Understanding The Funds In Our Portfolio
Learn more about the funds we invest in here at Betterment.
TABLE OF CONTENTS
Exchange Traded Funds
- What are ETFs?
- What is the difference between mutual funds and ETFs?
- What do I need to know about ETF versus mutual fund costs?
- What is an expense ratio?
- What are the potential tax differences between ETFs and mutual funds?
- Can I invest in an individual stock or fund (i.e. S&P 500 index)?
- What funds (ETFs) are in the Betterment portfolio strategy?
- What bond ETFs are used in the Betterment portfolio?
- What are the current overlaps of the same stock held within different ETFs?
What are ETFs?
An exchange-traded fund (ETF) is a security that tracks an index, a commodity or a basket of assets just like an index fund, but trades like a stock on an exchange. ETFs track fairly closely to the indexes that they follow, such as the S&P 500 or the Dow Jones Industrial Average. ETFs are bought and sold like stocks throughout the day, and therefore experience continually changing prices. Betterment uses ETFs in both our stock and bond portfolios because of the liquidity, diversification, and low management fees they provide. For more information on the ETFs you are invested in with Betterment, please visit our portfolio page.
What is the difference between mutual funds and ETFs?
An exchange-traded fund (ETF) is a security that generally tracks a broad-market stock or bond index or a basket of assets just like a mutual fund, but trades like a stock on a listed exchange. By design, index ETFs closely track their benchmarks (such as the S&P 500 or the Dow Jones Industrial Average). By contrast, most mutual funds are actively managed, and attempt to beat their benchmarks; the performance of the fund can be highly dependent on the portfolio manager making the decision to invest in one stock versus another stock, and can vary from year to year. Index mutual funds do exist, but there are many other benefits to using ETFs in a 401(k). ETFs are bought and sold like stocks throughout the day, and are heavily traded amongst many different parties. This liquidity reduces transaction costs, and also makes it easier to trade for on-demand activities like creating or rebalancing a portfolio. In contrast, mutual funds only trade once a day, and the fund administrator is the only counter-party for buyers and sellers.
What do I need to know about ETF versus mutual fund costs?
When you are thinking about buying an ETF, the Expense Ratio is pretty much all you need to know. ETF managers make money by deducting the annual expenses from the dividends they pay out through the year, and they tell you in advance how much that will be. There are no costs to buy or sell ETFs, and no hidden expenses. If you trade through a broker, the broker will charge you a commission to execute the transaction for you. Betterment covers these transactions for you.
Open-end mutual funds have purchase and redemption fees. These fees range from 0.25 percent to 2 percent and are charged by the fund to buy shares or to sell shares within a specified (usually short) period of time. Purchase and redemption fees differ from a commission because the money goes back into the fund rather than to a broker. These fees are meant to discourage short-term market-timing.
Mutual funds also have internal trading fees which are not disclosed on top of the stated fee. They are estimated to range from 0.11% of assets to 2%, with an average of 1.44%. The Wall Street Journal has a good primer on this issue. Many passive index mutual funds’ undisclosed trading fees are likely quite low, but they are non-zero, so that’s something to consider when doing a pure cost comparison.
What is an expense ratio?
Expense ratios are fees that mutual funds, exchange-traded funds (ETFs), closed-end funds and money market funds charge their shareholders. This fee is called a ratio because it is quoted as a percentage of assets per year, e.g. 0.85%. The expense ratio includes the administration, operating, legal costs involved in managing the fund, and sometimes marketing costs (“12b-1 fees”) to distribute the fund.
The expense ratio is important to consider when you invest in a fund. Even though you will never see a deduction of this fee from your account, you are still paying this fee. It is built into the price of the fund, so it accrues daily, and is proportional to your investment in the fund. Therefore, this expense directly impacts your return in the fund — and ultimately your wealth.
Some asset classes are inherently more expensive than others. For example, U.S. stock funds generally have a lower expense ratio than international stock funds, because the underlying assets are more expensive to obtain. So it’s important to compare the expense ratio of a fund with the cost of other funds by other providers in its asset class. Also note that the strategy of the fund will affect its expense ratio as well. Passively managed index funds will have lower expense ratios than actively managed funds, despite their typically better net-of-fee performance.
