Betterment Review – Asset Allocation Made Simple

Betterment
Review of: Betterment
Reviewed by:
Rating:
5
On July 14, 2014
Last modified: July 24, 2014

Summary:

Betterment makes investing easy for beginners by focusing on low cost ETFs, and good asset allocation.

In this low-interest rate environment most investors know parking their money in a bank CD is almost a surefire way to lose money against inflation. For the average individual, investing in the stock market can be complicated. So, what is someone to do?

You have to be concerned about high fees, good asset allocation and whether a financial advisor has your best interest at heart. Betterment is one possible solution to make investing easy. This Betterment review has been updated for 2014.

Traditionally, investing and asset allocation require basic finance skills — of which many individuals lack. If you were to use an investment advisor, their fees are quite cost prohibitive. Which is why advisors are usually only available to high net worth individuals. Betterment gives similar investment advice, in an automated fashion and at a much lower annual fee.

How Does Betterment Work?

Betterment is all about the end-game. When saving, we don’t care about investment theory, we care about the end result. We are investing for some purpose, whether saving for retirement, college, home down-payment or for a vacation trip to Hawaii.

Allocation Summary

Allocation Summary
(Click for full view)

Betterment walks you backwards in the steps required to meet your end goal. From your initial deposit, monthly savings and time horizon, Betterment will tell you the chances of achieving your objective.

There’s no researching which investments you need to purchase, and at what percentage for each. Betterment does this all for you automatically. This makes investing easy for beginners, and is different than any other discount stock broker we’ve reviewed.

Betterment’s goal is to maximize return but minimize the risk. This sounds like an oxymoron, but it’s not. The question I’m sure you are asking is; how do they do this? They do it via the Modern Portfolio Theory or MPT for short. By investing in a diverse pool of assets it should collectively lower the risk and yet stabilize returns over the long-term.

Traditionally this type of service was only available with a full service financial adviser. So this makes Betterment somewhat unique since it’s all done via automated methods.

Betterment was created from the start to make investing as easy as opening a bank account. Though, let me be clear, Betterment is NOT FDIC insured. Your returns are not guaranteed and are subject to market risk. It’s possible your investment could lose principal. Though compared to other investment options which don’t have principal risk, they do have other types of risk. Betterment is a SEC registered broker-dealer and member FINRA/SIPC.

With the service, you don’t own individual stocks or bonds, instead investments are held in the form of an exchange traded funds or ETFs. The ETFs own a portion of the equities market via indexing. The asset allocation between these various ETFs then ensures your account is not weighted too heavily into one specific area, company, country or sector. While this doesn’t lead to outrageous returns, it prevents putting all your eggs into one basket.

The way Betterment is designed, you have access to a lot of automated options and the process is streamlined so that it requires little day-to-day involvement. It’s kind of set it and forget it, compared to traditional investing options.

Easy Signup Process

The signup process is easy and takes approximately five minutes. During the process you respond to a series of short questions about your investment needs. There is also a slide bar that allows users to set the allocation of their assets (ie: 60% stocks with 40% bonds). Once the choices are selected, you must then link your personal checking account. Money can be transferred into the Betterment account whenever you desire or you can setup an automated deposit.

Portfolio Potential

Graph with possible investment outcomes

When money is moved into the account, Betterment will then automatically purchase exchange traded funds (ETFs). The purchases will be made based on the way you’ve defined your asset allocations. Your investments are very liquid and selling your investments is also made simple. Betterment will perform the sell trades for you. Any dividends earned will be automatically reinvested. Each quarter, any portfolio that is off by more than 5% is rebalanced automatically.

Model Portfolio

When I first reviewed Betterment, their stock asset allocation was slightly different than what is available today. Originally, Betterment did not include international equities and only included TIPS for the bond portfolio. They have since fixed this with the new model portfolio and it was a much needed improvement.

Stock Portfolio Makeup

  • Vanguard Total Stock Market ETF (VTI)
  • iShares S&P 500 Value Index ETF (IVE)
  • Vanguard Europe Pacific ETF (VEA)
  • Vanguard Emerging Markets ETF (VWO)
  • iShares Russell Midcap Value Index ETF (IWS)
  • iShares Russell 2000 Value Index ETF (IWN)

Bond Portfolio Makeup

  • iShares Barclays Short Treasury Bond ETF (SHV)
  • Vanguard Short-Term Inflation Protected Bonds ETF (VTIP)
  • iShares Core Total US Bond Market ETF (AGG)
  • iShares U.S. Corporate Bonds ETF (LQD)
  • Vanguard Total International Bonds ETF (BNDX)
  • Vanguard Emerging Markets Government Bonds ETF (VWOB)

In September 2013 they replaced the previous bond portfolio they just had of iShares Barclays TIPS Bond Fund ETF (TIP) and iShares Barclays 1-3 Year Treasury Bond Fund ETF (SHY). According to Betterment the two reasons they made this change was because it:

  1. Reduced the average maturity of the bond basket for low-risk goals. Generally, the shorter the maturity of a bond, the less sensitive it is to interest-rate changes.
  2. Diversified away from U.S.-only bonds. International bonds are still somewhat responsive to U.S. interest rates, but that movement should be dampened significantly compared to a U.S.-only bond basket.

