Betterment Review – An Experiment with My Money
- Review by Andrew Fiebert
Is Betterment the silver bullet they suggest it is? That’s where this Betterment Review and Experiment comes in. I’ve put my own money on the line and detailed everything so you don’t have to.
I’m a lazy guy and my time is crunched as it is. I want my savings to make me money but I don’t want to spend a lot of time managing it. I’m looking for solid long term investments that kickass and beat the market average.
At its core, Betterment is a highly automated “robo advisor” that takes into account your age and risk tolerance to build you an optimal portfolio.
Betterment’s goal is for investing to take minutes a month to maintain, have all the necessary logic built into the tool and whip all the traditional investment managers on cost.
After using it for 2+ years with a large portion of my wealth, I think they’ve succeeded on all counts. It’s an awesome tool to build wealth and the proof is in the pudding.
Girl, look at that body
The body of this article has been completely rewritten to go deep on the concepts within Betterment and how they work.
The goal is to teach you a lot about Betterment as well as what goes into building a successful portfolio over time. Details like Allocation Drift and Tax Optimization matter.
If you just wanted a sales page to sign up then just go here. If you want an in-depth analysis on the tool and it’s features, you’ve come to the right place.
To make things easy I’ve broken the article down into a few key sections. Feel free to click on the sections that interest you and skip directly to them:
- How does Betterment Work?
- Amp Returns with Tax Loss Harvesting
- RetireGuide – Understand How to Retire
- RetireGuide – Don’t Fail at Retirement
- Invest your Change with Smart Deposit
- TL;DR Betterment Review Summary
- Learn from the Betterment Team
- The Betterment Experiment
- Experiment Updates
How Does Betterment Work?
Traditionally when you wanted to invest you would do two things to be successful. Do a metric ton of research picking a slew of funds (or stocks if you’re hardcore) that diversify you enough so you won’t lose your life savings on a bad day.
You’ll also try to make sure it’s actually aggressive enough so you grow your savings over time. Nobody wants to miss out on the boom cycle or get destroyed by the bust cycle.
At its core, this is the problem Betterment attempts to solve.
From the start they have you tackle these two things and they make it pretty easy. Since every decision you make automatically updates this sweet graph and shows you what sort of growth you should expect, you only really need to answer one question.
What is your ultimate goal? Are you trying to buy a home, retire, fill an emergency fund, etc? Based on your decision they will give you a rough idea on how much risk they think you should take on based on your age.
For example, if you’re trying to fill an emergency fund they’ll suggest you take it slow and recommend a 60/40 stock/bond split.
In the top left of the screenshot you’ll notice a little slider that moves between stocks (risky) and bonds (conservative). The faster you want to grow, the more stocks you need and the aggressive you’ll have to be. They’ll let you decide but they will also let you know what they think by labeling your risk with “Too Aggressive”, “Aggressive”, “Moderate”, etc…
This now leads me to the secret sauce of Betterment – their execution of Modern Portfolio Theory. Simply put, this is how they diversify and distribute your investments so that you’ve got exposure to U.S. growth, international growth, stalwarts of business and rock solid bonds for your foundation.
They are completely transparent and show you exactly what your risk level means through what your holdings will be:
If you’re a finance nerd like me, one of the first things you may notice is that the vast majority of the funds Betterment selects for you are from Vanguard. We’re about as obsessed with Vanguard as we are with Betterment and most of their choices are in our list of top Vanguard funds. Badass. Their taste is impeccable.
Now, as you flip your risk slider between 0% and 100% you’ll notice the fund weightings (and the number of funds) change. I’d say that 40% of the value of Betterment is in their execution of Modern Portfolio Theory, the fund choices they’ve made and how pleasurably easy it is to manage your money like this.
Since we’ve got the basics down, let’s go over that other 60% where the real heavy lifting gets done behind the scenes.
Amp Returns with Tax Loss Harvesting
Everybody talks about the monster gains they get when investing but few people talk about the cost of those gains. When the tax man cometh.
Unless you’re the lucky 0.5% richest investors or 1% poorest, you will pay a 15% long term capital gains tax rate. That means if you profit $1,000 you need to hand $150 over to the government for the privilege.
Betterment’s TLH+ shifts the scales in your favor by harvesting the natural dips in the stock market as losses to weigh against your gains.
