We believe it's important to understand what your money is invested in. This guide takes time to explain the how and why of what Betterment does.
What is Betterment?
Betterment is a robo-advisor. They use software to allocate your investing dollars. They take your age and risk tolerance into account to build you an optimal portfolio.
Before Betterment, if you wanted your money managed, you had to go to a financial advisor (human) for help.
Betterment's Key Features and Services
Betterment gives you advice based on your needs. They start with your goal, the reason your investing, then make recommendations based on your risk level, amount you have to invest, and type of account.
This strategy is called "goal-based investing." This strategy is to encourage optimal behavior.
A few situations they can help you with:
• Planning for retirement
• Buying a home
• Having a baby
• Switching jobs
• Received an inheritance
• Not sure what to save for, they can provide guidance
Click here to learn more.
Personalized retirement advice. They help you with three things.
• They examine your external accounts for high fees, idle cash, and allocations out of line with their advice.
Projected retirement spending
• They show you how much you can expect to spend given your current and future savings.
Retirement savings plan
• They help plan your savings tax-efficiently for your retirement. In my view, having a savings plan is the best first step you can take.
Click here to learn more.
Click here to try out their retirement savings calculator.
You can roll over a 401(K) into a Betterment IRA. See the video below for more information.
A trust allows a third party, a trustee, to hold assets on behalf of a beneficiary or beneficiaries. Trusts can be used in many ways. A common use is the passing of wealth from one generation to the next. Fidelity has a good article on trusts.
Betterment helps in three ways:
• Creating multiple goals tailored to each beneficiary.
• Automate cash transfers for beneficiaries on a custom schedule.
• Manage different trust accounts with a single login.
For more information, click here.
Smart saver invests your account in 80% short-term U.S. Treasury bonds, and 20% in short-term investment grade bonds.
• They use the iShares Short-Term Treasury Bond ETF, ticker SHV, for the 80% portion.
• They use the iShares Short-Maturity Bond ETF, ticker NEAR, for the 20% portion.
They are pitching Smart Saver as an alternative to a traditional savings account.
To learn more, click here.
Tax loss harvesting
Tax loss harvesting is when you sell a security at a loss and replace the sold security with a similar one. The loss can offset other gains and reduce ordinary taxable income by as much as $3,000 per year.
Suppose you held Coke in your portfolio and it was down 10% on the year and your loss on that position was $500 dollars. Betterment would sell your Coke position, locking in the $500 dollar loss, and buy Pepsi with the proceeds, maintaining your asset allocation.
The $500 dollar loss can offset other gains and be used to reduce your ordinary taxable income.
• Betterment's tax loss harvesting white paper.
• Introducing tax loss harvesting: Blog post.
A tax-coordinated portfolio optimizes and automates a strategy called asset location.
It places your highly taxed assets in your IRAs, which have big tax breaks. Then, it places your lower taxed assets in your taxable accounts.
This is a new product. They have a simulation you can play around with here.
My general rule is to keep things as simple as possible. If something seems too complicated, take a pass and stick with the simple stuff.
If you would like to speak with a human about your finances, they offer that option too.
They aren't clear on how much they charge.
They offer unlimited help with the premium plan. In order to be on the premium plan, your balance must be at least $100,000 dollars.
If you're not on the premium plan, they pair you with a vetted advisor in their network. Which is fine, good ones will save you money in the long run.
To learn more, click here.
For more information
The Investor Junkie has a comparison of the top robo-advisors. He lays out what they charge and if they would be a good fit for you. Check it out here.
Before you go further
When Betterment talks about risk, they define risk as volatility or how much fluctuation, in percentage terms, you can expect your portfolio to rise and fall over a certain time period.
How Much Does Betterment Cost?
Betterment offers two pricing plans. Once your account balance reaches $100,000 dollars, you can upgrade to the premium plan for an additional 0.15% for a total fee of 0.40%.
