to announce that you can now skip any individual recurring deposit before it happens. You can now skip any recurring deposit you’ve set up before it happens from a link in the email sent before your recurring deposit occurs. We’ve heard scenarios like this many times: I have an unusually high credit card bill I want to pay off (rather than save). I need to put a deposit down on my kids’ school tuition and need to skip this month. I need to pay taxes but otherwise want to continue saving regularly. Until today, if you had set up a recurring deposit with Betterment and didn’t want it to proceed, you needed to turn off your recurring deposit completely. This not only meant you needed to remember to come back and turn it on later, it also meant your plan would (incorrectly) be off track simply because you don’t want to save for one deposit. One of the cardinal rules of behavioral finance is never make someone make more decisions than necessary. If clients want to skip just one deposit, they should be able to do it. So from now on, you can skip any individual recurring deposit, so long as it is before 4 PM EST on the scheduled deposit date. How To Skip An Individual Deposit There are two places you can go to skip a recurring deposit. First, Betterment sends you an email a day before your scheduled recurring deposit takes place. In this email, you’ll find a link directly taking you to Betterment’s site where you can skip your upcoming deposit. Just click on it, sign in, and confirm. Second, you can see all pending recurring deposits on the “Transfer” tab of your Betterment homepage. So long as it is before 4PM EST on the deposit initiation date, you will have the option to hit the “skip” button on the right. Then, you'll see: Too many skips can knock you off track. For the vast majority of goals, missing one deposit won’t be enough to knock you off track. Our advice will automatically update to consider your new balance and the skipped deposit, and may slightly increase the recommendation for remaining recurring deposits (as you’d expect). But it is possible that skipping many recurring deposits will reduce the confidence that you’ll reach your target balance on the target date. However, you can always defer the goal a bit in order to make up for your current circumstances.
What Are The Most Effective Deposit Settings?
Choosing the right deposit strategy is an important step towards helping you reach your goals. ...What Are The Most Effective Deposit Settings? Choosing the right deposit strategy is an important step towards helping you reach your goals. We recommend setting up your auto-deposits so that they occur right after each paycheck. You’ve set up your account, prioritized your financial goals, and you’ve linked your checking account. Now you’re ready to start making deposits. Automating your deposits helps you to “pay yourself first” by quickly separating your savings money and spending money. It also reduces the amount of idle cash you hold, which could be earning more value if it was invested. More importantly, regular deposits help protect you from trying to attempt the impossible: effectively timing the market. Deposit Types There are many ways you can deposit into your Betterment account. You can make a one-time deposit, you can set up recurring auto-deposits, and you can even allow us to manage your extra cash by using Two-Way Sweep to automatically fund Cash Reserve, which is a cash account that earns a 0.10% *. One-Time Deposit A one-time deposit is an ad-hoc type of deposit where you choose a specific dollar amount to transfer from your checking account to any of your investment goals at Betterment. They can work well when you have cash on hand that you’re ready to invest, right now. A major downside of a one-time deposit is that you must initiate it manually. You’ll need to log in to your account every time you want to make a deposit. Even though we have a convenient mobile app for both iPhone and Android, we know you’re busy and likely have a lot on your to-do list already. Two-Way Sweep Two-Way Sweep is specifically designed to make your life easier by automatically transferring money back and forth between your checking account and Cash Reserve as needed. First, we’ll monitor your spending patterns and provide you with advice on what to do with any extra cash. Then, we’ll seamlessly transfer your cash back and forth between your checking account and Cash Reserve, depending on where it’s needed most. Auto-Deposits Auto-deposits eliminate the manual process required for a one-time deposit, and instead, allows you to schedule recurring future deposits for a specific dollar value. The set amount will be transferred from your bank account on a repeating frequency that you designate—either weekly, every other week, monthly, or on two set dates per month, making it a great option for anyone who likes to know exactly how much will be transferred and when, on an ongoing basis. We’ll email you the day before a scheduled auto-deposit so that you can make any necessary adjustments before the money is withdrawn from your bank account. The email will provide you with an option to skip the auto-deposit if you need to. Many people utilize the auto-deposit feature as a way to dollar-cost average into the market. Auto-deposits help you stay on track and are the preferred deposit method for any of your goals besides Cash Reserve, which has the additional Two-Way Sweep deposit option. What are the most effective auto-deposit settings? The most behaviorally effective auto-deposit strategy is to set up your auto-deposits so that they occur right after each paycheck. Choosing the day after you get paid as your auto-deposit date allows time for your paycheck to completely settle in your bank account before we start the transfer to Betterment. The principle of having auto-deposits set up for right after you get paid is something you actually may already be doing in your employer-sponsored 401(k) account. Your 401(k) contributions come right out of your paycheck, and never actually reaches your bank account. With other investment accounts that aren’t provided to you by your employer, like IRAs or individual taxable accounts, it’s generally not possible to move money directly from your paycheck to those investment accounts. Instead, the next best thing you can do is to schedule auto-deposits for the day after your paycheck hits your bank account. Optimize Timing You may have heard of the saying “pay yourself first” when it comes to saving money. Setting up your auto-deposits for right after you get paid allows you to do this by separating your paycheck into two categories: savings and spending. From a behavior standpoint, this protects you from yourself. Your paycheck is immediately going towards your financial goals first, and any leftover cash in your checking account can then be used for your other spending needs. Avoid Idle Cash Delaying your deposits for any period of time after you get paid allows your cash to sit in your checking account—which can be problematic. Cash that sits in a traditional bank account is likely earning either no interest or very little interest at best. This means that over time, your cash is effectively losing value due to inflation. Letting the cash sit may also tempt you to try to time the market, which might lead you to ultimately hold on to your cash for even longer because of market activity. Not investing that cash could cause you to miss out on dividend payments or coupon income events that you otherwise would have received. Reduce Taxes Another perk of using auto-deposits is that they can help keep your tax bill low. Regular and frequent deposits and dividends help us rebalance your portfolio more tax-efficiently, which keeps you at the appropriate risk level without realizing unnecessary capital gains taxes. We do this by using the incoming cash to buy investments in asset classes that you might be underweight in, instead of selling investments in asset classes that you’re overweight in. Even little amounts help, because we can use those small amounts to invest in fractions of investments. How much should I deposit into each goal? Not sure how much you should be saving in each of your goals per month? We’ll tell you. You can see our recommendations on the Plan tab of each of your goals. We’ll calculate how much you should be saving towards each goal using information such as how much you already have saved, how long you’ll be saving for, and the expected growth rate of your investments. For more information on how our recommendations are determined, please see our goal projection and advice methodology. Ready to put your savings habits on auto-pilot? If you’re already a customer, setting up your preferred deposit type is easy. On a web browser, simply head to New Transfers and choose the deposit option. If you’re using the mobile app, simply log in and choose the Deposit button that will appear at the bottom of the screen. If you have any questions about how to schedule your auto-deposits, we have a team of customer experience associates available to help with any questions or concerns you may have.
