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Edit: I think it would be beneficial for any answers to include whether the answerer uses a diversified portfolio or not in their own finances, and whether they have any affiliation with Betterment or other similar financial service that charges a fee to do this sort of thing.

Edit#2: Following my first edit, I am a recent college graduate, am not affiliated with any financial service, and just recently started using Betterment with a 90/10 stocks/bonds Roth IRA and a 40/60 Stocks/Bonds regular investment account (safety net). I also bought a few shares of SPY on Robinhood.

Original post: What is the advantage of something like Betterment -- which diversifies my investments for me but also charges a fee -- if I can just buy SPY on Robinhood for no fees and do better?

These graphs show % return from July 2007 - present.

2007-Present

2009-Present 2009-Present

2011-Present 2011-Present

2013-Present 2013-Present

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    Oh look, someone asks why sales people are lying! – littleadv Feb 2 '15 at 17:14
  • Welcome to the site pittofdirk. I think you can improve this question by framing it as "how should I evaluate a planned portfolio (ig betterment) against an index fund (eg SPDY)?" I think this is what you really want to know and betterment is just an example, but the language could be improved. I would like to see this being a little less specific. (I don't see how those changes will affect the existing answers either.) – MrChrister Feb 2 '15 at 18:41
  • I don't think it matters what affiliation we have (perhaps unless employed by or similarly affiliated with Betterment or SPY, in which case it probably would be required regardless of the question) or what investments we make; the answer to the question is the same. – Joe Feb 2 '15 at 19:55
  • I'm 99% sure there are fees charged by the company that runs SPY that are taken out of the dividends but this requires doing some research. Also, don't forget that you may have to buy SPY in whole share numbers and not partial amounts. – JB King Feb 2 '15 at 20:18
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    That's not really how SE works, though. Our answers should be answers without any context from the answerer. That's not always truly possible, but that's why voting exists - for the best answer to rise to the top. It shouldn't matter if the answerer is a day trader with separate positions in a hundred stocks or derivatives, or someone with retirement goals and entirely invested in VOO. – Joe Feb 2 '15 at 22:34
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Diversification and convenience:

  • In event of crash stocks will go down. In case of large event like 2001-2008 it may be a significant loss of portfolio. If you are close to retirement then you want to 'play safe' and avoid risk - at cost of lower returns - see part around 2009 and 2010 - conservative portfolio preserved value so in long run cost of withdrawing when market is down is much higher.
  • If you have diversified portfolio you can rebalance when you are down (I'm not sure if the graphs are smart enough to do so) - so you can use bond part when the stocks are cheap.
  • Historically the international equities had similar returns to US but it did not have the same correlation. During period in question it did not perform as well as US. So looking only on the recent period you see international stocks to be a dead weight even though they don't necessary are such. For similar reasons people use RETI (see also rebalancing).
  • For better or worse (usually worse) people do try to time market and/or use costly advisers and/or are too lazy to begin. The 0.15-0.35% fee may seem reasonable for them.
  • Finally for some people initial investments in mutual funds are too high and ETFs would provide well off allocation (say you can invest $100/month). On the other hand they pay small fee for small investments at Betterment.

Is .15-0.35% fee worth it? It depends on your net worth, amount you invest and value of your time (if you have high net worth and low cost of your time the fee is highier then in case when you have low net worth but high cost of time - so Betterment seems to be a better option to young professional just after college then to someone already retired), your interest in finance, your willpower etc. Is Betterment allocation better then pure SPY? From what I understand about finance theory - yes.

EDIT (as requested) I don't have any affiliation with any financial institution as far as I know. I opened it to get used to just investing as oppose to saving and ups and downs of market (and read up on the portfolio management, especially index funds) and I guess it worked well for me. I plan to move out entirely out of it once the cost of the account would be more then paying for a few coffees and move the account to Vanguard, Schwab or something similar. In other accounts (HSA/...) I use simpler portfolio then the Betterment one (US Total, Small Value, Developed, Emerging and Bonds) but there are people who use simpler (search for 3 fund portfolio).