If you had a $100,000 dollar account on the digital plan, your annual fee would be $250 dollars. (100,000 * 0.25% or .0025)
If you upgraded, your annual fee would be $400 dollars. (100,000* 0.40% or .0040)
The premium plan offers two services not included in the free plan.
• In-depth advice on investments outside of Betterment. They aren't specific on what this means. I would speak to someone and get a better understanding of what they offer.
• Unlimited access to their CFP professionals for guidance on life events such as having a baby, buying a house, or retiring. This would be worth talking to someone about. Especially as you grow older and have more assets to manage.
Betterment's Three Goals
First up; the safety net goal
We will start with "select an investing goal" (red box).
They ask a few questions.
• Are you currently retired? Most of us aren't, we'll select no.
• How old are you? Enter your age.
• What's your annual pre-tax income? Type in yours. For our example, we'll use $50,000 dollars.
On this page, you want to pick the goal that is your main priority. As they note at the top, you can change this later or add a new one.
Let's go through each of these.
First up is Safety Net (red box).
They define safety net as an emergency fund for life's unplanned hiccups.
We've all had these. Your tire blew out, your pet got sick, your computer breaks, etc, etc.
They are using this portfolio as an alternative for a cash savings account. This is the most conservative goal they offer.
The portfolio they show you to the left (red box) is composed of 40% stocks and 60% bonds.
We'll break down the asset allocation in a minute.
But first. Let's dig deeper. Click read more (purple box).
Here, they compare their safety net goal vs a traditional savings account.
From above: (yellow highlight)
"Our rigorous modeling and testing has shown that investing is a reliable alternative to a cash savings account."
Let's back up and define what a cash savings account is.
A cash savings account is a deposit account held at a bank or another financial institution that pays a modest interest rate.
Three common ways to invest your cash are:
- Cash savings account
- Money market account
Most banks offer all three.
All three, a savings account, a money market account, and a CD are considered low-risk, safer investments, relative to stocks and bonds.
There are advantages and disadvantages to each. We won't go over all of them; since our focus is on traditional investments like stocks and bonds.
From the second paragraph: (yellow highlight)
"A Safety Net goal provides an investment portfolio that we expect to grow faster than inflation."
A quick refresher
Inflation is defined as a sustained increase in the general price level of goods and services.
Put another way. When inflation is rising, every dollar buys a smaller percentage of a good or service.
We want our investments to keep pace with inflation in order to consume goods and services in the future.
From above: (yellow highlight)
"Included in our target recommendation is a buffer of 30% to allow for as much as a 23% drawdown in the portfolio's value over a 5-year time period while preserving the minimum balance you need to have available."
When they say "a 23% drawdown in your portfolio's value."
That means there is some chance your portfolio's value will decline by at least 23% in the future.
It may never happen.
It might only drop 15 or 20% or could drop 30 or 40%.
The takeaway is to develop proper expectations; so if your portfolio drops 25% over six months, you won't be surprised and panic.
•This goal (safety net) is appropriate for someone who cares more about the return of their money than the return on their money.
• This goal is the most conservative goal they offer. The value of this account will be least affected by volatility in the stock market; relative to the other two goals.
Important to remember
No investment is risk-free. All carry varying degrees of risk; even cash.
Next, let's look at the "retirement goal." This goal is useful if you have a specific age you would like to retire at.
Depending on your age, the asset allocation graph (red box) will look different.
Since I am 35, my portfolio will be more aggressive and tilt heavier toward stocks. If you are over 55, bonds will make up a greater percentage of your allocation.
Click read more (purple box).
From above: (yellow highlight)
"When you have 20 or more years until your planned retirement age, we recommend 90% stocks in order to maximize growth."
In other words, if you plan to retire at 65, they recommend a 90% allocation to stocks until you turn 45.
Every year after 45, your allocation toward bonds will increase and your allocation toward stocks will decrease.
• This goal is appropriate if you have a specific age you would like to retire at.
• You can modify this goal as you get older and your needs and circumstances evolve.
