Are You Better Off Investing with Betterment?
In a recent article titled “The Truth Behind the Rise of Robo-Advisors“, we talked about how a “robo-advisor” is only similar to a robot because it is automated. It does not use any sort of artificial intelligence (at the moment) which means the strategy itself is very similar to what a traditional wealth management advisor would offer. It’s really just the traditional wealth management offering at a lower price point and with lowered required minimums. The “low cost” aspect of the offering is particularly appealing to retail investors planning for retirement, because that low fee structure is most likely better than what they are currently paying for their retirement accounts. While we’ve talked about robo-advisory offerings in the context of large well-established wealth management firms, there are “robo-advisor” startups that are starting to steal assets under management (AUM) from traditional wealth management advisors. One of the largest, if not the largest robo-advisor startup at the moment is Betterment.
Founded in 2008, New York-based Betterment has taken in 5 rounds of funding totaling $105 million so far from firms like Citi, Bessemer Venture Partners, and Northwestern Mutual. The Company claims to have over $3 billion under management with +125,000 users which would mean an average investment portfolio size of around $24,000. While some of the reviews we’ve read on Betterment simply elaborate on all the marketing literature provided by the Company, we’re more interested in understanding their business model, investment methodology, and most importantly fees. What are they doing to earn their money?
Update 09/30/2021: Betterment has raised $160 million to accelerate growth across its core retail investment products and advisor solutions, and particularly its rapidly growing 401(k) offering for small and medium-sized businesses. This brings the company’s total funding to $435 million to date.
First, let’s talk about Betterment’s methodology which they say is “built on decades of Nobel-prize winning research“. One basic question to ask candidates in a finance interview is if they know the difference between an “active” money manager and a “passive” money manager. The difference is this. A passive manager simply tracks the performance of a benchmark like the S&P 500 while an active manager tries to beat the benchmark by overweighting or underweighting certain stocks, industries, or factors. Betterment uses a passive investment strategy that allocates your funds across fixed income and equity using a variety of ETFs. This means the process is almost completely objective. Like every single other wealth management strategy out there, it is indeed “built on decades of Nobel-prize winning research“, or as finance professionals would call it “modern portfolio theory“.
When you first look at the Betterment investment offerings, the only 3 things they want to know about you are your age, whether or not you are retired, and the amount of money you make per year. They then use this information to allocate your money across a basket of fixed income and equity ETFs. The amount of money you earn per year makes no difference to the allocations but is simply used to estimate how much money you might have when you retire. From age 18 to 48, the allocations don’t change but from 48 years old onwards the allocation percentages change every year. You can see how the allocations change based on your age:
So far this is a textbook wealth management strategy; as you age, your portfolio’s allocation to equities decreases and the allocation to fixed income increases. Nothing too special so far. So what fees are we paying for this strategy? Here are the fees for all the investment products (red text) in a sample Betterment portfolio along with Betterment’s fees (green text):
Many of the ETFs in this portfolio are from Vanguard who claims to have some of the lowest investment fees in the industry. The entire portfolio has very low fees, so the question becomes whether or not Betterment’s fees are reasonable. Why couldn’t we just replicate this strategy ourselves by buying this portfolio of ETFs? Using Motif Investing, we can buy up to 30 ETFs for the flat fee of $9.95 per trade and weight them as seen above. This means we’re paying a transaction cost of around 4 basis points to buy an average-sized Betterment portfolio of $24,000. We would have to pay an additional 4 basis points every time we want to rebalance the portfolio, perhaps once per year. We would also have to pay 4 basis points every time we sell some or all of our position. On the other hand, Betterment allows you to invest one time or a fixed amount per month with no fees ever. Betterment also allows you to withdraw your money at any time for no fees and they always sell your shares in a way that minimizes tax for you.
So are you better off investing in Betterment? We think so. The real value add behind Betterment is the fact that by using their product you are saving money, not only in fees, but in the fact that you are actually saving money. Americans, the people who make of the majority of our audience, don’t tend to invest much of their discretionary income. Betterment is selling an investment product with low fees, an objective “passive” methodology based on widely accepted principles of investing, and an automatic rebalancing function. Is charging 15/25/35 basis points for that platform acceptable? It is certainly a fair price, since if you have a very small amount to invest, you can get access to this platform by investing just $100 a month. If you have $100,000 to invest, then fees at 15 basis points seem reasonable and are certainly less than what you can expect from a traditional wealth management advisor.
Robo advisors like Betterment provide a low-risk way to invest that we recommend for beginner and advanced investors alike. You can open an account with no minimums and contribute as often and as much as you'd like. Don't have cash on hand to invest? You can roll over your 401(k) or IRA in just 60 seconds. Click here to get started.