TABLE OF CONTENTS
- What funds are in my portfolio?
- What is the Betterment portfolio allocation?
- Why and how has Betterment selected this portfolio?
- How and when is my portfolio rebalanced?
- Will my Betterment portfolio beat the market?
- Can my investment lose value?
- I live in California or New York and have a taxable account. Can I have state-specific municipal bonds in my portfolio?
What funds are in my portfolio?
All Betterment customers are invested into a globally diversified portfolio (with over 5,000 companies) of low-cost and liquid ETFs. Funds are invested into this portfolio according to your chosen allocation (depending on how much risk you want to take). You can find the portfolio here.
What is the Betterment portfolio allocation?
When you deposit money with Betterment, every dollar is seamlessly invested in up to 12 different asset classes, optimized for your selected asset allocation.
You can see the full breakdown of the ETFs at each allocation by clicking here to read about our investment selection methodology.
Why and how has Betterment selected this portfolio?
Betterment constructs globally diversified strategic asset allocation portfolios appropriate for an investor’s goals and time horizon. Each portfolio is selected as the result of a systematic portfolio optimization process that simultaneously balances forecasts for long-run expected returns for each asset class against both historical and forward-looking downside behavior for the portfolio as a whole.
In forecasting expected returns, we utilize the Black-Litterman Global Portfolio Optimization model to appropriately marry market expectations extracted from historical performance and current price levels with Betterment’s views on long-run asset class behavior and correlations. Our advice is based on expected returns as well as downside risk and uncertainty as measured by historical episodes of underperformance and simulated stress tests of the asset performance. The result is a portfolio that provides an optimal blend of asset class exposures across different economic regions, investment styles and security types to deliver the best possible risk-adjusted returns for every level of risk.
The long-term performance of a portfolio can be negatively impacted by interest rates and inflation. Our fully diversified global portfolio helps smooth out the impact of these factors since different areas of the world experience them at different times and with varying severity. Our portfolio also avoids a common behavioral error of investors called home-bias, or the tendency to own companies from the country you live in.
To see the Betterment portfolio’s efficient frontier compared to less robust alternatives, read more about our portfolio optimization.
How and when is my portfolio rebalanced?
Why Rebalancing is Necessary
Over time, the value of individual ETFs in a diversified portfolio move up and down, drifting away from their target weights. For example, over the long term, stocks generally rise faster than bonds, so the stock portion of your portfolio will go up relative to the bond portion – if you don’t rebalance. The difference between the target weights for your portfolio and the actual weights in your current portfolio is called drift.
Measuring Portfolio Drift
We define portfolio drift as the total absolute deviation of each asset class from its target, divided by two. Here’s a simplified example, with only four assets:
|Total / 2||10%|
A high drift reduces the efficiency of your portfolio and may expose you to more (or less) risk than you intended when you set the target allocation.
Taking actions to reduce this drift is called rebalancing, which Betterment automatically does for you in several ways, depending on the circumstances, and always with an eye on tax efficiency.
Cash Flow Rebalancing
This method involves either buying or selling, but not both, and is preferable when cash flows into or out of the portfolio are happening anyway. Every cash flow (deposit, dividend reinvestment or withdrawal) is used to rebalance your portfolio. Fractional shares allow us to allocate these cash flows with precision to the penny.
Inflows: You are rebalanced whenever you make a deposit, including when you auto-deposit or receive dividends in your account. We use the inflow to buy the asset classes you are currently under-weight, reducing your drift. The result is that the need to sell in order to rebalance is reduced (and with sufficient inflows, eliminated completely). No sales means no capital gains, which means no taxes will be owed.
This method is so desirable that we’ve built it directly into your Portfolio tab. Whenever your drift is higher than normal (approximately 2% or higher), we calculate the deposit required to reduce your drift to zero, and make it easy for you to make the deposit.
Outflows: Outflows are likewise used to rebalance, by first selling asset classes which are overweight. (Once that is achieved, we sell all asset classes equally to keep you in balance.) We employ a sophisticated ‘lot selection’ algorithm called TaxMin within asset classes to minimize the tax impact as much as possible in taxable accounts.
In the absence of cash flows, we rebalance by selling and buying, reshuffling assets that are already in the portfolio. When cash flows are not sufficient to keep your portfolio’s drift within a certain tolerance, we sell just enough of the overweight asset classes, and use the proceeds to buy into the underweight asset classes to reduce the drift to zero.
Sell/Buy rebalancing is triggered whenever the portfolio drift reaches 3%. Our algorithms check your drift approximately once per day, and rebalance if necessary.
Note: In addition to the higher threshold, we built in another restriction into the rebalancing algorithm for taxable accounts. As with any sell trade, TaxMin selects the lowest tax impact lots, but stops before selling any lots that would realize short-term capital gains. Since short-term capital gains are taxed at a higher rate than long-term capital gains, we can achieve higher after-tax outcome by simply waiting for those lots to become long-term before rebalancing, if it’s still necessary at that point.
As a result, it’s possible for your portfolio to stay above the 3% drift if we have no long-term lots to sell. Almost always, it’s because the account is less than a year old. In this case, we recommend rebalancing via a deposit to avoid taxes. The Portfolio Tab will let you know how much to deposit, as described above.
Allocation Change Rebalancing
Rebalancing brings you back to your target allocation. Moving the slider in your goal does an allocation change, which changes that target. This sells securities and could possibly realize capital gains. Moreover, if you change your allocation even by 1%, you will be rebalanced entirely to match your new desired target allocation, regardless of tax consequences. As with all sell trades, we will utilize TaxMin to reduce the tax impact as much as possible.
If you’d like to turn off automated rebalancing so that Betterment only rebalances your portfolio in response to cash flows (i.e., deposits, withdrawals, or dividend reinvestments) and not by reshuffling assets already in the portfolio, please email our support team at firstname.lastname@example.org.
Will my Betterment portfolio beat the market?
Betterment’s portfolio is designed to keep up with the market and not under-perform, but it is not designed to beat the market. Beating the market is difficult to do with any certainty and involves a lot of risk.
Betterment is a strong believer in passive investing. The majority of the evidence shows that active management, whether by individual investors or fund managers, cause more harm than good in net-of-fee returns. We invest in low-cost, passive investments which always seek to match the market’s performance.
You can expect market-matching risk-adjusted returns in our portfolios.
Can my investment lose value?
Like all market investments, the securities you own in your account are subject to market risk. If the markets are up, your balance will grow. When markets are down, your account can lose money. Fluctuations are especially hard to predict over the short term, but historic data shows that over the long-term your investment is likely to increase.
I live in California or New York and have a taxable account. Can I have state-specific municipal bonds in my portfolio?
While the standard Betterment portfolio for taxable accounts utilizes MUB, a bond ETF providing exposure to national municipal bonds, Betterment offers the CMF (for CA customers) and NYF (for NY customers) ETFs, which provide exposure to California municipal bonds and New York municipal bonds, respectively, in lieu of MUB for customers with a minimum balance of, or intent to fund, at least $100,000. We hope to offer this feature to all customers in the future.
State-specific municipal bonds are generally advantageous for those in high-income tax brackets. For more background on when it might make sense to invest in local municipal bonds, please see the following article, Muni Bond Exposure: When Does It Make Sense to Go Local?
To switch out MUB in your portfolio to CMF or NYF, please contact us at email@example.com. We generally recommend making this switch before you fund your account, but if your account is funded, we will sell you out of MUB over time in a way that attempts to minimize realizing any taxable gains for you.
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