General investing goal
The final goal is "General Investing." This goal is similar to the retirement goal.
The difference with this goal is you don't know when you are going to retire and have no future need in mind.
With this goal, the asset allocation (red box) is the same as the retirement goal; initially.
Click "read more" (purple box).
From above: (yellow highlight)
"The General Investing goal allows for this flexibility-it's our utility player of investment goals.
This goal does not have a specific purchase or withdrawal date baked into the advice, which makes it an ideal goal for objectives such as long-term savings that are earmarked for generational wealth transfer, assets that may be converted into a trust account at a later date, or an unknown future major purchase."
With this goal, your stock allocation never dips below 55%.
• If you aren't sure where to start, pick this goal. You can modify it later as your needs change.
That's the three types of goals Betterment offers.
- Safety net
- General investing
The most important part is to get started. You can change your goals and allocations when your needs change and you are better educated.
Important to remember
The greater your allocation to stocks, the more volatile your portfolio will be.
Greater volatility is not a bad thing. If you have twenty plus years until retirement, a 50% drawdown gives you a chance to add to your account at cheaper prices.
The point of a service like Betterment is to keep you on track toward your goal and to minimize behaviors that lead to bad outcomes.
To get started, pick a goal, if you are unsure, pick general investing. Click "select this goal". (red arrow)
Next, you will need to fill out personal information.
When you have filled out the information, they will ask you to verify your email.
At this point, you have two options:
• You can verify it later. If you do that, you will be taken to this page. (see below)
For our example, we'll choose "Customize your new goal." If you need to sync an external account or transfer a 401(k) or IRA, you can do so.
• If you verify your email, you'll be taken to your home dashboard. (see below)
Navigating your dashboard
Most items on your dashboard are self-explanatory.
Your goals will be listed on the left. Currently, our goals are Smart Saver and General Investing (orange box).
Smart Saver is a new goal they launched in August 2018. You can read their blog post about it here.
We'll focus on the "General Investing" tab. (red arrow)
Next, click "Plan" (red arrow).
Before we dig deeper, let's talk about four things.
First, the preview mode (big orange arrow) shows how much your portfolio will grow based on the inputs you enter.
Second, the sentence "All values are nominal (not inflation adjusted) (big green arrow) means the returns they project are before taking inflation into account.
If they project your return to be 8% and the inflation rate is 2%. Your real return is 6%.
My take: Projections are educated guesses about the future. They are not statements on what will happen in the future. Take projections with a grain of salt.
Focus on things you can control; like saving, contributing regularly to your retirement, educating yourself, and maintaining discipline.
Fourth, scroll down and you'll come across this option (red box).
If you would like help with a licensed professional, click "Upgrade your plan."
Let's take a quick look at the upgrade option (blue box).
Two major differences b/w the Digital and Premium plan:
- The annual fee (red box) is 0.40% for the Premium plan vs 0.25% for the Digital plan. If you had $100,000 dollars with the digital plan, your fee would be $250 dollars per year. With the premium plan, your fee would be $400 dollars per year; $150 dollars more expensive than the digital plan.
- The minimum balance for the premium plan is $100,000 dollars.
Click "Preview Mode." (red arrow)
This view reveals how your investments would grow using three inputs.
• Monthly auto-deposit (red box).
• One-time deposit (green box)
• Time in years (orange box)
In this example, I used $200 dollars as my monthly auto-deposit; $10,000 dollars as my one-time deposit; and 29 years as the amount of time my money would be invested.
You can change any of these and see how it affects the final result.
The chart also shows three lines (red arrow).
• Avg. market outcome (dark blue line)
• Poor market outcome (light blue line)
• Total deposits (black line)
Remember, these lines are projections; not stated facts.
If you scroll your mouse over the chart, a box of probabilities will pop-up (red box).
In this box, they show you the chance of having at least a certain dollar amount on a specific date.
In the example above, they give you a 97.5% chance of having at least $110,913 dollars by 2044 (26 years from 2018).