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    "If you have diversified portfolio you can rebalance when you are down": Can you clarify? Does this mean when the stock market goes down you would change from for example 50/50 stocks/bonds to 90/10 stocks/bonds? – Andrew Roth Feb 2 '15 at 17:58
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    If you were at 50/50, and the stock market goes down, you will probably be at 20/80 without making any changes to your allocations. This is because your net-worth is decreasing, but the majority of the decrease is in stocks. You can then rebalance your assets back to 50/50 by moving money from bonds to stocks. – Bishop Feb 2 '15 at 18:02
  • To expand the Bishop's answer - the goal is to buy stocks when they are cheap so from example above you would get 56.25% return when the market is back to the same level you started with (though move from 50/50 to 20/80 would require move by 75% so this is extreme example). – User Feb 2 '15 at 18:07
  • Marking this as the accepted answer as it gave me the most to go on. Thanks for your help User whoever you are. – Andrew Roth Feb 15 '15 at 0:32
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The reason diversification in general is a benefit is easily seen in your first graph. While the purple line (Betterment 100% Stock) is always below the blue line (S&P), and the blue line is the superior return over the entire period, it's a bit different if you retired in 2009, isn't it? In that case the orange line is superior: because its risk is much lower, so it didn't drop much during the major crash. Lowering risk (and lowering return) is a benefit the closer you get to retirement as you won't see as big a cumulative return from the large percentage, but you could see a big temporary drop, and need your income to be relatively stable (if you're living off it or soon going to).

Now, you can certainly invest on your own in a diverse way, and if you're reasonably smart about it and have enough funds to avoid any fees, you can almost certainly do better than a managed solution - even a relatively lightly managed solution like Betterment. They take .15% off the top, so if you just did exactly the same as them, you would end up .15% (per year) better off.

However, not everyone is reasonably smart, and not everyone has much in the way of funds. Betterment's target audience are people who aren't terribly smart about investing and/or have very small amounts of funds to invest. Plenty of people aren't able to work out how to do diversification on their own; while they probably mostly aren't asking questions on this site, they're a large percentage of the population. It's also work to diversify your portfolio: you have to make minor changes every year at a minimum to ensure you have a nicely balanced portfolio. This is why target retirement date portfolios are very popular; a bit higher cost (similar to Betterment, roughly) but no work required to diversify correctly and maintain that diversification.

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What is the advantage of something like Betterment -- which diversifies my investments for me but also charges a fee -- if I can just buy SPY on Robinhood for no fees and do better?

Because Betterment is more diversified than the S&P, glaringly when it comes to non-US investments. The US's economy is huge. It represents 22% of nominal global GDP and 17% of global GDP (PPP). While I think that the US's stability is good reason to be overweight US, being 100% invested in 22% of the market isn't well diversified.

  • Good answer; a lot of "index-fundies" don't say that not all indexes are equal; index fund retirees in Japan betting on the Nikkei have had a tough 30 years. Still, diversifying can be done through Robinhood for free with the right selection. – user541852587 Feb 7 '15 at 18:53
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This is Ellie Lan, investment analyst at Betterment. To answer your question, American investors are drawn to use the S&P 500 (SPY) as a benchmark to measure the performance of Betterment portfolios, particularly because it’s familiar and it’s the index always reported in the news. However, going all in to invest in SPY is not a good investment strategy—and even using it to compare your own diversified investments is misleading. We outline some of the pitfalls of this approach in this article: Why the S&P 500 Is a Bad Benchmark.

An “algo-advisor” service like Betterment is a preferable approach and provides a number of advantages over simply investing in ETFs (SPY or others like VOO or IVV) that track the S&P 500.

So, why invest with Betterment rather than in the S&P 500?

  • Superior risk-adjusted diversification
  • Smarter investment management Services
  • Better tax management features

Let’s first look at the issue of diversification. SPY only exposes investors to stocks in the U.S. large cap market. This may feel acceptable because of home bias, which is the tendency to invest disproportionately in domestic equities relative to foreign equities, regardless of their home country.

However, investing in one geography and one asset class is riskier than global diversification because inflation risk, exchange-rate risk, and interest-rate risk will likely affect all U.S. stocks to a similar degree in the event of a U.S. downturn.

In contrast, a well-diversified portfolio invests in a balance between bonds and stocks, and the ratio of bonds to stocks is dependent upon the investment horizon as well as the individual's goals.

