Betterment Resources | Original Content by Financial Experts

3 strategies to narrow the racial wealth gap

Here’s How Other Millennials Are Saving For Retirement

How To Avoid Money Fights

How 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 Methodology

Cash 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 Methodology

Manage Your Cash the Modern Way With Two-Way Sweep

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 Vacations

Plan 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.

Special Needs Trusts For Family Members With Disabilities

How To Invest When You Have Family Members With Disabilities

How the Industry Fails You on Managing Cash

How Banks Fail in Helping You Save Money

How 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 Planning

Lifestyle 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 Goals

How 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.

things to save for retirement emergency fund house

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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