Betterment Asset Allocation

The percentage of the ETF allocation is no longer fixed either. Depending upon your allocation of stocks-to-bonds, Betterment adjusts the allocation of each individual ETF to meet the efficient frontier. In plain English: this means Betterment has optimized the portfolio to give you the best performance possible.

All the ETFs Betterment has selected are great picks. They all follow their respective index very closely, are very liquid (which lowers the bid/ask spread), tax efficient and low annual fees.

Even with these recent changes in their asset allocation, I would like to see some additional asset classes (such as commodities and REITs).

Though Betterment’s portfolio should be more than adequate for someone investing less than $100,000. Betterment no longer offers custom portfolios if you have over $100,000 in assets. Betterment now requires $500,000 for custom portfolios. Though based upon the new portfolio mix the need for customization (except as I mentioned sectors above) is almost now nil.

Betterment Fees

Betterment Annual Fees

The great thing about their service is you can start with little money to invest and the fees are quite low (0.35%). Once you get past $10,000, they decrease the annual fee to 0.25%. Past $100,000 invested with Betterment and it lowers to 0.15%.

While you can start with no money, they do request you deposit at least $100/month. Otherwise you get charged an additional $3 per month, if under $10,000. I do think it’s a great idea on their part. It does create some forced savings and I have no issue with their pricing. This fee structure translates to about $17.50 a year on an account with a $5,000 balance.

Introducing Tax Loss Harvesting

In June 2014, Betterment announced a new service called Tax Loss Harvesting, which helps boost your after-tax returns and is twice as effective as other TLH strategies. Basically, an investor with Betterment can improve their after-tax returns by capitalizing on investment losses.

This service doesn’t require any action on your part and is fully-automated for Betterment customers. The extra growth within the investment portfolio has been studied and found that it offers no additional risk or cost. See the graph below:

betterment tax loss harvesting

Is tax loss harvesting right for you? According to Betterment, tax loss harvesting is best for the majority of investors who can write off losses against capital gains, and have up to $3,000 of ordinary income. If you’re in a high tax bracket, and start using tax loss harvesting now, the more beneficial this service will become over time.

Backdoor $25 Bonus For New IRA Accounts

I was somewhat disappointed their $25 signup bonus offer does not apply to new IRA accounts. In talking with Betterment’s customer service, I discovered a backdoor method to get this bonus. It’s possible to get $25 via their Refer-A-Friend promotion.

Since I am a customer of Betterment, all you need to do is click on this link. When opening your IRA account deposit $500. The bonus will count as contributions for the current year.

Summary

Betterment’s service makes it super easy to implement a savings plan. You can setup a new taxable account in minutes, or transfer an existing 401(k) or IRA account.

Betterment is a perfect starting point for young investors. It helps teaches the ropes to investing and more importantly, proper asset allocation. This, in my opinion, is a “good thing” as too often I hear about inexperienced investors with poor, or no, asset allocation. Their fees are low enough if you have a less than $10,000 to invest that it won’t eat away too much of your investments.

Without question, the fees are much lower than if you were to hire a professional money manager. If anything, with a professional money manager you would get similar or lower returns but pay much more in management fees.

Their goal setting feature makes their service somewhat unique and perfectly visualizes the steps required to meet your objectives. Though this feature is available in some personal finance apps (like Quicken), Betterment’s is one of the best available either online or offline.

For the more advanced investor or higher net worth individual, Betterment might not be the perfect fit. If you can roll your own asset allocation and know investment theory, there’s little need for using a service like Betterment. The more advanced investor will do better with a more diverse asset allocation selection and save money in annual fees in the process.

Individuals with more than $100,000 and do not want to do it themselves, Personal Capital might be a better option. Typically individuals with that level of net worth or greater have a much more complex investment portfolio. Unlike Betterment, Personal Capital has access to see your entire net worth. This allows them to get more holistic view of your life. Betterment’s asset allocation is cookie cutter and makes it somewhat limited for more advanced needs. Keep in mind Betterment does not know about or have access to other accounts outside of their service.