These paper losses continue to add up over time and when it’s time for you to withdraw your investments it dramatically reduces your tax bill. It’s important to note that you never actually lost any money, it’s more of a clever paperwork process that you’d need a computer to accomplish.
While there is a lot of complicated logic behind the scenes which pulls this off, the actual concept is rather simple. For every fund in your portfolio, Betterment has a secondary and tertiary that it can flip between. They are for all intents and purposes identical in their contents, they are just managed by different companies and have different names.
For example, VTI (Vanguard’s Total Stock Market ETF) will get swapped with SCHB when the timing is right. You can read about it in all of its glorious detail here. I highly recommend reading it if you’ve been having trouble sleeping lately. It’s that good. Sorry Betterment!
Basically, when your primary fund is at a point where it’s below the value you purchased it at, it is automatically sold and the identical secondary fund is purchased. This process is repeated as often as it makes sense for as long as you keep your money invested.
They outperform the competition in this process by 0.99% as per that white paper. Go Betterment!
The end result of more money in your pocket when it comes time to withdraw your investments. Could you do this on your own? Sure. Would you want to spend your time on this instead of going outside and having fun? Probably not.
Feel like you’re missing out on that white paper and want to see a visual of what happens behind the scenes in TLH+ while simultaneously throwing an IRA account into the mix for fun? Here ya go:
As always, you’re welcome.
RetireGuide – Understand How to Retire
If Betterment had a killer feature, this would be it. Most financial tools give a lot of lip service to retirement and how important it is but few actually put their money (and talent) where their mouth is. Betterment set the bar very, very high.
With any retirement discussion you need a few inputs:
- How old are you and when would you like to retire?
- How much monthly income do you need to retire comfortably?
- How much are you able to save every month towards retirement?
- How much have you saved already?
All of this information is necessary to accurately predict when you can retire.
Don’t have anything saved yet? No problem, just push back your projected retirement age.
Can’t save enough to hit your spending goal? No problem, you’ll just need to adjust how much you can spend in retirement.
The beauty of answering the above questions and figuring it all out is so that you can understand if what you’ve already been doing is correct. If not you can change course before it’s too late.
In an effort to be as precise as possible, Betterment goes all out. Bask in all of their calculator’s glory.
They cover the basics like how much do you make and when do you want to retire but every retirement calculator you’ve ever used does that. That’s the price of entry. What really impressed me is how they account for things like my existing assets and cost of living in how much income I’ll need in retirement.
For example, if I lived in Ames, Iowa (50010) like Thomas, Betterment’s calculator tells me that my cost of living will be 4% less expensive than the national average. However, I live in Hoboken so it’s 116% more expensive than the national average.
Therefore I’ve got to save an epic amount more both if I want to continue living here AND retire here. Having Betterment break things like this down for me is eye opening to say the least. Perhaps I need to retire next door to Thomas.
Good calculators give you the answer, great calculators make you think. This is definitely a great calculator.
RetireGuide – Don’t Fail at Retirement
You saw two RetireGuide sections and were like, “Oh no he didn’t”. Well, guess what, yes I did.
Want to know about the really important thing that people talk even less than accurately estimating how much you’ll need to save? How to spend in retirement.
Just because you reach the amount necessary to retire or even retire in excess, that doesn’t mean that you can’t blow it. You need to know how much you can withdraw and when you can do it so your nest egg can go the distance.
Betterment’s RetireGuide does all of the heavy lifting necessary here.
Since I’m not quite ready to retire yet I put some sample numbers into their calculator. I set my assets to $200,000 and estimated that I’d be able to withdraw $600/month on that from now through the end of retirement. Betterment already knows I’m 31.
As you can see they ran a Monte Carlo Simulation similar to what they do when you signup and set your risk. This simulation is in reverse as we’ll be drawing down our account while trying to potentially make it last through retirement.
The cool part is that you don’t need to guess what you can withdraw in retirement like I did with the $600. Betterment will actually calculate what the chances are that you’ll successfully be able to do that and when necessary suggested a better amount that they estimate has a 99% accuracy.
As you continue through retirement Betterment will continually re-run this simulation and inform you if they believe that this number should decrease or increase based on how the market is acting. This takes all of the guesswork out of retirement.
I know two sections is a lot of words to dedicated to RetireGuide but it goes really far towards creating a complete end-to-end automated solution for retirement. That’s not something to take lightly.
Invest your Change with Smart Deposit
While there is support for a fixed and scheduled monthly contribution that most services offer, one size fits all doesn’t work for everyone. If you’re a contractor or self employed this should make you very excited.