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3 Strategies That Can Narrow The Racial Wealth Gap3 Strategies That Can Narrow The Racial Wealth Gap Decades of voting, housing, job, and banking discrimination created a racial wealth gap in the U.S. Here are three strategies Black Americans can use to take charge of their finances. One of the hallmarks of this country is an opportunity to become whatever you want to be. But if we look at the racial wealth gap, it unravels a historical narrative of unequal levels of opportunity that continue to impact us today. The Brookings Institute noted that “At $171,000, the net worth of a typical white family is nearly ten times greater than that of a Black family ($17,150) in 2016.” Mehrsa Baradaran, the author of The Color of Money, puts it best when she states, “The wealth gap is where historic injustice breeds present sufferings.” Looking at the racial wealth gap is like a cobweb. Each strand, or in this case, a reason for the racial wealth gap, can be overcome. But if you combine the strands—the reasons—it grows into a web. These strands are decades of voting, housing, job, and banking discrimination, to name a few, and years of this repeated pattern over generations creates a ripple effect that leads to racial wealth disparities today. A Case Study: How The U.S. Systematically Prevented Black Veterans From Military Benefits In World War II. Although there are many examples of how Black Americans were economically set back by the U.S., one tipping point in modern history is how lawmakers and business discrimination practices denied millions of WWII Black veterans access to GI bill benefits. The post WWII GI Bill benefits included low-cost mortgages, educational grants, and low-cost loans to start a business, which are all key wealth building and wealth transfer vehicles. Ira Katznelson, author of “When Affirmative Action Was White,” said, “there’s no greater instrument for widening an already huge wealth racial gap in postwar America than the GI Bill.” Here are some examples of how Black veterans were negatively impacted during this time period: Housing discrimination left many Black veterans out of the suburban housing boom after WWII. In New York and northern New Jersey, there were about 67,000 post WWII GI Bill mortgages: non-white people made less than 100 of these mortgages. Black people, as well as other ethnic groups, were denied access to vocational training and college education. Even Black veterans who were lucky enough to get GI Bill education benefits faced Jim Crow laws that prevented many from going to college. No access to education benefits hampered many Black veterans from getting better paying jobs. Low paying jobs, combined with living in neighborhoods where schools had fewer resources, had its ripple effect. Their children, the baby boomer generation, were less prepared for college, and their parents couldn’t afford to send them to school. Today, the lack of inherited generational wealth also means that: Fewer Black Americans are investing. More Black Americans have high amounts of student loan debt. More Black Americans have credit card debt, most of which have crippling interest rates. While many of these issues require systemic changes to law, business, and legal practices, there are also tangible strategies Black Americans can adopt now to take charge of their finances: 1. Earn more than just a living wage. Our ability to earn an income is one of the biggest wealth generation tools. If you’re currently looking for employment, do not take the hiring manager’s word for what the salary is. Research the role on websites like Glassdoor, Salary.com, and even your potential employer’s website, to ensure you’re paid what you are worth. Do not be afraid to negotiate your pay when you get an offer or even negotiate in your current role; No one will fight for you like you can fight for yourself. Finally, earning a living wage also means taking advantage of all potential money streams: if you have a 401k plan with an employer match, make sure that at a minimum you are contributing enough to get the full match. 2. Focus on wealth building vs. wealth stripping behavior. As a financial coach, most people I speak to learn about wealth building behavior from their parents, which means that many of us may need further education about how to build wealth. Think of wealth-building behavior as increasing your net worth and wealth stripping behavior as decreasing your net worth. For example, building your savings, investing, and paying off debt are all wealth-building behaviors. On the other hand, not paying off your credit balance in full is wealth stripping behavior. If you’re not sure where to start, Betterment offers excellent tools to help you build wealth: A high-yield cash account for your savings. A high-yield cash account is an incredibly important modern financial tool: Think of it as an alternative to a standard savings account with none of its common drawbacks like transfer limits, minimums, and fees.1 A goal-based investing approach aligned to your life goals. If you don’t know the first thing about investing, or you don’t want to build your own portfolio, Betterment is for you. Depending on what you’re investing for and when you want your money, Betterment will recommend a portfolio specific to you. And if you’re passionate about issues like the environment and social equity, you can choose from three different socially responsible investing portfolios that align with your values: Broad Impact, Climate Impact, and Social Impact. 3. Decide whether or not homeownership is for you. I mentioned before that homeownership is considered a path to building wealth if done correctly. Here are a couple of things you can do to begin your homeownership journey: Determine and stick to a budget: take a good look at your individual finances and spending preferences to determine the monthly payment range that you feel you can comfortably afford. Pull your credit reports and review for accuracy. Use credit monitoring tools to gauge your credit score. Research interest rates to estimate mortgage rates in your desired living area. This is important: Don’t be afraid to question an unusually high rate. Black and Latinx applicants are typically charged higher interest than their white counterparts. Websites like the Consumer Financial Protection Bureau and HUD offer a ton of information about the mortgage process and your rights. Learn about mortgage scams and how someone can take advantage of an extremely stressful experience, particularly for Black first time home buyers. If you feel that you’ve experienced housing discrimination, file a complaint. Remaining silent only enables the discrimination to continue for yourself and others. Individual change is second to systemic change. It’s important to remember that the racial wealth gap is a systemic issue beyond any individual person’s actions: We can’t pretend to solve all racial economic inequality with these recommendations, but they’re a start. The solution involves widespread efforts that protect the rights of Black Americans through legislative change and business practices, as well as becoming your own advocate. 1 For Cash Reserve (“CR”), Betterment LLC only receives compensation from our program banks; Betterment LLC and Betterment Securities do not charge fees on your CR balance. While there is no minimum balance required to be maintained, the minimum amount to open the account is $10.
4 Reasons Why Women Need To Start Saving More And Sooner4 Reasons Why Women Need To Start Saving More And Sooner Women face unique financial challenges that make saving for retirement more urgent. When I first started in the 401(k) business and heard someone express the need for a special seminar on women and investing, I balked. Why do we need to talk about saving and investing to women differently than we do to men? As I quickly learned: the need to save for retirement is even more urgent for women because they face several undeniable headwinds. Gender Pay Gap1 For starters, most people are well aware of the gender pay gap, which currently translates into women earning just 82 cents to every man’s dollar. To put it mildly, improvements in this number over the years have been slow, and at the current rate of progress, estimates are that the gender pay gap will not close until 2093. And this number is for all women: for women of color and older women, the gap is even larger. Lower earnings over a working lifetime mean that women are more likely to have less saved for retirement. Longer life expectancies. In addition, the average life expectancy for women is about 81 years compared to 76 years for men.2 That’s five more long years that women have to support themselves in old age when a regular paycheck is no longer coming in. And that’s just based on averages. One-third of women aged 65-years old today who are in excellent health will probably live to age 95—a full three decades past the traditional retirement age.3 So any money that women have saved for retirement needs to stretch further, in some cases much further. In some cases, this forces older women back into the workforce, often at low-paying jobs. Less time spent working. Compared to men, women often have less consistent income streams during their working years. As the primary caretaker in most families, women are more likely to interrupt their earning years to care for a loved one—whether a child, a parent, or someone else. Or they may elect to take a part-time job which not only reduces their income but often, too, their access to benefits, including a retirement plan. Lower participation in workplace savings plans. Women (and especially women of color) are more likely to work in part-time or other positions that don’t include retirement benefits.4 Even when they have access to a workplace retirement saving program, women are less likely to take full advantage of it. As part of recent study about retirement saving attitudes and behaviors among Millennials and Gen Z, Betterment found that overall, men are simply more engaged than women when it comes to retirement saving.5 Specifically with respect to workplace retirement plans like a 401k: Nearly twice as many women aren’t contributing to a retirement plan. Of those contributing, significantly more men increased their contributions in the last year—so they’re tending to their accounts. More men are maximizing the employer’s match. That means that ⅓ of women who have a match are leaving money on the table. Women’s Lower Participation In Workplace Savings Plans Wow. That’s a lot of headwind! And that was even before the pandemic hit. As a result of COVID-19, women are more likely than their male counterparts to leave their paid positions to take care of school-age kids, which means the workplace is losing ground in terms of gender diversity.6 But the risks for women are even more personal: dropping out of the workforce means losing traction not only as it relates to career advancement, but also as it relates to financial security and building savings. And once again, women of color are impacted disproportionately: The pandemic impacted the very industries in which they are heavily represented, even while Hispanic and Black women are more likely to be single heads of households and the main source of financial support for their families.7 For all these reasons, women should start saving for their future—regardless of their age—before it’s too late. Younger generations can learn from older women: in one study, 41% of women across all races and ethnicities said that their biggest financial regret was not making the effort to invest more.8 Other research shows that women are 14% more likely to feel financially stressed than men and 13% less optimistic about their financial future.9 Women of all ages need to understand these challenges which may not be affecting them now, but likely will in the future. And if they’re already saving, then they (and everyone else!) should help spread the word. It’s never too soon to start saving for retirement. And Betterment can help. Whether you have your 401(k), IRA or other account with us, we can help you create a plan and determine how much to save, how to invest, and which accounts to use. And our automated tools and strategies will help to keep you on track.