When we first reviewed Betterment, we gave them three and half out of five stars. This was mainly because of their high annual fees and limited asset allocation. But with the decreases in their fees and some improvements in their asset allocation, Betterment is an almost perfect investment service. We now rate them five out of five stars.

Disclosure: I have over $11,000 invested with Betterment’s service since August 2012.

Comments

  1. Michael says:

    I am really starting to warm up to this. Most active management will charge you 1% and probably under perform.

    • Larry Ludwig says:

      Hi Michael. If you like Betterment you might want to look at Personal Capital’s portfolio management as well. They are similar to Betterment, but they get your entire portfolio picture (whatever you enter into their site). So your assigned financial advisor can look at the entire picture and not just a typical narrow view.

      • Michael says:

        I just talked to them last night. I’m coming off a pretty bad experience with a money manager and I’m not sure I want to put all my eggs in one basket again. Their minimum is 100K to get assets under their management and charge 0.95%. They do offer more in terms of assets classes compared to Betterment, for instance REITs will be part of your portfolio. Sometimes I think I should just dollar cost average Vanguard’s VTI and call it a day.

        • Larry Ludwig says:

          I haven’t had direct experience with Personal Capital’s financial advisors other than speaking with them, so I can’t say how good/bad they are. What I CAN say is you can speak to them with no obligation.

          Keep in mind too with Personal Capital they are not exactly an index (unlike Betterment). They closely mirror the index by the asset allocation into various individual stocks and ETFs. That lowers your annual fees.

          With the price changes Betterment is now much cheaper.

  2. Ken Faulkenberry - AAAMP Blog says:

    While this may be a good short term strategy for someone trying to learn; but the fact Betterment is based on Modern Portfolio Theory makes it risky. Modern Portfolio Theory has largely been discredited. While it’s theory’s provide interesting investment lessons; markets are not efficient.
    It does not make sense have the same asset allocation when stocks are expensive as you do when stock are bargains. Should you have had the same allocation to equities in 2000 as in March of 2009? That does not make sense!
    Investing is hard work and those that are willing to put the effort into investing can beat the market averages just by being wise shoppers and not follow “easy” rules such as Modern Portfolio Theory would have you believe work.

    • Larry Ludwig says:

      Ken,

      While I don’t disagree with you, you make the assumption that a novice investor would know when stocks are cheap or expensive. What most beginner investors or average savers is a hodge-podge of investments with no asset allocation.

      MPT while not perfect it is better than what most investors have currently which is nothing. For the audience this service targets hiring a financial advisor will cost them more than in fees than sticking with MPT. So that route is inefficient and would cost much more.

      So while for higher net worth individuals and/or individuals with investment experience what you suggest makes sense.

      Someone with a few thousand dollars and just starting off, IMHO this is a much better route than most other options.

      • Ken Faulkenberry - AAAMP Blog says:

        I totally agree with your reply. I just believe more investors should get beyond the novice stage and make better informed decisions. Both of us have blogs that are dedicated to doing that! Great job!

        • Robocop says:

          I always get a chuckle when I hear people talking like they can tell when a stock is cheap. Study all you want, that won’t give you insight into the future. Trying to time the market is nice as a hobby but it is not prudent if you are trying to make money in the long run.

  3. Kevin Cimring says:

    Hi Larry, this is a very insightful review with some key points about the pros and cons of the service. Its great that you are reviewing these types of services and exposing them to the public. The overriding intention of all these services is to help individual investors achieve better outcomes, and the more awareness about these services, the better.

    best regards,
    kevin

  4. Ishwar says:

    Betterment does NOT use a third party custodian to hold customer assets.

    Can Betterment withdraw money from any customer account?

    Most advisors use a thrid party custodian such as Interactive Brokers, Fidelity, TD Ameritrade, Schwab, etc.

    A thirty party custodian provides a higher level of comfort to the customer.
    Can Betterment withdraw money from any customer account?

    • Katherine says:

      Hi @Ishwar,

      Katherine from Betterment here. You ask a great question about security, and I’m happy to provide more color around how we put our customers’ security and trust first.

      At Betterment, we developed a vertically integrated structure as a way to deliver a premium customer experience. As a custodial firm like Fidelity or Charles Schwab, we are responsible for handling customers’ funds and keeping all records of their assets.

      Betterment has two separate arms: the first, Betterment LLC, is an SEC-registered investment advisor, which operates the advice and investment platform customers experience when they access their Betterment accounts. The second arm, Betterment Securities, is a FINRA member broker-dealer, which executes trades on customers’ behalf and is the custodian of customers’ assets.

      Betterment is subject to the same set of strict capital requirements and regulatory oversight as Fidelity, Charles Schwab, and other qualified custodians. These requirements ensure customers’ safety and make us unique among other online investment managers, many of whom are introducing firms. Introducing firms have minimal capital requirements and in practice, pass customers’ fund through to another firm that custodies them. With Betterment, the only company customers ever deal with is Betterment.