By constructing a portfolio from stock and bond ETFs across the world, Betterment reduces your portfolio’s sensitivity to swings. And the diversification goes beyond mere asset class and geography. For example, Betterment’s basket of bond ETFs have varying durations (e.g., short-term Treasuries have an effective duration of less than six months vs. U.S. corporate bonds, which have an effective duration of just more than 8 years) and credit quality. The level of diversification further helps you manage risk.

Dan Egan, Betterment’s Director of Behavioral Finance and Investing, examined the increase in returns by moving from a U.S.-only portfolio to a globally diversified portfolio. On a risk-adjusted basis, the Betterment portfolio has historically outperformed a simple DIY investor portfolio by as much as 1.8% per year, attributed solely to diversification.

Now, let’s assume that the investor at hand (Investor A) is a sophisticated investor who understands the importance of diversification. Additionally, let’s assume that he understands the optimal allocation for his age, risk appetite, and investment horizon. Investor A will still benefit from investing with Betterment.

Automating his portfolio management with Betterment helps to insulate Investor A from the ’behavior gap,’ or the tendency for investors to sacrifice returns due to bad timing. Studies show that individual investors lose, on average, anywhere between 1.2% to 4.3% due to the behavior gap, and this gap can be as high as 6.5% for the most active investors. Compared to the average investor, Betterment customers have a behavior gap that is 1.25% lower. How? Betterment has implemented smart design to discourage market timing and short-sighted decision making.

For example, Betterment’s Tax Impact Preview feature allows users to view the tax hit of a withdrawal or allocation change before a decision is made. Currently, Betterment is the only automated investment service to offer this capability. This function allows you to see a detailed estimate of the expected gains or losses broken down by short- and long-term, making it possible for investors to make better decisions about whether short-term gains should be deferred to the long-term.

Now, for the sake of comparison, let’s assume that we have an even more sophisticated investor (Investor B), who understands the pitfalls of the behavior gap and is somehow able to avoid it. Betterment is still a better tool for Investor B because it offers a suite of tax-efficient features, including tax loss harvesting, smarter cost-basis accounting, municipal bonds, smart dividend reinvesting, and more. Each of these strategies can be automatically deployed inside the portfolio—Investor B need not do a thing. Each of these strategies can boost returns by lowering tax exposure.

To return to your initial question—why not simply invest in the S&P 500? Investing is a long-term proposition, particularly when saving for retirement or other goals with a time horizon of several decades. To be a successful long-term investor means employing the core principles of diversification, tax management, and behavior management. While the S&P might look like a ‘hot’ investment one year, there are always reversals of fortune. The goal with long-term passive investing—the kind of investing that Betterment offers—is to help you reach your investing goals as efficiently as possible.

Lastly, Betterment offers best-in-industry advice about where to save and how much to save for no fee.

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    -1. This looks more like a sales pitch. – littleadv Feb 14 '15 at 23:47
  • When I initially asked the question I also emailed Betterment support posing the same question. They said they would be responding to this question since it is in a public forum. Ellie Lan is likely an employee of Betterment (Which is fine, I did ask them as well). – Andrew Roth Feb 15 '15 at 0:30
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    If you are associated with Betterment, it would probably be helpful to state this. – jmg229 Feb 15 '15 at 2:13
  • @jmg229 - it's in her profile. Do we have a requirement for it to be stated in the text of this answer? I don't know, that might be a meta question. – JoeTaxpayer Feb 16 '15 at 19:39
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    +1: With the clear connection to Betterment, and the explanation. People clearly identified with the topic of the question should be allowed to comment @littleadv. They'd hardly be knocking their approach, but I don't see anything wrong with them giving the "party line" in a public forum. – Peter K. Feb 16 '15 at 22:52
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Betterment Advantages:

Good for lazy investors, time-restricted investors, investors with little knowledge, investors who want a hybrid of advice and tools without paying the crazy fees of mutual funds or an advisor.

  • Tools are great, although they can be found online
  • Portfolios & Rebalancing are not terrible
  • Cost is relatively cheap when compared to a mutual fund, advisor or active trader.

The biggest advantage, is that it is easy, quick and convenient

Disadvantages:

  • Limited by portfolios offered
  • Lack of data for performance in a bear market
  • Still relatively new, things are being developed/ironed out

If you have the time and knowledge, this might not be for you

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