Save for Retirement While You’re Self-EmployedSave for Retirement While You’re Self-Employed Entrepreneurs and small business owners have several options for saving for retirement while saving on taxes. Owning a small business is a lot of work, and planning for retirement may feel like the last thing on your to-do list. CNBC reports that up to 34% of entrepreneurs don’t have a plan for how they’ll retire. Getting started isn’t as hard as it seems. We’ll outline the most common self-employment retirement account options, including tips for who should consider using them, how much you can contribute, and how to set them up. Common Sources of Self-Employment Income While it is widely believed that you must set up a formal business, such as an LLC, to be classified as self-employed—it’s not true. Working freelancers and independent contractors with no formal legal business structure are treated as self-employed individuals. Examples might include Uber drivers, tax preparers, and any freelance workers, such as software engineers. The gig economy has propelled more workers than ever to venture out on their own, seeking to be their own boss and therefore managing their own retirement plan. One Participant 401(k) Plan—Solo 401(k) A Solo 401(k) is similar to a regular 401(k). However, with a Solo 401(k), the participant is both the employer and the employee. This means they can contribute up to the regular employee contribution limit plus up to the employer contribution limit as well. You can also set it up as a Roth 401(k) and make non-deductible contributions now so that you can take tax-free withdrawals after retirement. Who: Self-employed individuals who either have no employees or only employ their spouse. How: Complete the paperwork provided by investment companies that offer Solo 401(k)s. Be sure to research, among other things, plan fees and investment fees. Note that Betterment does not currently support Solo 401(k)s. Contribution Limits: In 2021, you can contribute up to $19,500 as the employee plus up to either 20% of the business’s net earnings or 25% of total wages as the employer—as long as your total contribution does not exceed $58,000. If you are 50 or older, you can catch up with an additional $6,500, bringing the total amount to $64,500 total. Note that if you are also participating in another employer’s 401(k) plan, the employee limits apply per person, not per plan. Dates to Know: You must set up the account by December 31st, but you can contribute up until the tax filing deadline of the following year. Heard about the “Mega Backdoor Roth” 401(k)? Simplified Employee Pension—SEP IRA With a SEP IRA, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee. Who: Self-employed or small business owners who do not qualify for a Solo 401(k), or who have employees and are looking for a low-cost retirement plan for their company. How: Simply file a form with the IRS (Form 5305-SEP) and open a SEP IRA at a bank or financial institution. Betterment offers SEP IRAs for self-employed individuals with no employees—read more here. Contribution Limits: For 2021, the business can contribute up to 25% of either the employee’s compensation or 20% of the net earnings from self-employment up to $57,000—whichever is less. There is no catch-up amount for those 50 and older. For 2020, the business can contribute up to 25% of either the employee’s compensation or the net earnings from self-employment or up to $57,000—whichever is less. There is no catch-up amount for those 50 and older. Dates to Know: Set up your SEP IRA by the first tax filing deadline for the year, and you can contribute for the 2020 tax year until your taxes are filed. Learn more about Betterment SEP IRAs. Savings Incentive Match Plan for Employees—SIMPLE IRA A SIMPLE IRA is ideal for small business owners who have 100 employees or less. Both the employer and the employee can contribute. Who: Ideal for small business owners with employees. How: File form 5305-SIMPLE or 5304-SIMPLE with the IRS and open a SIMPLE IRA at a bank or financial institution. Note that Betterment does not currently offer SIMPLE IRAs. Contribution Limits: For qualified employees earning more than $5,000, the 2021 maximum contribution amount is $13,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. Catch up with $3,000 extra per year if you’re 50 or older. For qualified employees earning more than $5,000, the 2020 maximum contribution amount is $13,500. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. Catch up with $3,000 extra per year if you’re 50 or older. Dates to Know: You must open the SIMPLE IRA by October 1st of the year you wish to contribute in. Traditional IRA or Roth IRA In addition to one of the business-sponsored accounts described above, you can also fund a Traditional IRA or Roth IRA. If you’re looking to use a Traditional IRA to get an income tax deduction, you may be limited in that deduction by the amount of your contributions to other retirement accounts and by the amount of your earned income. If you’re a new business owner or entrepreneur that’s just starting out, you may find yourself in a lower tax bracket, which may mean it’s a good time to convert an old Traditional 401(k) or Traditional IRA into a Roth. That would allow you to capture lower taxes today, and in the future when you’re in retirement and withdrawing from the Roth, there won’t be any taxes on qualified distributions. Learn more about how a Roth conversion might benefit you. You can might be able to roll over your old 401(k) into an IRA to consolidate and possibly save on fees. Who: Anyone with earned income can contribute to an IRA. How: Open a Roth or Traditional IRA with a bank or financial institution. Betterment offers both Traditional and Roth IRAs at a low cost. And the best part? We don’t require any paperwork to open and start funding an IRA. Contribution Limits: For 2020 and 2021, you can contribute a maximum of $6,000 per year to a Traditional or Roth IRA, or $7,000 if you’re age 50 or older. Roth contributions may be limited by your income level. Dates to Know: You can open your IRA at any time. You have up until the first tax filing deadline—no extensions—to contribute to an IRA for the preceding tax year. How to Choose Which tax-advantaged account should you consider using to save for your retirement? That depends on the nature and size of your small business, as well as your own age and future plans. Here’s a scenario for a 30-year old entrepreneur with no other employees, and who is classified as a single member LLC (disregarded entity). The business nets $100,000. Type of Plan Maximum Contribution (2021) Solo 401(k) plan $39,500 SEP IRA $20,000 SIMPLE IRA $16,500 Source: IRS Publication 560 Based on this chart, you might be wondering why anyone would do anything but the Solo 401(k). Here’s why. First, setting up a Solo 401(k) typically requires more advance planning and paperwork than opening a SEP IRA or SIMPLE IRA, either of which can usually be opened online in just a few minutes. In addition, Solo 401(k) plans require you to file Form 5500-EZ with the IRS every year once the plan reaches $250,000 in assets. And of course, with the Solo 401(k), you have to be your own company with no employees. And remember, if your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account. Betterment is not a tax advisor, and this post is not tax advice. Please seek out qualified professionals that provide advice on these issues for your specific circumstances. When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. The information on this page is being provided for general informational purposes and is not intended to be an individualized recommendation that you take any particular action. Factors that you should consider in evaluating a potential rollover include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account and consult tax and other advisors with any questions about your personal situation. Uber is a trademark of Uber Technologies, Inc.
Here’s How Other Millennials Are Saving For RetirementHere’s How Other Millennials Are Saving For Retirement Our research indicates that the majority of millennials and Gen Z are saving for retirement, and shows how much they’re saving.
How To Avoid Money FightsHow To Avoid Money Fights If you’re like most people, you probably don’t look forward to talking about finances with your partner. Here’s one piece of advice you can start using today. Couples in healthy marriages are twice as likely to discuss money dreams together. But, discussing money can be difficult, which is why so many couples avoid it entirely. How can you start to have productive, healthy conversations with your significant other? Answer: a monthly financial check-in. Below are tips on how to do it right, and why it works. What’s a monthly financial check-in? A monthly financial check-in is time set aside for you and your partner to talk openly about any financial topics you want. It’s an opportunity to look back on the previous month and to plan ahead for the next month. There are no strict rules on what you can and can’t discuss, as long as it’s money-related. Some common examples might be: Upcoming large expenses: Coachella, friends coming to town, or a wedding. Financial goals: Buying a home, saving for college, or retirement. Important tasks: Updating your W-4, opening a new credit card, or combining your finances in a joint high-yield cash account. Why monthly check-ins work so well. The key is balance. You want to talk about money, but it’s not healthy to have it creep into every conversation. A recurring monthly check-in solves both these problems. Some people don’t like talking about finances at all. A monthly check-in gives you a safe space to start the conversation. Other people think and talk about money all the time, which can be draining on a partner. Unless the matter is urgent, you can make a note and wait to bring it up until the next monthly check-in. 3 Tips To Make Them Effective Choose a fun location: Try a new coffee shop or head to your favorite sandwich spot. Finance isn’t always fun, so tying your monthly check-in to something exciting can help. Set a time limit: Don’t let your monthly check-ins drag on for too long. Talking money can be mentally draining, so try limiting your check-ins between 30 and 60 minutes. Avoid placing blame: For example, if your partner went over budget last month, don’t berate them. Instead, discuss how you can plan better next month. Being smart with money is hard enough on its own. Don’t make it harder by adding relationship stress to the mix. If one of your next financial discussions involves which joint account you should park your short-term cash at, consider opening a joint Cash Reserve account. Start saving for your future together with a high-yield cash account that features a variable rate up to 0.10% *, no monthly transaction limits, and FDIC insurance up to $2 million once deposited at our program banks†. It doesn’t get better than this.
Cash Analysis MethodologyCash Analysis Methodology Betterment's cash analysis aims 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. TABLE OF CONTENTS How We Analyze Your Checking Account Predicting Future Expenses Based on Past Expenses How We Define Extra Cash in Checking Accounts Evolving How We Help You Manage Cash 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. 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 Cash Reserve. 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. Betterment only analyzes expenses that are debited from your checking account, so expenses made through a credit card are analyzed as an aggregated credit card expense, not as individual expenses. For those with multiple checking accounts, it’s important to keep in mind that we only analyze the one checking account linked to Betterment. Predicting Future Expenses Based on Past Expenses We make a prediction about future expenses by looking at your last year of expenses. To get a better idea of your ongoing expenses, we filter out and remove very large, one-off expenses. We consider expenses to be large or one-off if they are over either the greater of $5,000 or the 99th percentile of all your expenses. If multiple expenses occur on the same day, we’ll add all of those expense totals together as if it was all one expense. To make the forecast, we averaged the last year of the combined, filtered expenses and scale by the upper and lower bounds of the forecast period (21 days and 35 days). Our predictions are updated on a regular basis as new expense data is available, which means that you may see them 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 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. We aim 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 Cash Reserve. It is important to note that we assume a cash solution is the appropriate use for any extra cash in your checking account and do not consider whether that money might better be used for investing, or for another purpose, such as paying down debt. Cash Analysis is not available for goals that can be held in Betterment cash or an Investing portfolio strategy. These features can only be accessed through a Cash Reserve goal. 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 cash 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.