That means you earned $38,513 dollars on $72,400 dollars of deposits for an average annual return of 2%/year over 26 years.
Betterment considers that a "poor market outcome" (light blue line).
They also give you a 2.5% chance of having at least $443,361 dollars by October 2044.
That means you earned $370,961 dollars on $72,400 dollars of deposits for an average annual return of 19%/year over 26 years.
Betterment considers that a great outcome, but they put the chance of that happening at 2.5%.
At the top of the box they put your average outcome at $220,834 dollars.
That means you earned $148,434 dollars on $72,400 dollars of deposits for an average annual return 7.88%/year over 26 years.
That's a reasonable expectation. Just remember, these return projections are nominal (before taking inflation into account).
If inflation averaged 2% during this 26 year period, your real return would be 5.88%. (real return = nominal return - inflation rate) (7.88% - 2% = 5.88%).
The Main Takeaway
Probabilities are not certainties. Betterment bases these projections on past data. People didn't think housing prices could collapse until they did. The best way to prepare for an uncertain future is to have ample savings (cash), and have a plan for the worst-case scenario; even if the worst-case scenario has a low probability of occurring.
The next tab is "Portfolio Analysis" (red box).
This tab shows how your portfolio is allocated.
Note the blue box. It states your auto-adjust is on. This means it will raise or lower your allocation toward stocks and bonds over time; based on your needs and goals.
The other tabs under General Investing are Holdings, Activity, and Performance.
Activity and performance aren't important right now. They will populate as time goes on.
In the next section, we'll break down the holdings tab and explain how Betterment is investing your money.
Click the "Holdings" tab (green box). This tab shows how they allocate your portfolio between stocks and bonds.
Since our goal is general investing and I am 35, they recommend a 90% allocation to stocks and a 10% allocation to bonds (red box).
This section is broken into four columns.
• Holdings (red box)-Shows what ETF your money is invested in.
• Current weight (yellow box)-Shows how much, in percentage terms, is allocated to an ETF.
For example: The first holding is U.S. Total Stock Market. Its current weight is 31.8%. If you have a $100,000 dollar portfolio, $31,800 dollars is allocated to this ETF.
• Fund fees per year (purple box)-Shows how much you pay for an allocation. You can view the fee in percentage or dollar terms.
• Current value (blue box)-Shows the current value of the ETF.
In the next section, we'll break down an individual holding in detail.
Digging deeper on Vanguard VTI
Let's break down the first ETF they recommend: U.S. Total Stock Market (red box).
They have assigned this ETF the largest weighting at 31.8% (orange box). If you have a $100,000 dollar portfolio, $31,800 dollars would be invested in this ETF.
This ETF is from Vanguard (ticker symbol VTI). The ETF charges 0.04% (0.0004) or four basis points per year (purple box). Which means you're charged 4 cents for every $100 dollars invested.
In our example, your fee would be (amount invested($31,800) x fee(0.04% or 0.0004) = $12.72/year).
The majority of ETFs they recommend are from Vanguard. Occasionally, they use iShares, a Blackrock product. Vanguard and Blackrock are the two largest ETF providers. Their products are low cost and liquid.
On this page, you can read the summary prospectus, the full prospectus, the annual and semi-annual report, and the statement of additional information (blue box).
The summary prospectus is a high-level overview of the ETF.
On the summary prospectus tab, scroll down to the "Investment Objective" heading (red box).
"The fund seeks to track the performance of a benchmark index that measures the investment return of the overall stock market."
What does that mean?
ETFs track an index, they are not an index themselves. When it says "to track the performance of a benchmark index", it means this ETF is modeled on an existing index.
To find that information, scroll down the 'Principal Investment Strategies" heading (red box).
It reads: (yellow highlight)
"The Fund employs an indexing investment approach designed to track the performance of the CRSP US Total Market Index, which represents approximately 100% of the investable U.S. stock market and includes large-, mid-, small-, and micro-cap stocks regularly traded on the New York Stock Exchange and Nasdaq.
