Betterment Inc. (“Betterment”) is an SEC-registered automated investment service firm, or ‘robo-advisor’ based out of New York. It was founded in 2008 and as at end-October 2016, has approximately $6.1 billion in assets under management, making it the largest in the business.
Betterment does not hold its clients brokerage accounts directly, but does so through the Apex Clearing Corporation.
As with most robo-advisors, Betterment’s investment methodology is based on Modern Portfolio Theory , which states that a broadly diversified investment portfolio allows for maximum return for a given risk level. Betterment estimates that its methodology will be able to excess returns of 4.30% over that of an average investor over a 20 year period.
As such, Betterment does not invest in individual securities but in low-cost index-based Exchange Traded Funds (“ETFs”) that represent each asset class. Currently, Betterment only invests in stocks and bonds using the following ETFs; note that the ETF selection differs depending on whether the account is taxable or is an IRA.
To begin, users will have to fill out their age, annual pre-tax income, and status (retired or employed). From there, Betterment offers 3 recommended portfolio allocations:
• Safety Net – 60:40 stocks to bonds allocation. A conservative portfolio that Betterment recommends as a superior alternative to a cash savings account. It is designed to beat inflation while including a 30% buffer that allows for as much as a 23% decrease in value over 5-years while still preserving the minimum balance.
• Retirement – Recommended allocation changes according to age; starts at a high 90% recommended stock allocation that begins decreasing after age 48 until it reaches a 56% recommended stock allocation at retirement then a continued reduction thereafter.
• General Investing – For general growth and preservation of capital. Recommended stock allocation begins at 90% until age 45 and thereafter decreases until a 55% recommended stock allocation at age 65; it remains at that allocation thereafter.
You can also go deeper into each goal to see their recommended allocation on a per-ETF basis. An example is presented below.
Currently, Betterment offers the following accounts to its clients: Traditional IRA, Roth IRA, Rollover IRA, SEP IRA, trusts, non-profit, individual, joint, and 401(k).
Minimum Account Balances
Betterment’s currently has no minimum amounts for account balances or withdrawals.
Betterment has 3 fee tiers based on the average account balance. Fees are charged at the end of each quarter. They are:
• $1 - $9,999: 0.35% annual fee with a $100 monthly recurring deposit required. Without the recurring deposit, fees are $3/month instead.
• $10,000 - $99,999: 0.25% annual fee.
• $100,000 and up: 0.15% annual fee.
On top of the above fees, clients will also have to pay embedded ETF fees as well, which Betterment states averages 0.13%.
Note: Betterment has a referral program which gives you 30 days free with each referral with said referral receiving 6 months free. Upon your third referral, you get a bonus 1 year free.
Main Account Features
• Automated Portfolio Rebalancing
• Tax Impact Preview
• Daily Tax-Loss Harvesting
• Tax-Coordinated Portfolio
Automated Portfolio Rebalancing
Betterment’s software automatically rebalances its clients’ portfolios based on portfolio drift, meaning the degree that the movement of an asset class causes a drift in a portfolio’s target allocation. A client’s portfolio is automatically rebalanced whenever there is an inflow or outflow; Betterment also allows its clients to keep tabs on the level of portfolio drift and gives clients the option of making deposits to further reduce the level of drift. And because Betterment can buy fractional shares in an ETF, the cash flows can be allocated precisely.
Even without cash flows, Betterment can reduce portfolio drift by selling overweight assets in a client’s portfolio and buying the underweight assets. This method is triggered at a portfolio drift level of 3%. Clients can also elect to turn off automated rebalancing if they so choose and can also alter their desired target allocation at any time.
Tax Impact Preview
The selling of securities by a client, such as when altering the target allocations of a portfolio can often result in unexpected taxes payable. This tool, available on all accounts, gives an estimate (based on highest applicable tax rates, so it is an upper-bound estimate) of the potential tax impact a transaction will have. An example of how the tool works is shown below.
Daily Tax-Loss Harvesting
Tax loss harvesting is a tax deferral strategy whereby capital losses from selling a depreciated asset is used to offset capital gains while also purchasing a similar correlated asset to one that has been sold. This maintains the portfolio at the targeted allocation level while generating tax savings. This feature is fully automated by Betterment and is available to all taxable accounts.
Betterment uses what it calls its proprietary Parallel Position Management system to facilitate tax loss harvesting and it estimates that based on back-testing from the 2000 to 2013 period that its system would have provided an additional 0.77% to an investor’s after-tax returns.
For a more detailed explanation, you can refer to Betterment’s tax-loss harvesting white paper here.
Betterment’s Tax-Coordinated Portfolio is another tax efficiency optimization feature that makes use of asset location. This strategy takes advantage of different tax treatments between taxable and IRA accounts. As a basic example, consider an investor with a 70:30 stock to bonds allocation with a taxable, traditional IRA, and a Roth IRA account. In a non-tax coordinated portfolio, each of those three accounts would follow the same 70:30 allocation, bringing the overall portfolio allocation at 70:30.
However, by using asset location, Betterment alters the allocation mix between the accounts such that each of the three accounts would not have a 70:30 allocation individually however the overall portfolio allocation would still maintain a 70:30 allocation. In this manner, Betterment estimates that a typical investor would have an estimated annualized benefit of 0.48% across the entire portfolio over a 30-year horizon, equating to a 15% more after-tax return available in retirement.
For detailed information on their methodology, refer to Betterment’s white paper here.
RetireGuide is a series of questionnaires that Betterment posts in order to provide its clients an idea of how on-track or off-track they are with their retirement goals. The main goal it tracks is the planned retirement age of the client and their desired annual spending in retirement. It then presents a probability of the client’s portfolio in reaching said goal. An example is provided below and you can access their full RetireGuide methodology here.
This is an auto-deposit feature that automatically transfers money from client’s bank account to their Betterment portfolio. The feature allows customers to set a maximum amount they want in their checking account as well as the maximum amount per deposit. The difference between the current bank account balance and the maximum checking account balance will then automatically be transferred to Betterment up to the maximum amount per deposit limit.
Who is Betterment Suitable For?
As an automated investment advisor based on Modern Portfolio Theory, Betterment is suitable for investors with a longer term outlook who are not looking for active portfolio management. Investors who believe in beating the market through market timing or active security selection should not invest with Betterment. Investors with account balances of over $100,000 will also incur very low levels of management fees and will also likely be able to take better advantage of its Tax-Coordinated Portfolio if said balances are spread across multiple taxable and IRA accounts.