Two-Way Sweep MethodologyTwo-Way Sweep Methodology Two-Way Sweep helps make everyday cash management easier to handle by seamlessly moving your extra cash from your linked checking account—and back when you need it. TABLE OF CONTENTS A Recurring Analysis Sweeping in to Betterment Sweeping Out of Betterment An Automated Solution for Extra Cash Betterment aims to help its customers manage their cash and investments more effectively by analyzing external accounts and making smart suggestions about how they could potentially be earning more or saving on fees. In this methodology, we’ll describe how Two-Way Sweep helps make everyday cash management easier to handle. Here’s how it works: Our recurring analysis determines whether your checking account holds enough cash to meet expected cash expenses for the next 21 to 35 days. If extra cash is found, Two-Way Sweep will automatically transfer money from your checking account to Cash Reserve. If your checking account balance falls below the balance we predict you’ll need in the next 21 days, we will automatically move money back into your checking account. A Recurring Analysis The goal of Two-Way Sweep is to seamlessly move your extra cash from your linked checking account to our high-yield cash account—and back when you need it. Two-Way Sweep combines a daily recurrent cash analysis with an automated cash transfer. We believe that a checking account must have enough cash reserves at all times to meet expected future cash expenses, yet this cash amount should not be excessive. Ideally, excess cash should be put to work to earn a yield that’s safe, yet higher than what’s typical in an average savings account. Two-Way Sweep monitors your linked checking account daily and aims to keep the account balance between the lower and upper bounds. How are these bounds defined? The lower bound is computed as an aggregate of 21 days of projected cash expense and recurring account transfers, while the upper bound is computed as an aggregate of 35 days of expense and recurring account transfers. You may also add additional padding to these bounds, which we discuss later in more detail. The range of 21 and 35 days is chosen to minimize the amount of extra cash in your checking account while also providing enough cash to meet expected cash expenses in the near future. You may also set your own target balance range for your checking account if you wish to do so. Each day, Two-Way Sweep will estimate the lower and upper bounds. By balancing what we predict you’ll need in your checking account in the next 35 days with the objective of not holding too much extra cash, Two-Way Sweep helps you earn more on your extra cash by shifting it to our high-yield cash account. No cash transfer takes place if your checking account balance already falls between the lower and upper bounds. Sweeping Into Betterment Two-Way Sweep’s movement of cash into Betterment is essentially automating our cash analysis and using Cash Reserve, our high-yield cash account, as the default destination for your extra cash. As we’ve articulated in this comparison, there may be other products you might also consider for earning a high yield on extra cash, but our cash account’s advantages in terms of yield and liquidity make it an ideal spot for your extra cash within Betterment. Betterment uses cash analysis to repeatedly analyze how much extra cash you may have in your checking account. The decision to sweep money into Cash Reserve is based on whether your linked checking account balance is greater than the upper bound, calculated as the amount of cash needed for the next 35 days of cash expenses. When Two-Way Sweep is activated and extra cash is found, we will move your extra cash, up to $5,000 per sweep, into Cash Reserve. After the sweep is complete, another sweep in will not occur again for at least seven days, as a rule. If you initiate a manual withdrawal from your cash account to your checking account, Two-Way Sweep will be automatically paused for two weeks, with the assumption that you plan to use the funds and don’t want them to be swept back to Cash Reserve right away. We will notify you via email before a sweep takes place. You have until 12 PM EST the following day to cancel the sweep, either through the link in the email, or in your account. Sweeping Out of Betterment Although our automated sweep to put your extra cash to work in your cash account is innovative, the true innovation of Two-Way Sweep is its ability to also sweep cash back into your checking account when you need your extra cash. Identifying When You May Have Too Little Cash If, on any given day, your linked checking account balance falls below the cash amount we estimate you‘ll need in the next 21 days (the lower bound), Two-Way Sweep will transfer cash back to your checking account. The sweep will transfer back enough cash to restore your checking account balance to the midpoint between your lower and upper bounds (as calculated on the day of the transfer). The maximum that we will transfer to your checking account is the total balance in your cash account. If your savings are less than the amount needed to bring your checking account balance back to the midpoint between your lower and upper bounds, we will transfer your full Cash Reserve balance back to your checking account. However, after the transfer, your checking account balance will still be below the midpoint. Moving Cash to Your Checking Account If our daily cash analysis finds that you have less than 21 days of expected cash expenses in your checking account, Two-Way Sweep will start the process of automatically moving cash into your checking account from Cash Reserve. If, during the transfer period, our cash analysis finds that your checking account balance is now sufficient (or if extra cash is now detected), the transaction will still continue to process. While a transfer is in progress, we will not initiate any additional sweeps, either to or from your cash account. If, on the day after a sweep into your checking account completes, our cash analysis again shows that your balance is low, Two-Way Sweep will initiate another sweep from your Cash Reserve account to your checking account. We will notify you via email before a sweep takes place. You have until 12 PM EST the following day to cancel the sweep, either through the link in the email, or in your account. Setting a Custom Target Balance Range If your bank requires you to hold a minimum balance, or you are aware of expenses that are not accounted for in our prediction of your lower and upper bounds, you can set your own target balance range for your checking account. This gives you additional control and flexibility to set a range that works for you and that you are comfortable with. Note that Two-Way sweep does not guarantee that your checking account balance will not drop below the lower bound. An Automated Solution for Extra Cash Two-Way Sweep is an automated solution for reducing cash drag in your checking account. It monitors your checking account and estimates future cash expenses on a daily basis with the goal of maintaining a checking account balance that’s within an optimal range while also putting any excess cash to work. Two-Way Sweep takes advantage of Cash Reserve to earn a yield that’s above the usual rate offered by an average savings account.
Manage Your Cash the Modern Way With Two-Way SweepManage Your Cash the Modern Way With Two-Way Sweep Manage your cash the modern way—effortlessly. Try out Two-Way Sweep, our latest in cash management technology. Most of us organize our day-to-day financial lives using three different accounts: a checking account, a savings account, and a credit card. The Headaches Of Cash Management After paying bills and paying down credit card balances each month, you may accumulate extra cash in your checking account. Over time, if you leave this extra cash in your checking account, it will likely lose value to inflation, and you may wish to move that extra cash to an account that earns a higher yield over time. On the other hand, if you find that you end up spending more than your income in a given month, you may need to move cash back from your savings account (or from another type of account) to your checking account. If you choose to manage your cash manually, not only would you have to take time to move money back and forth, but to get the most out of your hard earned money, you may also end up spending your time comparing banks to find the best yield for your savings account. Does all this sound like the perfect job for a computer? It is. Two-Way Sweep Provides A Solution The next evolution of cash management for Betterment customers is here. By working alongside our cash analysis recommendations and Cash Reserve, Two-Way Sweep minimizes the need for tedious manual cash management practices. Two-Way Sweep automates transfers between your checking account and our Cash Reserve account so that idle cash you might have in your checking account is moved to help earn a higher yield. Conversely, if we detect insufficient funds in your checking account for your expected future spending needs, Two-Way Sweep will move cash back to your checking account from Cash Reserve. Now you can have a personal cash management tool that helps you earn a high yield on money that may otherwise be sitting in cash, and also aims to keep enough cash in your checking account to cover expected future cash needs. Ready To Try The Latest Technology? We have automated cash management by addressing two competing objectives: increasing returns on idle cash while sufficiently funding your checking account to cover expected future cash needs. Get started or log in to access Two-Way Sweep in your Betterment account. We’ve also got all your Two-Way Sweep questions covered in our methodology and our comprehensive overview.