In other words, this ETF represents most all U.S. publicly traded stocks.
You can also find this information on their website.
Go to Google and type in "Vanguard VTI".
Click on the first non-ad link (red arrow).
It takes you to VTI's homepage where you can see an Overview, Price Performance, Portfolio & Management, Fees, Distributions, and News & Reviews (blue box).
On the overview tab, you can see the Product summary, ETF facts, Risk potential, Performance, and Portfolio composition by scrolling down the page.
Let's take a quick look at the "Portfolio & Managment" tab (green arrow).
Portfolio & managment
This tab gives you a peek inside the holdings of this ETF.
Scroll down to the "Equity characteristics" heading. This graph shows how well the ETF (VTI) tracks its benchmark index (green arrows). The closer the better.
Scroll down to the "Equity sector diversification".
This section shows the weightings each sector represents in the ETF.
These weightings change over time as some sectors grow larger and some shrink.
For example, the technology sector (red box) is the second largest behind financials (blue box); thanks in part to the rise of Google, Facebook, Apple, and Amazon over the past decade.
Scroll down further and you can see the ten largest holdings.
The top ten holdings represent almost 20% of the fund's assets (red box). The top five holdings are all technology companies (blue box).
With such a large weighting, the top ten holdings will have an outsized influence on the performance of this portfolio.
This analysis can be applied to all other ETFs that make up your portfolio. In the next section. we'll do a high-level overview of the ETFs they recommend for this portfolio.
The other ETFs
Ten other ETFs make up this portfolio outside the first one (U.S. Total Stock market).
Here is a brief rundown of them.
U.S. Value Stocks
Value stocks are broken into large-cap, mid-cap, and small-cap. Definitions on what a large, mid, and small cap company are can vary, but below are general guidelines and the funds they use.
- Large-cap-$10 billion + market cap.
- Mid-cap-$2-$10 billion in market cap.
- Small-cap-$300 million-$2 billion in market cap.
How Betterment defines "value"
Betterment defines value stocks as those that trade at a lower price relative to their dividends, earnings and/or sales than the average stock.
Note: The idea of value investing is to buy $1 dollar for 80 cents. Meaning the market overreacts to bad news and some companies become cheap relative to their future potential.
The skill is knowing which companies are likely to have a better future and which companies are cheap for a reason.
Since this is hard, these ETFs diversify across a number of companies that meet their criteria.
For example, the Vanguard small-cap value ETF holds 852 companies. This way, no one company can sink your portfolio.
Interenational developed markets
International developed markets are non-U.S. markets such as the United Kingdom, Japan, Germany, and others.
Developed markets have stable governments, currencies, and legal systems, relative to developing markets.
Betterment uses the Vanguard FTSE Developed Markets ETF, ticker symbol VEA, to express this allocation.
Interenational emerging markets
International emerging markets include China, Russia, Brazil, India and others.
They are emerging because their economies are not fully developed relative to markets like the U.S. and the United Kingdom.
China is considered emerging even though its the second largest economy in the world. Parts of their financial markets are restricted from foreign investment and their bond market is underdeveloped, relative to other major countries.
They carry a higher degree of political risk (see Brazil), less economic stability, and historically have been export, commodity-driven economies.
You can expect greater volatility investing in these economies.
Betterment uses the Vanguard FTSE Emerging Market ETF, ticker symbol VWO, to express this allocation.
Betterment uses four categories for the bond allocation of this portfolio.
• U.S. Inflation-Protected Bonds
• U.S. High-Quality Bonds
• U.S. Municipal Bonds
• International Developed Market Bonds
• International Emerging Market Bonds
Betterment is an easy way to get started investing in your retirement.
It's user-friendly and easy to understand. If you haven't started investing in your retirement, get started today, even if it's with a small amount.
This post will be updated as Betterment comes out with new features. If you have a question about something, email me at email@example.com. In the subject line write "Betterment Question."