      In the event of a worst-case scenario such as company insolvency, assets with Betterment Securities are protected by SIPC up to $500,000 per account. And to be sure, it’s extremely rare that a firm cannot return customers’ assets in a crisis, or that customers must rely on SIPC. Over SIPC’s 42-year history, less than 1% of broker-dealers have been subject to SIPC proceedings.

      Customers are always able to check investments and holdings at all times. Our investment platform has verification built in at every step—customers’ transaction amounts are reconciled with cash transfers and ACH transaction amounts, which are then reconciled with trade amounts, which are then reconciled with positions, and then with fills. We also undergo regular, rigorous examination independently both by the SEC and by FINRA to ensure that we properly maintain our customer records and satisfy our capital requirements. Finally, the way we handle our operations capital is yet another way we ensure the safety of customers’ investments. It’s a core part of our integrity as a company. Our operational funds are always 100% segregated from any kind of customer investment activity, always in different accounts. As Betterment Securities is the custodian of your assets, we also maintain substantially higher levels of net capital than an introducing firm—another way we have a higher level of security than many other online investment managers.

      Let me know in the comments if you have other questions about security with Betterment. Our customers’ trust is incredibly important to us, and we work hard to maintain it every day.

      Katherine

  5. Barrett says:

    Larry,

    Outstanding review. I’m looking to invest more than $100k. I read your mention of Personal Capital…they’ve targeted me through my Mint account and I’m considering them Could you expound upon why you think Personal Capital might serve my needs better than Betterment?

    Also, do you know of a blog review or site review of the differences or advantages between Betterment, Personal Capital, and Wealthfront? ALL 3 are on my radar.

    THANK YOU!

    • Larry Ludwig says:

      Hi Barrett,

      I can’t speak for you personally, but can tell you the difference. Betterment is a completely automated (without human) asset allocation system. Personal Capital is a tech assisted financial advisor. Wealthfront is similar to Betterment with some slight differences. Wealthfront has improved in the past year, but still prefer Betterment over Wealthfront.

  6. Chinmay says:

    Hi Larry,

    I am starting to invest with Betterment, though I had this question – I was looking into having a 60% stock – 40% bonds mix, and I have already reached my IRA limits this year, so would have to go for a taxable account with Betterment. My initial capital to start with Betterment this year would be < 5000. With this in mind, is it wise to have such amount of bonds with Betterment, as they would generate more capital gains OR should I wait till next year when I can start investing in IRA again and have an IRA account with Betterment?

    Thanks for providing such an in depth review of betterment. It made me go overboard to actually start investing with them!

    Best Regards,
    Chinmay

    • Larry Ludwig says:

      Hi Chinmay,

      I cannot give you individual advice since I’m not a registered broker. What I can say is it depends upon what you are going to use this saved money for. It sounds like you’ve filled up your tax deferred space and going to use this for retirement savings as well. One option is you can mix your asset allocation between both accounts since both are for the same time frame and effectively one large account in two different types of accounts.

      In taxable accounts it is usually better to place tax efficient investments like stock indexes than bonds. Then place into your tax deferred accounts investments that are tax inefficient (ie bonds, REITS, etc.) So individually they may seem lopsided when together they are not and get your desired asset allocation strategy. Hope this helps.

  7. Chinmay says:

    Hi Larry,

    Thanks for the response and the advice. Though, the question indeed was meant for Goal based savings – like for home purchase, marriage, and the sort. The time frame is around 5 years at least for the home. I just want to put my money (except emergency fund) into something which is more useful than an online savings account.

    The problem I have is that I don’t understand all the different types of bonds completely yet (currently reading some stuff on it) and so the decision to go with Betterment for the time being. As the current investment is going to be in a taxable account for now – Is it advisable to keep some portion of it as bonds (and incur the penalty of taxes) ? As I had mentioned before, the investment is going to be <$5K. Also I do not know how much penalty I will incur with such an amount for 30-40% in bonds. Another strategy can be to max out in betterment for stocks and purchase the bonds in IRA next year, but its still 5 months away and I don't really like the risk for 100% stock. May be there is some middle ground here, but I have not yet stumbled upon it.

    I understand that you are not a broker, but what I am really looking for is a nudge in the right direction, so that I can make proper decision with this investment!

    Thanks once again!

    Best Regards,
    Chinmay

  8. Ralph Stevens says:

    Has anybody done any research on the relative performance of Betterment and vs their competitors (after fees)? I’m curious if they outperform brick and mortar active managers as well as other online services.

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