What is Dollar-Cost Averaging?What is Dollar-Cost Averaging? Although it’s not always the most optimal investment strategy, choosing to dollar-cost average into the market has behavioral and psychological benefits that may help you over the long run. Dollar-cost averaging (DCA) is the practice of regularly investing a fixed amount of money over a period of time, regardless of market activity. For example, if you choose to invest $100 on the 15th of the month, every month for 1 year, you would be implementing the investment strategy of dollar-cost averaging. You don’t vary the dollar amount you choose to invest ($100), or the timing of the investment (on the 15th of each month), based on market activity. Types of Dollar-Cost Averaging There are two types of dollar-cost averaging: voluntary and involuntary. Voluntary DCA is when you have a specific amount of cash to invest, but are choosing to parcel it out over a period of time, rather than investing it all at once. Involuntary DCA is when your ability to invest depends on when you have the money to do so. Perhaps you set up auto-deposits, so that you can invest as you earn more money over time with each paycheck. The major difference between these two types of DCA is that involuntary DCA implies that you could not have invested sooner, while voluntary DCA is an investment strategy where you could have, but chose not to. Real Life Example Let’s pretend you have $1,200 sitting in cash that you can invest right now. You choose to invest that $1,200 by investing $100 per month for a period of one year. This would be an example of voluntary DCA. Now, let’s pretend you don’t have any money to invest right now, but through your paychecks you earn $100 per month that you could invest. You invest $100 per month for a period of one year. This is an example of involuntary DCA. Should You Dollar-Cost Average? This question really only applies to voluntary DCA and not involuntary DCA. If you don’t have any money sitting around to invest, then you’ll need to wait until you have the money to invest. For involuntary DCA, the choice becomes whether to invest that money as soon as you earn it, or to let that money build up over time so that you can invest the entire balance. An optimal strategy for involuntary DCA is to schedule auto-deposits as soon as you get paid. If you do have money sitting around to invest, the question then becomes, should you invest it all right away, or should you DCA it into the market over time? There are a couple of answers to this question. The Head vs The Heart The expected total return of markets is positive over time. Therefore, from a purely unemotional investment strategy perspective, it makes sense to invest your cash immediately and not DCA into the market. Studies show that a lump-sum investment will outperform DCA roughly two-thirds of the time and will consistently outperform DCA across global markets. Yet, we all know that leading with the head is easier said than done. Luckily, following one's heart can come with its own set of benefits. Since DCA is a fixed rule, independent of market performance, it is unemotional, diversifies your purchase price, and makes you less susceptible to the counterproductive behaviors people often have when investing. More specifically, DCA can make you less susceptible to the disposition effect, which is the tendency to sell assets that have increased in value, while keeping assets that have dropped in value. People significantly dislike losing more than they like winning, which is more formally known as loss aversion. This goes hand in hand with helping to reduce your susceptibility to anchoring bias, which is when you attach yourself to an irrelevant stock price and begin making investment decisions based on that irrelevant stock price at a later date. Additionally, DCA can prevent you from trying to time the market—which is generally a losing investment strategy over the long run. It also minimizes your chances of feeling regret and may reduce any potential anxiety that you “bought in at the top.” Maybe most important of all, DCA can help you establish good investment habits. After all, choosing to DCA into the market is better than never investing your cash at all. Make A Decision To recap, if you have a pile of cash sitting around to invest, studies show that investing it all right away is the optimal decision the majority of the time. However, choosing to voluntarily DCA into the market has many behavioral and psychological benefits that can have a positive impact on your investing behavior. The most important thing is picking your approach and getting started. It’s better than doing nothing and leaving your cash out of the market completely.
Plan Ahead When Saving For VacationsPlan Ahead When Saving For Vacations We’ll help you plan and save so you can stress less about your bank account while you’re on the beach, on top of a mountain, or wherever else your travels take you. Taking a vacation isn’t something that should make you feel guilty. Unplugging from work can help you connect with your loved ones, the world around you, and even yourself. Here at Betterment, we recognize this with policies that encourage work-life balance for our employees. Thankfully, our financial advice can help you, too. When you’re prioritizing your financial goals, consider any vacations you plan to take in the future. Perhaps you know you’ll have to travel for a wedding next summer, or your family always takes an annual summer vacation when the kids are out of school. Don’t make the mistake that 55% of Americans make—forgetting to budget and save for an expected vacation. As your financial partner, Betterment can help you plan so that you can be a smart investor and get some well deserved relaxation. How To Plan A Vacation I live in New York City, so when I think about a vacation, I often think about pristine white sand beaches and serene ocean views. Let’s say you were planning a hypothetical vacation to the beaches of Florida next summer: we’re going to walk through the setup of a major purchase goal so that you can see exactly how Betterment helps you prepare. First, let’s talk about cost. Although the cost of a vacation can vary greatly depending on your destination, the price tag of the average vacation is about $1,145 per person. For a family of four, this would increase fourfold to a total of about $4,580. These figures will frame our discussion today, but make sure to do your own research on your desired destination before setting up your vacation goal in your Betterment account. Know that if costs change, your goal can be adjusted and updated at any time. Setting Up A Major Purchase Goal After choosing a destination and determining the cost, the next step is to set up a major purchase goal, either on the website or through the mobile app. Simply using a goal-based system to save and invest for a vacation can help you actually achieve that goal—among other benefits. Let’s name the goal “Florida Vacation” to stay organized and differentiate it from other savings goals. If you wanted to take this vacation in the next year, set the time horizon for one year, just in time for next summer. Assuming that you’re traveling alone, select the average vacation cost of $1,145 for the target amount, knowing that you may end up needing more or less, depending on what flight and hotel deals you’re able to find. As shown above, Betterment has selected a risk level for you that’s 24% stocks and 76% bonds. This risk level is based on the amount of time you’ll be investing for, which is only one year. Generally, the shorter your time horizon, the less risky you’ll want to be with your savings. Auto-adjust is also selected by default, which means that the risk level will automatically be dialed down even more as you get closer to your vacation date. Reviewing The Possible Outcomes As shown in the screenshot below, after setting up the target amount, time horizon, and risk level, you’re then presented with a graph that tells you the earnings over the designated time period under certain levels of expected market performance. You will likely meet your savings target plus an additional $6. That’s good, because airport coffee can be expensive. If the market performs poorly, Betterment’s technology predicts that the growth projection is $45 less than the target. This means that you would likely need to make some minor last-minute adjustments to your plans (for example, taking public transportation to and from the airport rather than a cab). Regardless, you can still feel good knowing that you’re saving most of what you might need. Automating Future Deposits Most importantly, the screenshot above demonstrates how Betterment also recommends a monthly deposit amount you should be putting into the goal so that you can reach your target of $1,145. It looks like a monthly deposit of $94.49 is the recommended amount according to Betterment, although you could always split it in half and set up auto-deposits to occur when you get your paycheck (every two weeks, bi-weekly, etc). Because this is the one of the most recommended ways to set up auto-deposits, you should choose the option that aligns with your pay schedule. For a family of four, coming up with $4,580 to drop on a summer vacation might seem like a challenge when thinking about all of your other expenses. However, breaking it down into “per-paycheck” deposit amounts over a year period makes it seem more manageable. For a Betterment major purchase goal that’s set for a one year time horizon, and a target amount of $4,580, the recommendation is a monthly deposit of $377.95. Split between two paychecks per month, and even between two spouses, the “per-paycheck” savings per spouse would be about $94.49. As you can see, it pays to plan ahead. If you don’t have a Betterment account yet, there are no upfront costs associated with signing up to create your own major purchase goal. Take a look at the advice and play around with different target amounts and time horizons. If you do decide to invest your savings with us, our management fee of .25% offers unlimited access to automated portfolio management, Tax Smart investing features, personalized financial dashboards and customer support. In a year’s time, you will thank your past self for taking the time to set up a major purchase goal and automating your deposits. I suspect that your family will, too.
How To Invest When You Have Family Members With DisabilitiesHow To Invest When You Have Family Members With Disabilities Having family members with disabilities requires lifelong planning that might not be easily addressed by typical financial planning advice. Planning appropriately for their lives can ensure they are protected and secure. If you have children or other family members with disabilities, one of your most precious financial priorities may be providing security for your loved ones. As a caretaker, you may be able to provide attention and financial stability during your lifetime but there are a different set of challenges to overcome if you are to pass away. Special Needs Trusts are an extremely beneficial tool that can ensure that your family member will be taken care of and provide you with peace of mind. What Is A Trust Account? Generally speaking, a trust allows an individual - otherwise known as the grantor - to provide specific guidelines on how funds that are placed in a trust can be used. Essentially, a trust allows the grantor to have more control over what happens to their assets after they pass on, while also providing unique estate and tax planning benefits. Along with the grantor, there are two other major players involved with the creation of a trust: A trustee, who is an individual or group of individuals charged with the responsibility of adhering to the rules outlined in the trust documents by the grantor. A beneficiary, who is the person or person(s) that are entitled to the trust’s assets. In most circumstances, the grantor, trustee, and beneficiary are different people; in some cases one person can play multiple of these roles. There are two broad categories of trusts: revocable (able to be changed) or irrevocable (not able to be changed and considered to be a final gift). Special Needs Trusts Benefits Special Needs Trusts provide three specific advantages for a beneficiary with disabilities. First and foremost, the creation of the trust allows you to set aside funds in a specific vehicle that is intended to support your beneficiary with disabilities. Additionally, you have the luxury to hand-select the trustee who will manage finances accordingly when your beneficiary otherwise may not be fit to manage this on their own. Finally, by having assets placed in a Special Needs Trust, you can ensure that government benefits, such as healthcare coverage, Supplemental Security Income (SSI), rent subsidies, and job assistance, will still be available for your loved one. Many of these public programs have financial limitations that could prevent someone with disabilities from receiving benefits. For example, someone may be eligible for SSI, but if they have assets in their name of over just $2,000, SSI is not available. A Special Needs Trust can shield those assets and keep your beneficiary eligible to receive SSI. These types of government benefits can be extremely valuable for someone with a disability to help make sure they have an income stream and a place to live after you have passed. To be effective, a Special Needs Trust should be irrevocable, otherwise these benefits may be at risk. Types of Special Needs Trusts There are three types of Special Needs Trusts: First Party The assets in a first party Special Needs Trust rightfully belong to the person with disabilities. Commonly, this pertains to inherited assets, settlements, or windfalls - even their own personal savings. As long as these funds are held within the Special Needs Trust, the beneficiary can still qualify for government benefits. During the beneficiary’s lifetime, funds in the trust can be used to pay for the needs not covered by government program support. When the beneficiary passes away, any remaining funds must be paid back to the government, up to the amount of Medicaid care that the beneficiary had received during their lifetime. Third Party A third party Special Needs Trust can be established by any parent or family member of someone with disabilities. The grantor gifts their own assets into the trust, such as bank or investment accounts, that can be used during the beneficiary’s lifetime to cover their needs. Like the first party trust, the third-party trust doesn’t negatively impact the beneficiaries ability to receive government benefits. However, unused funds at the end of the beneficiaries lifetime do not have to be paid back to the government. This allows grantors to ensure that their beneficiary with disabilities is taken care of first, but then funds can be left to other family members after. Pooled In first and third party Special Needs Trusts, you must appoint a trustee(s). If you don’t know an individual that you are confident can act responsibly as a trustee, a pooled trust allows you to name a charity as manager. Funds for multiple beneficiaries are pooled together for investment purposes, but each beneficiary has their own respective account. At the end of the beneficiary’s life, there is a payback clause to the government for Medicaid benefits, and the charity will also receive payment for managing the trust. Managing A Special Needs Trust At Betterment Trustees have a long list of responsibilities, including a fiduciary responsibility to make sure the trust’s assets are in a sound investment plan with the right risk profile that meets the needs of the beneficiaries. Betterment trust accounts can be ideal for trustees who seek a professionally managed portfolio with a hands-off approach. Betterment will provide automated fiduciary advice that includes risk recommendations, a diversified investment portfolio, automated rebalancing, tax-efficiency, and low fees. As trustee, you can create multiple goals for an individual trust, allowing you to customize investment needs for each financial objective. For example, this means that you can invest funds for short-term and long-term needs at varying risk levels. Additionally, our platform allows you to manage multiple trusts at once, and you can access them all from one single login. While Betterment can help trustees invest trust assets appropriately, we are not able to help in the creation of a new trust. If you are considering establishing a Special Needs Trust, we recommend seeking the guidance of an estate attorney.
