Updated Sept. 13, 2018: If you’re anything like 93% of millennials who say that they aren’t confident about investing, you physically recoil when you read the word. According to a 2015 survey by Capital One, that lack of confidence is directly related to a distrust in the market and a lack of investing knowledge.
Here’s what most millennials don’t know: you don’t actually need to know a lot about investing to get great returns from the market. In fact, you can pay a robot to do it for you.
Betterment, an online investment advisor founded in 2008, aims to make investing easier, cheaper, and smarter for anyone who doesn’t know a ton about stocks and bonds or just generally distrusts the stock market.
In this review, we’re going to look at how Betterment works, Betterment’s unique features, Betterment’s fees, and Betterment’s returns – all to answer the question, "Is Betterment right for me?" But before we jump into that, we have a very important question to answer...
Why am I investing in the first place?
It’s all about asset allocation and diversification. Before we jump into all the financial mumbo jumbo, let’s start off with an awesome example of diversification from the Securities and Exchange Commission (SEC):
….have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that's the point. Street vendors know that when it's raining, it's easier to sell umbrellas but harder to sell sunglasses. And when it's sunny, the reverse is true. By selling both items – in other words, by diversifying the product line – the vendor can reduce the risk of losing money on any given day.
The same concept holds true for your money. On "sunny" days, you don’t want the person carrying around an umbrella (i.e. a low-interest savings account). But on "rainy" days, you don’t want to be stuck with just a pair of sunglasses (i.e. high risk stock portfolio).
There are three basic asset categories that you can throw your money into:
Cash or cash equivalents like savings accounts, certificates of deposits (CDs), and money market funds
Bonds, which are sort of like a loan to the company or government that issues them
Stocks, which are an ownership stake in a company
Cash and cash equivalents are the least risky – on a rainy day, your cash is cash, and unless the government burns to the ground you’ll be okay. Bonds and stocks both earn higher returns than cash, with stocks earning higher returns than bonds. On sunny days, stocks and bonds are great, but the risk of losing both your returns and your initial investment is higher on rainy days.
The reason you take that risk, however, is because the possibility of return is so high. If you’re in your 30s, you have another 30 or 40 years before you retire. That’s a very long "time horizon," the number of years you have before you need to achieve a financial goal, before retirement. Just saving cash won’t get you the nest egg you need to comfortably live in retirement; you need to diversify your assets.
This is just a high level overview – I strongly suggest you take a look at this beginner’s guide to asset allocation by the SEC (surprisingly good for government literature!) and our guide to millennial investing if you want to learn more about why you shouldn’t keep all of your money under your mattress.
What is Betterment?
In industry parlance, Betterment is what’s known as a "robo-advisor." You put your money in and robots move your money around so you make more money. (It’s actually just software with artificial intelligence, but it’s more fun to imagine they’re real robots moving your money around).
Of course, there’s more to it than that. Betterment is an online brokerage that automatically manages your investment portfolio using artificial intelligence (AI). Thanks to this AI, it can offer users lower rates than non-robotic advisors and brokerages, while also promising higher returns.
What does it mean to automatically manage your money? Betterment’s portfolios are built out of index funds, which are collections of stocks or bonds. Index funds typically perform much better than buying individual stocks or bonds because your assets are more diverse – if one stock goes under, it’s not that big of a deal to the bigger picture.
Betterment is constantly working behind the scenes to buy and sell small amounts of the index funds in its portfolio in order to make sure you’re getting a high return. Additionally, Betterment works to rebalance your portfolio to keep your target allocation (i.e. the ratio of stocks to bonds) on track. You can read more about Betterment’s portfolio on their website.
Betterment will also reinvest any dividends that you receive from your investments. Unlike other brokerages, Betterment can actually invest in fractions of a share, which means that none of the money in your account is sitting on the bench, waiting for a turn at bat. All of your money is working for you to grow your initial investment.
All of this is to say that at its basic level, Betterment is always working to get you the highest return on your investment at a low cost to you.
What are Betterment’s special features?
The most interesting Betterment feature is the ability to create multiple portfolios for different goals.