Some mutual funds have different share classes, each with their own expense ratio and also minimum investment. For example, the Vanguard Total Stock Market Fund Investor Share Class (VTSMX) has an expense ratio of 0.17% (minimum investment $3,000), but the Admiral Share Class (VTSAX) has an expense ratio of 0.05% (minimum investment $10,000).
Typically ETFs have lower expense ratios than mutual funds. This is one of the main reasons, along with better tax efficiency and no minimum balances, that Betterment utilizes exchange traded funds in its portfolio. For the Vanguard Total Stock Market Fund example above, the ETF equivalent (VTI) costs 0.05% like the Admiral shares but has no minimum at all.
What are the potential tax differences between ETFs and mutual funds?
It’s easy to quickly get deep into the weeds here, but strictly speaking, even a “tax efficient” mutual fund (which could mean a number of things) is not necessarily as tax efficient as an ETF:
- When you own a share of an ETF, you directly hold a single security directly for tax purposes, and you’re in control of events that trigger tax consequences (primarily, selling it).
- When you own a share of a fund, a number of circumstances you have no control over can trigger taxable events for you. The fund manager may choose to sell some underlying securities to rebalance or otherwise readjust the index, or investors other than yourself can withdraw, forcing the manager to sell in a way that can have tax consequences for you, even though you haven’t sold anything.
A manager of a “tax efficient” fund presumably seeks to minimize such outcomes, but it may not always be under his control either.
Can I invest in an individual stock or fund (i.e. S&P 500 index)?
You cannot invest in an individual stock or fund. All Betterment customers are invested into a globally diversified portfolio (with over 5,000 companies) of low-cost and liquid ETFs. The portfolio was chosen to help provide optimal returns at every level of risk, and is rebalanced as the market fluctuates, and as you grow closer to retirement.
Betterment is a strong believer in passive investing. The majority of the evidence shows that active management, whether by individual investors or fund managers, can cause more harm than good in net-of-fee returns, so we invest in low-cost, passive investments and seek to match the market’s performance.
You can learn more about our portfolio and historical performance here.
What funds (ETFs) are in the Betterment portfolio strategy?
Betterment’s recommended portfolio strategy, the Betterment Portfolio Strategy, is professionally constructed using a two-part process: asset allocation and fund selection. Together, they determine the ETFs that make up your portfolio.
See each fund in the Betterment Portfolio Strategy or log in to review one of your goals that follows Betterment’s recommendations. In “Portfolio Analysis,” you’ll see your specific asset classes for that goal and the underlying ETFs.
Some funds in the portfolio strategy only appear in certain stock-to-bond allocations.
What bond ETFs are used in the Betterment portfolio?
Read more about the stock and bond funds used in the Betterment Portfolio Strategy here.
What are the current overlaps of the same stock held within different ETFs?
We won’t get into details here, but the only stocks which will have overlap is value stocks and small-cap stocks.
Betterment’s stock basket has a value & small-cap stock tilt. To achieve this tilt, we own one “whole US stock-market” ETF as a core holding, and then hold three additional value-based ETFs (IVE, IWS, and IWN. You can see the specifics on our Investments page.)
Stocks which fall into these three ETFs will have double exposures, which is exactly what we want – to be overweight them compared to the broad market.
How Betterment Works During Volatile Markets
It can be difficult to ride out a market downturn when you can see it affecting your investment portfolio. We have automated features in place to address volatile markets when they occur.
Why Stock Market News Might Be Misleading You
Learn to separate the meaningful information from the noise. Knowing the right way to interpret market news can help us to make smarter decisions about how to manage our investments.
How Checking Performance Might Hurt Your Performance
As your investment manager, we strive to maximize your returns and reduce your investment costs. But did you know that we also try to help you reduce your stress?
Explore your first goal
Our high-yield account built to help you earn more on every dollar you save.
This is a great place to start—an emergency fund for life's unplanned hiccups. A safety net is a conservative portfolio.
Whether it's a long way off or just around the corner, we'll help you save for the retirement you deserve.
If you want to invest and build wealth over time, then this is the goal for you. This is an excellent goal type for unknown future needs or money you plan to pass to future generations.