How Banks Fail in Helping You Save MoneyHow Banks Fail in Helping You Save Money You may not realize it, but our financial lives are shaped by a great divide: banking vs. investment managers. In between lies most people’s pinnacle challenge: saving for the future. I have the good fortune of being able to question the institutions that shape my financial life. I studied economics in school. I earned a CFA credential while working in consulting. I started a financial tech company when I found problems that the industry seemed content to leave unsolved. But not everybody can afford to question the institutions they work with. To most Americans, the bank is the bank. It’s where you put your paycheck, who you talk to for a car loan, what form you look at when you file your taxes. Your 401(k) is your 401(k); who provides it, what the investments are, what fees are charged—these are questions that most people only get to ask on occasion, if they ask them at all. Today, I see millions of people tied to two kinds of institutions often misaligned to their needs. The first is banking. Neither banks nor credit unions have a fiduciary duty to put their clients’ interests first. Instead, they have a proclivity for charging extra fees and an unjust ability to earn profit on the rates loaned out by the Federal Reserve as their clients lose their savings to inflation. The second is investment managers. Whether a 401(k) plan, an advisor, or a broker, investments are still designed mostly for institutions and the wealthy, and the managers are often far too focused on asset allocation when Americans’ real financial outcomes are most determined by savings. While I have critiques for each group, the greatest problem to me is the fact that there are two. Somewhere in between their bank and their investment manager, Americans lose out on the most important element of finance: Saving their cash. Make no mistake; your savings is what matters. It’s what matters when paying down debt. It’s what matters for starting a business. It’s what matters for securing a healthy retirement. And yet, banks typically don’t help you become a better saver; they encourage holding cash at the ready for spending and sell you loans when you don’t have enough. Meanwhile, most investment managers pay little attention to your saving; they focus on larger deposits, like retirement money withheld from a paycheck. Between working with a bank and an investment manager, we, as a nation, fail to save enough for the things we need. The everyday American deserves a cash advisor. The truth about the future is that saving is all we have. Younger generations can’t count on Social Security the way Baby Boomers still do. And the pension plans of yesteryear are gone. Not only that, students today are graduating with more student loan debt than ever before, and no other part of life is becoming cheaper. Houses, cars, kids—they’re all becoming more expensive, not less. The average American aged 35-44 has $133,100 in debt according to Money. As a nation, we’re mostly deep in the red, not the black. To avoid debt, to save enough for retirement, to successfully navigate inevitable emergencies, Americans need a partner who has their best interests at heart not just in investment advice but for managing their cash. For helping you manage the day to day, so that, at the end of the month, you’ve actually saved more for the future. We need a cash advisor perhaps more than any other kind of financial advisor. For years, RIAs have encouraged their clients to outline their financial goals, to set a budget, and to save enough to fund each of their goals. But what have we been able to do to help ensure our clients’ success? Coaching, support, suggestions—yes, RIAs have led in this arena. But is it working? Americans today are saving less than they ever have. And even worse, they’ve seen limited wage growth and increasing inequality at the same time. Forget budgeting. Cash advice must automate the act of saving. What investment managers and banks silently have agreed on is that saving each month is the client’s responsibility. It’s the client’s money, and so, it’s theirs to set a budget. To me, the suggestion to “set a budget” is a failure of advice. It implies a lack of empathy for how a wallet really works or how human minds decide to spend. These are the facts: The world gives us many reasons to spend, and it offers far fewer reasons to save. Store sales. Credit card rewards. Low interest rates. The world creates many reasons to buy things. Meanwhile, no part of the industry solves saving. Banks and investment managers leave it to their customers to solve. The solution is having an advisor that puts the work in to do what real humans struggle with: Automating your savings. Helping to keep your spending in check. And nudging you toward your long-term goals. Ask any financial engineer and she’ll tell you that predicting the right level of cash you need each month is no great feat. As predictive modeling and advanced technology goes, your cashflow isn’t a big mystery. The choice to build that business so that everyday Americans can live better? Now, that is a different story. America’s future depends on how we save cash. Who will solve it? You can look at national debt, student debt, Social Security insolvency, or growing income inequality. As a country we need ways to help people save, and so far, the answer I see suggested most is Mint, a budgeting tool from Intuit that only helps if you’re already good at budgeting to begin with. And if you’re not, it mostly serves to sell you credit cards or investment apps. And I don’t blame Mint; it’s great for budgeting, just not for the reality of saving. Will you trust a bank to help? Maybe one of the new online banks or app-based banks? Banks have every opportunity to change how we save for our goals, and yet, they won’t. They thrive when you’re using your debit cards and taking out loans. They love it when your savings sit growing at less than 1% while they’re loaning your money at 4%. When we, as a nation, need every ounce of the risk-free rate we can get to save for our goals, banks prove again and again that they’re not problem-solving, they’re taking advantage. So, who would you rather work with? The solution I see is that we have to turn to those whose interests align with our own. I want to see fiduciaries get into the business of managing cash and savings. I want registered investment advisors and CFP® professionals to become true cash advisors. To use innovative technology at scale. Yes. To drive empirically better behavioral outcomes. Absolutely. To make a profit. It’s a must. But, at the core, we need advisors acting in their customers’ best interests; not just for already-wealthy individuals, but for everyday Americans looking to save their way to wealth.