Let’s say, for example, you wanted to save $10,000 to visit Tokyo for the next summer Olympics. To reach that goal, you’d have to save a little more than $200 per month for the next four years. You could put that money in a high-yield savings account, which may earn you a few bucks per year, or you could put that in a Betterment portfolio that is specifically formulated for a low-risk investment. Potentially, you could make enough from that portfolio to fly first class to Japan, or just spend a few more dollars on souvenirs for your parents.
That portfolio would be in addition to your other goals, like a higher-risk retirement account and a low-risk emergency fund. You can essentially think of Betterment as allowing you to create souped-up savings accounts for short-term savings goals.
One important thing to keep in mind, however – Betterment is not FDIC-insured, and there is the risk that you can lose money on any investment. Keeping some form of cash or cash equivalent savings is still an important part of your overall asset allocation.
Another really cool feature from Betterment is their Smart Deposit feature. Betterment has always had "auto deposits" – set amounts of money that you automatically put into your account every month – but sometimes, you have a little extra in your bank account that could be working towards your larger investment goals.
Smart Deposit is a little, well, smarter. You tell Betterment the maximum amount of cash you want in your checking account. You then tell Betterment the maximum amount you want them to "smart deposit" on a weekly schedule. After that, Smart Deposit goes to work. Once a week, it will check your account to see if you have more money than you want in your checking account. It will then take money out of your account (but no more than the max you set) and automatically put it towards your selected Betterment goal.
RetireGuide and more
There are a ton of other features Betterment offers that you might enjoy, like their RetireGuide, which allows you to connect third-party accounts, including your 401(k) (if you don't choose to roll over your 401(k)), to see a fuller picture of your investments. You’ll also probably enjoy their automatic tax loss harvesting features the next time you go to do your tax return.
How does Betterment’s fee structure work?
Betterment has different tiers depending on the level of support you want, but both offer advice from licensed expert via their mobile app. The fees are based on the plan tier chosen:
Betterment Digital: 0.25%/year, no minimum balance
Betterment Premium: 0.40%/year, $100,000 minimum balance
New accounts opened with at least $10,000 can have management fees waived for up to a year, depending on the amount of money deposited within 45 days of opening. Additionally, fees are waived for accounts with balances of over $2,000,000.
Betterment compares their fees to "traditional managers," which they estimate to be about 1% annually. With that in mind, Betterment expects their customers to save about $850 annually on an account with a $100,000 balance versus a traditional manager.
Betterment’s estimate holds up when scrutinized – AdvisoryHQ actually pegs the average financial advisor fee at 1.12% for managing $100,000 in 2016. The fee only dips below 1% once you start investing over $1,000,000.
Your account balance is based on all of the money in your goals and is not calculated on a portfolio-to-portfolio basis.
What are Betterment’s returns?
In general, Betterment expects to outperform your "average investor." Betterment did a data analysis where it pitted historical data based on their portfolio mix against portfolios from traditional managers. In the data analysis, they found that Betterment outperformed an average private client investor 88% of the time.
Betterment’s returns depend on a lot of factors, however – like the global economy and the individual performance of the index funds they include in their portfolios. Betterment cannot promise you that you’ll make a return on your money. In fact, no investment advisor can or should promise you that. There is always the risk that you could not only fail to make a return, but also lose your initial investment.
However, when it comes to traditional investment providers, the data shows that Betterment’s artificial intelligence outperforms an old white guy in a suit.
Is Betterment right for you?
Betterment isn’t the only investment game in town – it’s not even the only robo-advisor in town. Competing startups like Wealthfront and Acorns incorporate similar artificial intelligence, while industry stalwarts like Charles Schwab have also entered the arena. Plus, there’s always your local financial advisor, who provide friendly faces for complex financial planning. Definitely look into your alternatives to see if other providers have features that speak to the way you like to handle your money.
At the end of the day, however, Betterment is a great option for managing your investment portfolios. They allow you to have multiple portfolios for different goals, which, personally, is my favorite feature, they have a Smart Deposit feature that helps you save more money, and they have low fees that only get lower as your money grows. If that sounds like it fits your needs, you should look into opening a Betterment account.
Disclosure: We may use affiliate codes when linking to third parties. These codes earn us a small commission, but their presence does not influence which services or apps we choose to recommend, or our reviews of them.