With Betterment’s Smart Deposit you can still invest on a consistent basis but instead of focusing on an arbitrary date you can set a specific amount to trigger an investment.
The most important part is that you can set a max deposit. If you set Smart Deposit to trigger at $5,000 and you get a $3,000 check in the mail, that doesn’t mean you want to send all $3,000 to be invested.
Personally I cap my max at $1,000 and if I decide to add more after all I can do it manually on my own time.
Smart Deposit is very easy to setup within your account and is specifically geared towards the 60%-70% of people who don’t maintain a regular budget. While Acorns is the first tool to focus on trigger based investing, their tool is not nearly as sophisticated as Betterment’s.
It also doesn’t withdraw nearly enough for any serious retirement plan. Let’s not kid ourselves, investing the “change” by rounding up every transaction to the nearest dollar will not net you much.
As per research conducted by the Federal Reserve the average family makes 58.7 transactions per month across Cash, Credit, Debt and “Other”. If every one of those was for $0.01 you’d only be investing $58 a month. Even Mr. Money Mustache can’t retire on that.
TL;DR Betterment Review Summary
Betterment is a simple to use automated tool ideal for new and hands-off investors. However, what it accomplishes is by no means simple.
Under the hood it’s a beast of a service putting traditional brokerages to shame with both its technological prowess and solid returns. As a result they now have over $3 Billion under management with nearly $2 Billion of that arriving in just the last year.
Betterment is the largest and fastest growing Investing Robo Advisor.
I’m a fan of the service and have done really well with it myself having over $26,000 invested with them. Here’s a pro-con breakdown of the service from a birds eye-view:
- No Trade or Withdrawal Fees: No need to fear the transaction cost of touching your money. Add and withdraw money for free just like you would a savings account.
- Easy Hands Off Investing: You don’t need to do your research, monitor your investments daily or worry about the tax implications of your actions. They take care of all of it. If you haven’t invested yet or are nervous to get started on your own, this service is for you.
- Cheap Portfolio Management: Most portfolio management services will charge you 1% for an equivalent service and a LifeCycle fund like what Fidelity offers will come it at 0.75% or higher. These are 3x-4x more expensive than Betterment without half the features.
- Plot your Retirement with RetireGuide: This tool takes your entire financial picture into account as well as helping you determine what you’ll need when you retire. It plots the whole thing out for you and helps keep you on track so you can be confident you’ll have what you need when the time comes. It’s deeply integrated into the entire service.
- DIY Investing is Cheaper: As you’d expect, if you did everything Betterment did on your own you’d save on average 0.25% a year in fees. There is nothing stopping you from mirroring their allocation and monitoring it on your own. Savvy investors might find this more appealing than a set-it-and-forget-it approach.
Learn from the Betterment Team
We’re nothing if not through. Not only did we reach out to Betterment’s CEO and Director of Behavioral Finance and Investments but we recorded it. These are brilliant men that have a ton of knowledge to impart. Give these episodes a listen during some downtime like your commute – you won’t regret it.
Our interview with the Betterment CEO Jon Stein. He shares quite a lot more than just the basic “Betterment review” and sales pitch. If you’re a fan of the podcast then you know we’re not shy.
Our interview with Dan Egan the Director of Behavioral Finance and Investments at Betterment. While we do talk about the philosophy behind how they invest, he also schools us on Opportunity Cost and how it relates to investing. It’s one of our best episodes and there is a lot to learn here.
A Preface to the Experiment
I use Betterment extensively when investing my own money because it’s incredibly easy to dial your risk up/down, the fees are almost non-existent (0.35% for balances under $10k) and you can transfer money in and out of the account as quickly as you can with a checking account (no transaction fees).
In the multi-step process of building wealth, Betterment can be used for the second and third steps. Once you have, budgeting, under control the next two steps are to regularly pull money out of your checking account for long term savings and then invest those savings so they grow exponentially. Betterment has you covered for both of those steps which we will talk about in a little bit.
Now, lets talk about the parameters of this experiment and its goals.
I put $500 into a new Betterment account in July and have since been tracking the progress. Starting on October 1st I will be depositing $1,000 a month into my Betterment account for a year. At the end of this year I will have contributed $12,500.
My account allocation will be 90% stock and 10% bonds which is considered aggressive. I’m 28 and am comfortable with a certain amount of risk. I also strongly believe in the buy and hold strategy so while there may be some short term losses (month to month), I know that over the long run I will come out ahead.