Lifestyle Creep: The Biggest Threat to Financial PlanningLifestyle Creep: The Biggest Threat to Financial Planning Lifestyle creep can severely impact financial planning by spending more income over time than we plan on saving. For the median person making $57,000 a year, it sounds ludicrous that others making $500,000 feel like they’re ‘scraping by.’ However, they’re humans just like us: we might find ourselves in a similar position in the future. How can we avoid excessive spending ruining our future? In this article, I will discuss the idea of “lifestyle creep”: what it is and how to realistically plan for it, how you can level expectations for earnings throughout your lifetime, and practical ways to avoid overspending gradual income raises. What is Lifestyle Creep? Income usually increases in irregular little jumps: 3% this year, 8% that year. After taxes and inflation are accounted for, the take-home difference is even smaller. So it seems harmless to use the extra cash to upgrade our apartment, car, sofa, TV, buy more takeout… There is always more you could spend money on. The problem isn’t the amount of money: it’s a combination of human behavior and the defaults in our financial system. When our income increases, by default, our saving rates decrease. Usually, the paycheck rolls into a deposit account and it’s spent. Spending more today is easy and pleasurable; saving more requires effortful planning. Two caveats to what I’m about to say: If you’re at a low income level, spending most of your income makes sense: a warm coat, a safe home, and reliable transportation are worth it. I’m discussing enjoyable spending only. A new home, car, food, clothes, phones, are all fair game. When daycare for my daughter, life insurance, and my mortgage end, I won’t feel worse. Lifestyle creep is one of the biggest invisible dangers to retirement plans. Why? Your requirement for ‘enough’ goes up. Downsizing our lifestyle is very unpleasant. People will take extreme actions to avoid it, including choosing risks and acquiring debt. It takes a strong person to voluntarily reduce their spending when they lose their job or take a pay cut. And increasing your lifestyle means you’re constantly raising the table stakes for contentment higher. It can blindside you long before retirement: a larger lifestyle means a larger emergency fund, further to fall if you lost your income, and more pressure to keep a high paying job you hate. One of the best ways to protect yourself against the pain of future income drops is to keep your lifestyle modest, which can give you breathing room if you want or need to have a lower income for a while. It also increases career options: I took a serious salary cut for a job once, which was okay because I had kept my lifestyle humble. A happy retirement gets more expensive. At retirement, you’ll probably want to maintain your previous lifestyle, or even bump it up temporarily by doing more traveling. By my estimate, for every additional $100 in monthly lifestyle spending you start having before retirement, you’ll need about an additional $30,000 at retirement to keep steady. It really is simple: An additional $100 per month x 12 months per year x 25 years in retirement = $30,000 Now, let’s analyze what that looks like depending on different levels of lifestyle creep. If you’re 25 years old making $40,000 a year, with a 60th percentile lifetime earnings—and who can earn a 1% in returns—then how much will you need in retirement savings if your lifestyle creeps upward? That’s what I show in the figure below (the horizontal axis shows lifestyle creep). Just look at it for a moment: Someone in that situation who spends 80% of their raises needs a retirement balance that is 41% larger than somebody who only spends 20% of their raises. While yes, there are some easy criticisms of this analysis—not including social security, spending on children that ends, possible investment returns, or taxes—the fact is, lifestyle creep’s impact on retirement is complicated enough as it is. And perfect is the enemy of what’s clear and understandable. The figure above shows a hypothetical simple view of the required retirement balance needed based on increases in “lifestyle creep” or current pre-retirement spending. This analysis is based on the simple scenario described above of a person making $40,000 per year and who earns 1% in returns as if earned in a savings account that isn’t subject to market changes. Neither the base scenario or percentage increases shown in the figure account for the impact of taxes or market changes. A few assumptions we made: The 25 years old we described will retire at 65 years old and plans to live until 90. We also accounted for taxes. We simulated gross income reduced by appropriate Federal, Social Security and Medicare, and a fixed 5% state tax rate. Lifestyle creep ruins your future savings plans. When we see how much we need to save for retirement, it can seem like it’s too much, we can’t afford it. And that since we plan on earning more in the future, we can save then, right? Yes, this can work out if you stick to it. But saving more tomorrow means saving a significant proportion of your increases, which requires a lot of self control. Challenges To Keep in Mind So, our challenge is to be intelligent about: How much we’re likely to earn over our lifetime, now and in the future. How much we will spend and save, now and in the future. How to set ourselves ourselves up to have a path over our lifetime through retirement which is robust to income and expenditure shocks. Have realistic lifetime earnings expectations. At 50 years old, the median individual earned slightly twice what they earned at 25 before tax, according to the Federal Reserve Bank of New York. However, that’s the point of greatest difference: after about 55, the earnings ratio begins to drop. The graph below shows a summary of earnings curves from the same paper with data on millions of American workers divided up by their lifetime earnings percentile. While we can’t predict what lifetime earnings percentile we’ll fall into, we can use these data as a guide. Over time it seems people either work fewer hours or a less financially rewarding job. This may or may not be voluntary: it could reflect changes in life priorities or job options available as the demand for specific skill sets decline in an area. Whatever the cause, it means less potential savings. Saving more vs. spending more: the balance act. You can run numbers to see how earning and saving more in the future is reasonable. Let’s consider the same typical 25 year old with no retirement balance, earning $40,000 a year, spending their full, likely after-tax income of $32,612. Again, we’ll assume they’ll be in the 60th percentile of lifetime earnings. Let’s look at 30% lifestyle creep. Each time they get a raise they save 70% of it and spend 30%. When their income starts declining later in life, they don’t spend less because their lifestyle spending has magnified. As a result, their highest savings rate happens at 50 years old, and they’re actually saving nearly nothing the year before retirement - they’re spending it to keep up with their lifestyle. Pre-retirement they’ll be spending $40,399 per year (adjusted for inflation). To maintain that standard of living for 25 years in retirement would require a $842,025 balance. Let’s assume a 1% real rate of return over the entire investment period. At retirement our example will have saved a total of $427,810, which has grown to $516,730. That’s not going to hit their $840,000 target balance. How much lifestyle creep could our youngster bake into their financial plan, and still be ok? It depends on the return they will experience. Reasonable returns you could plan on. Acceptable lifestyle creep is very sensitive to the expected real return. Remember, real returns mean inflation has already eaten away about 2% of your growth. With a Betterment portfolio, you would need a portfolio with 45% stocks, 55% bonds to have an average expected return of 3.5%, and that comes with an expected 9.4% annual volatility (those are our actual projections). The graph below shows that the individual can hit their target retirement balance with a 4% or higher return, but with anything less, they’re in trouble. Putting this all together, below I show the minimum return required to support any given level of earnings growth and lifestyle creep. For a person with median earnings growth, a conservative 2% real return yields an acceptable lifestyle creep ratio of 5%. You should save 95% of each raise you get, starting from 25. Practical Ways To Avoid Lifestyle Creep So what can we do to avoid the lifestyle creep trap? As long as you’re willing to live intentionally and thoughtfully, there is a ton you can do. It’s a very manageable problem. Escalate your savings rate. Evidence has shown that escalating your savings rate over time is one of the best ways to avoid spending what you should be saving. I like to do this both when I get income increases (I usually dedicate 75% of any raise to saving), and by small amounts over time so I don’t notice the loss of spending. If you have a way to do this automatically, either through your 401(k), payroll, or your financial advisor, that’s even better. Choose your peers and environment wisely. The best way to make someone go bankrupt is to have their next-door neighbor win the lottery. It’s very hard for us to resist trying to keep up with our peers, so be thoughtful about who you spend time with. Could you live in a less expensive house or apartment? Could you move to a neighborhood where your economic standing is in line with that of your neighbors’? When you vacation, could you choose inexpensive settings like outdoor trips and small cities? Spend time with people who value conversations over carats, books over Bugattis, and closeness over square footage. Mr. Money Mustache and Morgan Housel are wonderful at showing the joy in needing less. Cultivate a taste for inconspicuous consumption. It’s trivial to see that someone has an expensive car, watch, handbag, clothes, etc. Don’t be fooled by the surface: you can’t see if they’re in debt, or have no retirement savings, or how much they learned and shared last year. The longest lasting and most joyful experiences are rarely defined by their cost: a walk in nature; getting lost in a book in a cozy pub; helping someone overcome a challenge; a late running dinner with just a bit too much wine and good friends. Feel free to consume as much of these as possible: they’ll just set you up for an even more enjoyable retirement.
