As a PhD student in financial planning, I love reading about and discussing investment strategies. But I’m strange. Most folks don’t like studying investment theory or attempting to properly rebalance their own portfolio. At the same time, those same people realize that sticking all of their money in a savings account or CD won’t build any wealth, but they simply can’t afford to see a financial advisor (or just don’t want to).
Betterment is the new alternative to overpriced financial advisors and pure DIY portfolio management. This online company will manage your portfolio very well for a minimal fee.
Betterment’s selling point is ease of use. The online user interface is designed to be simple and minimalistic. And it works very well. For the individual who wants to automatically deposit some money each month and have it properly invested without having to worry about anything else, Betterment is for you. There’s no researching which investments you need to purchase or deciding when to rebalance your portfolio. Betterment does it for you automatically.
With the service, you don’t own individual stocks or bonds. Investments are held in the form of exchange traded funds, or ETFs. The asset allocation between these various ETFs then ensures your account is not weighted too heavily in any specific asset class, company, country, or sector. This diversification helps to lower overall investment risk.
When you deposit money with Betterment, it is seamlessly invested in a blend of two baskets: Bond Fund ETFs and Stock Market ETFs. Betterment gives you control over the level of risk of your investment by letting you adjust the proportion of your money invested in each of these baskets.
A quick note on ETFs – they are tied to a broad index, but trade like a single stock. So when Betterment purchases shares of VTI: Vanguard Total U.S. Stock Market, they are buying small (weighted) slices of each publicly traded company in the U.S. This is how any index fund works. ETFs differ from mutual funds in the way they are traded, but both can be tied to the same index (like the S&P 500 or total stock market). Betterment uses ETFs because they have lower expense ratios than index mutual funds, and they receive preferential tax treatment, making them a better overall investment vehicle.
Stock Market Basket
Betterment’s investment committee has chosen a stock market portfolio made up of ETFs that reflect the broad US market, as well as international exposure, which allows you to invest in literally thousands of companies all at once. Currently the Stock Market basket is made up of the following ETFs:
- Vanguard U.S. Total Stock Market Index ETF (VTI)
- Vanguard US Large-Cap Value Index ETF (VTV)
- Vanguard US Mid-Cap Value Index ETF (VOE)
- Vanguard US Small-Cap Value Index ETF (VBR)
- Vanguard FTSE Developed Market Index ETF (VEA)
- Vanguard FTSE Emerging Index ETF (VWO)
Why they recommend these options
The U.S. exposure covers the total U.S. market with a slight tilt towards value and small-cap stocks. The value and small-cap tilt has historically outperformed the broad market, based on research by Nobel-prize winner Eugene Fama and Kenneth French.
By adding international stocks, investors benefit from growth overseas in developed markets, including the U.K., Japan, and Europe, and achieve the same expected return with lower risk. With the emerging market stock ETF, investors can capture growth in small but expanding markets such as Brazil, India, and China. This further diversifies the portfolio, and results in lower risk for a given level of return.
Betterment’s investment committee has recently chosen to greatly expand their bond offerings. They now use:
- iShares Short-Term Treasury Bond Index ETF (SHV)
- Vanguard Short-term Inflation-Protected Treasury Bond Index ETF (VTIP)
- iShares Corporate Bond Index ETF (LQD)
- Vanguard Total International Bond Index ETF (BNDX)
- Vanguard Emerging Markets Government Bond Index ETF (VWOB)
- (For IRA accounts only)Vanguard US Total Bond Market Index ETF (BND)
- (For Taxable accounts only) iShares National AMT-Free Muni Bond Index ETF (MUB)
Why they recommend these options
These bonds ETFs allow investors to choose a precise level of risk, and then get the best possible return at that level of risk by balancing four different growth factors: U.S. interest rate risk, U.S. company credit risk, international interest rate risk, and international credit risk. When applicable, Betterment also considers the after-tax benefits of allocating to federally tax-exempt municipal bonds.
Taking on a higher exposure to any of these factors means higher expected returns, with higher potential for short-term losses. However, by blending them together intelligently, investors can maintain the return level and reduce the severity of losses.
In this Betterment review, I have to provide a common sense reminder. Like all market investments, Betterment’s stock and bond investments are subject to market risk. If the markets are up, your balance will likely grow. When markets go down, your balance will likely shrink. You have no guarantees and Betterment is not a FDIC insured savings account.
Over the very long term, historically, stock market investments have tended to outperform less-risky investments, such as bonds. Both investments have historically outperformed cash equivalents such as a savings account. But the value of your account may fluctuate widely, and you could lose money, even over a long time horizon.
At times when prices are down, it is often best to be patient and take the opportunity to add more money to your account rather than to withdraw money when your securities are worth less. You want to be selling investments when they’re up, not when they’re down.
The Betterment fees are quite low overall and are presented in a standardized, tiered system. A 0.35% fee is added onto any account with a investment balance under $10,000. Once you have invested $10,000, they decrease the annual fee to 0.25%. At $100,000 or more invested, the fee lowers to 0.15%.
While you can start with no money at all, they do request you deposit at least $100/month. If you don’t, you pay $3 per month in fees instead of 0.35% (until you have $10,000 saved). This expense gives an incentive for people to commit to saving and investing a certain amount each month.
Remember that in addition to the Betterment fees stated above, you’ll have to pay underlying ETF expenses. When you invest in any ETF, you will pay a fee. This is not unique to Betterment, and they don’t receive any kickback on the ETF expenses.
For instance, the Vanguard Total Stock Market Index ETF (VTI) that Betterment uses has a fee of 0.05%. If that were the only ETF held in your Betterment account (it’s not, this is just an example), and you had roughly $100,000 invested, you would pay 0.15% for the Betterment services and 0.05% for the ETF. The total expenses would be 0.20% or $200 on a $100,000 portfolio.
When it’s all said and done, it’s quite likely that your total ETF fees will average around 0.10%, plus the 0.15 – 0.35% Betterment management fees. This results in an average total cost to you somewhere between 0.25 – 0.50%. That’s cheap for ongoing wealth management.
Betterment Security Review
When researching Betterment, I wanted to verify the security measures taken by Betterment to ensure proper account safety. I was not disappointed and they do an excellent job of securing each individual account. They have the same security protection as commercial banks, including:
- Fraud Protection – Betterment will work to recover any loss that results from unauthorized use of your Betterment account
- SIPC Coverage – Securities in your account are protected up to $500,000 in the case of fraud or mismanagement
- 256-bit SSL Encryption – Increased data security for all your accounts
- Paramount Privacy – Your personal info is never shared without consent
Why Betterment Works
Sound Principles – The company deeply believes in passive, index investing which has been academically proven to outperform active trading strategies. With Betterment, you’ll get wide diversification and really low fees, which are primary indicators of investment success.