The primary goal at the end of the year is to have at least $14,250 in my Betterment account meaning that I expect to grow $1,750 in one year purely though investment gains.
Betterment has a statistical model that they use to help you project future gains and risk and this calculator suggests that I have a roughly 35% chance of meeting this goal. If I meet the goal, that would mean that my gains would be 14% which is pretty impressive.
The market on average is 7% so that would mean we would not only make some solid gains but technically beat the market by a full year. That said, I will celebrate anything above 7% yearly, I would just rather shoot for the stars than the average.
The secondary goal is to prove that investing can be simple and easy. Since there is barely any work involved in this process it’s hard to give an excuse like “I don’t have the time” or “I’m not knowledgeable enough about the market“. Most importantly I want to show the power of exponential growth and how a little bit of money over even a short period of time can generate significant gains.
The most important number to me is my monthly return. This will help me gauge if I’m on track with my goal and give me an idea of how competitive my results are from Betterment compared to the overall market.
In order to meet my goal of 14% annualized return I need a consistent monthly return of at least 1.54%. If you need help calculating the required monthly return to meet your goals you can check out this helpful article: How to Calculate Annualized Returns
As it stands, I’m well ahead of target sitting pretty at a 4.9% monthly return. I won’t count on having anything close to that in the long term but it’s a nice initial kick off for the experiment.
I’m going to use the S&P500 as the market average to compare my performance against. I like this index because it contains more companies than the Dow Jones Industrial Average and it has a lot of modern tech companies in it which I really admire.
This month is incredibly spectacular because in August the S&P500 had a monthly return of -3.13% so the first month out of the gate we are beating the market average by 8.05%. That’s amazing, I hope we keep it up!
Choosing Your Risk
Easily the most important decision you need to make is what level of risk you’re willing to accept. With Betterment you get a convenient slider that seamlessly splits your investment behind the scenes between a variety of stocks and bonds with bonds being on the more conservative end.
Everyone will have their own recommendation on what is best and it definitely depends on your own situation but for me I see it as the following. 20 year olds should be 90% stock, 30’s are 80% stock, 40’s are 70% stock, 50’s are 60% stock, 60’s are 50% stock and so on.
This should be easy enough to follow and provides a sliding scale of risk so that when you’re older you are geared towards more steady returns and when you are young you have a bigger potential to make huge gains in your portfolio.
Automate Your Savings
Even the best of us sometimes fall victim to overspending when there is extra cash in the checking account. Sometimes the money just begs to be spent. The best way to avoid spending your savings is to move the money to another account.
If you’re going to use Betterment, I highly recommend you set up a monthly auto deposit. The whole point of Betterment is to make investing a zero hour a month project. Let the system automatically save and invest for you. You can always withdraw if you need to but you’ll most definitely be making more money here than in your 0.8% annualized savings account.
Don’t worry if you don’t have enough money in your account on the day Betterment goes to pull money from your checking account. If the money isn’t there, Betterment won’t take it and you won’t have any overdraft fees so there is zero risk with your positive intentions.
Accessing your Betterment Funds
Investing is important but being able to access your money when you need it is even more important.
Normally when you invest you can buy your stocks/bonds the same day with a transaction fee and when you go to sell it can take 4-5 days to clear and there is another transaction fee.
The reason I like Betterment is that I don’t have to individually sell any of the underlying investments and get hit with multiple transaction fees. You still need to wait 4-5 days to transfer money out but that comes with the territory.
The only time you can expect to get an instant transfer is when you sacrifice all investment gains for something like a Savings or Money Market account.
For me I’ll be detailing the growth every few months keeping you posted on how well the investments are doing. Really though, that’s it. Auto deposit, set it and forget it with solid gains. A perfect investment for my lazy self.
For you, I definitely encourage you to try Betterment and let me know how it goes. If you want to participate in the experiment or already invest with Betterment it would be awesome (and very helpful) if you could share your results in the comments.
It’s important to have your money earning for you while you sleep and over time the exponential gains really make a difference.
The Betterment Experiment – December 2013 Update
Good news! The Betterment experiment continues to make me good money at a brisk pace with zero effort on my part.
The Betterment Experiment – August 2014 Update
I have incredibly high expectations and on the face Betterment looks like an excellent option. As it turns out, it’s better than what I expected.