How Much to Save: Our Advice Guides You Towards Your GoalsHow Much to Save: Our Advice Guides You Towards Your Goals A good financial plan has to adapt over time to be successful. Here’s how Betterment helps you do that. Voyager 1 and Rosetta were two very different space probes that achieved their missions in my lifetime. How they accomplished their missions is a lesson in planning. Voyager 1 was a bullet. Aim. Adjust for wind, gravity, friction. Fire. Pray. When Voyager was launched in 1977, we needed to get everything exactly right. Once it left Earth, it’s fate was sealed. Whatever path it would take… was set. A lot of unexpected events can happen across the millions of miles it was set to journey. Rosetta’s mission was magnitudes harder: it had to catch a comet. Launched March 2, 2004, Rosetta took 14 years to accelerate and catch it’s target. It used a lot of the same methods as Voyager, but finding the right path to take with so many moving bodies in the inner solar system is orders of magnitude harder than the bullet shot that was Voyager 1. Rosetta needed the ability to adjust as time went on and to deal with unforeseen changes. Rosetta was a guided missile: over half of its launch weight was taken up by fuel. That cost a lot at launch time, but it gave it the ability to adjust along the way, to make course corrections, and to opportunistically change its future position. It could avoid obstacles that would have ended Voyager. "Voyager 1 and Rosetta were two very different space probes... How they accomplished their missions is a lesson in planning." How Voyager and Rosetta were managed reflect different approaches to planning, including financial plans. My life now is so different than what it was five years ago. I have a dog, a mortgage, and a child. I work for a startup. I can’t imagine what my life will be like 5 years from now. I can’t plan like Voyager, I have to plan like Rosetta. So, when I plan, I need to expect some future flexibility: Some ability to opportunistically make the most of circumstances when they come up. The humility to let go of some ambitions when my priorities change. How Betterment Guides Your Investment Deposits One of the questions Betterment helps customers answer is “How much do I need to save?” We could provide you with a simple number, say $750 per month. That number is a bullet calculation. It will likely never be perfectly right in hindsight. For any given goal you set up at Betterment, our own advice and projections forecast that there is roughly a 20% chance you’ll be within ± 5% of your target balance if you took our initial advice and never refreshed it. But, since there’s a 60% likelihood of reaching your target based on our initial deposit recommendation, our saving behavior needs to be future-flexible—to account for how the future actually pans out. So what does being future-flexible look like? How much extra fuel might you need? In this article, we describe how our deposit recommendations really work. We make deposit recommendations by simulating possible futures. The analysis we’ll describe in this article—the analysis that informs how much we recommend you deposit—is based on our hypothetical simulations of Betterment’s recommended portfolios’ expected investment returns, because that assumed rate of growth informs how much we recommend you deposit. We do simulations to be highly realistic about our deposit advice. Not only that, we simulate the portfolios’ returns using our standard projection methodology taking into account our advice for portfolio allocations based on your goal, and assumptions about an individual’s savings behavior. In this article, to make our examples easier to understand, let’s assume your goal is for a major purchase with a target of $100,000 in 10 years. To be clear, our simulations, which are month by month, will assume that your portfolio follows our recommended portfolio strategy and target allocation. They also assume that the hypothetical returns include immediate dividend reinvestment, which is built into how Betterment operates—and a flat 1% risk-free rate of return. Further, we assume performance is net of the 0.25% annual management fee. The different scenarios you’ll see come from the distribution of possible expected returns. We generate 100 such portfolio return paths, and then for each path simulate the behavior of an individual using either a ‘regular’ deposit strategy or a ‘ratchet’ deposit strategy. In the ‘regular’ case, the individual saves the amount we recommend every month. In the ‘ratchet’ case, she saves the greater of our recommended amount, or their previous months amount. The recommended amounts vary based on the simulated portfolio performance. Since this is an illustration of how deposit recommendations should work—not actual portfolio performance—we’ve simplified for your convenience. Remember that these simulations should be considered illustrative and hypothetical. It’s better to be precisely right than approximately wrong. Let’s start by looking at how our savings advice might change over time. We’ve done a single backtest before that examines a possible poor market scenario, but a more thorough analysis, like a Monte Carlo simulation, offers a much richer view of how advice should change in response to future scenarios. The charts below show how we’ve put this kind of analysis into action at Betterment in our advice on saving. Our recommendation changes over time in response to positive or negative market movements. Underlying our simulation is an investment goal ten years away with a target stock-to-bond allocation that follows our recommended moderate glidepath. You can see that there is a wide spread of recommended monthly deposits over time and that most paths involve changing how much you save. In general, that’s not a bad recommendation because most of us are likely to make more money over time. Gentle increases to how much we recommend depositing makes for fairly acceptable advice. Yet, notice the far right side of the figure. If you were to experience poor performance leading up to the date of your goal, the only thing we can do is recommend to increase your deposit abruptly. The figure above shows Betterment’s recommended deposit amounts for a sample goal following our glidepath. The figure is based on the hypothetical simulations mentioned above, and is meant to show how our auto-deposit recommendations are likely to vary over time due to realized returns being higher or lower than planned for (based on our own projections). The graph is in no way meant to guarantee any type of investment performance. When we analyze such problematic possibilities in these unfriendly scenarios, we can start to find ways of making the smart pivots of a Rosetta-like journey. For instance, let’s assume any increases of >2% per year more than our starting recommended deposit amount are unacceptable (i.e., too much acceleration), and any increase of more than 6% over a 12 month period is also unacceptable (i.e. too much jerk—read more). Using these assumptions, we see unacceptable change at some point in time in 55% of the possible scenarios. Let’s be honest: that is a high rate for having to change your savings amount up by an unexpected and unacceptable amount. As an advisor, we don’t like making that kind of recommendation, and as an investor, you’re not likely to be able to follow it. Instead of settling for such a high hit rate, we should expect to have to change over time and let those expectations shape our advice on how much you should save and invest. Making More Rosetta-like Savings Recommendations What can we do to help reduce the need for these bumps up and down? How about a simple behavioral strategy, called a savings ratchet. A savings ratchet means you increase how much you save when you have to, but never decrease it afterwards. Below we show the month-to-month changes from a regular (downward adjusting) strategy versus a ratchet (only adjust upward) strategy. The figure above shows Betterment’s current recommended auto-deposit amounts for the hypothetical sample goal used in the simulations. It shows how our recommendations are likely to vary over time due to differences in projected and actual returns. The “ratchet” is a variant of Betterment’s savings advice, which will only increase over time, as explained below (versus regular goal savings advice that might decrease auto-deposits for a variety of reasons). The “ratchet” figure is hypothetical in nature, and not meant to guarantee any type of investment performance. Rather, it is meant to indicate how a “ratchet” strategy recommends only increasing deposits over time. As shown in the graph, ratcheting savings rates can produce greater final portfolio values, with only slightly more in total deposits. The ratchet uses market downturns as catalysts to help save more, but it doesn’t use performance above expectations as a reason to save less. As a result, future market drops can have a much smaller effect, and we don’t need to save more. The hypothetical ratchet strategy above sees unacceptable increases in only 24% of the simulations we ran, or less than half the original strategy. This chart shows final portfolio values for the simulations described above. You can see that for the total deposits made using a ratchet strategy, the range of final portfolio values has a broader possible range, compared to the regular strategy. However, please note that these are only simulations, and do not fully reflect the chance for loss or gain. Actual results of applying these strategies can vary from the results above. A missile like Rosetta makes the most of ongoing optionality. So does Betterment. Optionality is when you reserve the right to do something in the future, like when you pay for just the option to buy a certain security at a certain price in the future. Financial plans shouldn’t be bullets like Voyager 1: we’re likely to miss if we actually set it and forget it. Plans should be guided. But we need to strategically use fuel—our deposits—in a way that maximizes optionality in the future. Optionality isn’t free. A ratchet savings strategy does require more in deposits over time. But the optionality has value in that the other choice is to stick with the relatively high possibility of needing to deposit more than you have to reach your goal too close to its date. In the case of Betterment’s deposit recommendations and our advice for saving in general, we try to guide toward greater optionality: Maximizing your ability to adjust your goals as they change and re-prioritize where your savings are going. Sometimes that means realizing you won’t achieve certain goals you care about. But often it means purchasing some future optionality you’re not sure you’ll need. This post was inspired by The Constant Reminder and Hurricanes and Retirement.
A Smart Way to Boost Your Retirement Savings (Hint: More Income)A Smart Way to Boost Your Retirement Savings (Hint: More Income) Thanks to the recent recession, and the slow job market recovery, it is little surprise that many are turning to side projects and hobbies to earn a little extra money. With a plan, a few extra hours a week, and a decent amount of effort, it's possible to start a small side business, or monetize your hobby. What's difficult is managing your time once you start adding multiple projects into the mix. Turn Off the TV According to the American Time Use Survey (2011) the #1 leisure activity of those 15 and older is watching TV. On average, Americans watch 2.8 hours of TV per day. That's almost three hours. Most people come home from their regular jobs, maybe eat something, and then plop down in fornt of the TV for the evening. Even if you don't watch TV for that long each day, stop and think about how you are spending your time. Do you spend a lot of time on Facebook? One of my problems is that for the longest time novels were my TV. I love a good fantasy/sci-fi adventure. But I'd spend three or four hours a day reading these books that did little beyond entertain me. Keep a time diary for a week or two, and be scrupulous about recording how you spend your time. When I did this, I was shocked. There's nothing wrong with taking an hour or so to yourself to unwind each day, but I was spending three hours at a time entertaining myself. No wonder I was always falling behind! Realize where your time-sucks are and remedy the problem. Instead of watching TV for almost three hours when you get home from work, cut the TV time to one hour -- and spend the other 1.8 hours working on your side project or hobby. Prioritize There are times when, no matter how hard you try, there just isn't time to get everything done in one day. At times like these, you need to prioritize. First of all, figure out where your work fits into the priorities. If you need your job in order to pay the bills and stay afloat financially, that's your first priority. So make sure you are right with your work before you tackle something else. Next, prioritize the tasks related to side project or hobby. Figure out what needs to be done first, so that you can build on it the next day. Sometimes, you have to let your side project or hobby slide for a little bit. Look for ways to break tasks down into bite-sized bits, order them so that you continue to make progress. Eventually, if your side project takes off, you can re-evaluate your priorities and maybe even move work lower on your list. Take Care of Yourself It's important to take care of yourself during this time. You need adequate sleep to do well at your job, as well as to create a successful side project. You also need to take care of your body, and build your relationships. It's not always easy, but sometimes you just need to stop, say no, and relax for half an hour, or spend an evening out with your significant other. This will help you re-charge, and get you ready to tackle the next day. What are some of your ideas for balancing work with your other projects?
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