Their asset allocation appeared to adhere to complex advice I’d seen endorsed by smarter people than myself (William Bernstein, MD), with a tilt toward both small cap and value stocks supported by the Fama and French studies I’d read about. They diversified with international equities and bonds. They allowed me to designate the ratio of stocks to bonds I desired, so that my investments would reflect my personal tolerance for risk and volatility.
My portfolio was rebalanced automatically at set intervals or whenever I made a contribution, removing the human element that is capable of undermining even the soundest investment plans.
They exclusively use a small number of low cost ETF index funds, the bulk of which are either Vanguard or ishares. I liked that they used exclusively low cost investment vehicles. There were no trading fees.
An added value was their use of a tax loss harvesting algorithm: when an investment class lost value relative to the purchase price, Betterment automatically sold it to lock in the paper losses and purchase a similar ETF, the net result being a write off on my tax bill. Note that this pays off mostly for high net worth individuals, where it can cover the annual costs of Betterment and then some. To my knowledge, they were the first robo-advisor to offer this service to the unwashed masses like me. Also note that this only helps in a taxable account - you cannot write off losses in tax-protected accounts.
Betterment exclusively picks from a small number of low cost ETF index funds, so if you plan to move your assets from another brokerage to Betterment and you own anything other than those ETFs, you are simply out of luck.
They did not allow an in-kind transfer of my prior taxable investments from Merrill Lynch. As a result, I had to liquidate my investments at Merrill and then transfer them to Betterment and reinvest them. I paid a significant capital gains bill for the privilege of moving my assets to Betterment. I would characterize the mistake as mine entirely - beware the excess enthusiasm of the financially born-again! Still, it was a steep price to pay for entry, and one I would not have undertaken had I better grasped it at the time. Rookie mistakes can be expensive.
This argument does not hold up for tax-protected assets such as our Roth IRAs, where you can change custodians without tax implications or financial penalty. If it’s in a tax-protected account, no big deal, you liquidate your holdings and Betterment automatically invests in their preferred ETFs.
Another significant weakness was the inability to distribute assets in a tax-efficient manner for clients who hold both taxable and tax-protected accounts with Betterment. As someone with a Roth IRA, it made absolutely no sense that they would hold bond funds in my taxable account, where the dividends would generate taxable events. I wrote an email asking why Betterment they could not hold all bond funds in my Roth IRA account while maintaining the same asset allocation. Their otherwise excellent customer service, conducted via email, never replied. Eventually they rolled out tax-coordinated portfolio allocation, addressing this very question.
A few notable bloggers have made compelling arguments against Betterment, and these deserve fair consideration.
The folks at Early Retirement Now made a compelling case that for anyone with considerable taxable investments at another brokerage, the cost of liquidating investments in order to move them to Betterment can be considerable. I’d agree - in it’s current state, Betterment is a preferable choice for someone looking to invest new funds (i.e., new college graduates) than someone looking to move existing investments.
Jeremy at Go Curry Cracker, one of my favorite outside the box thinkers, wrote an incisive critique that has probably cost the company a large number of would-be clients from the financial independence community. He homes in on a few big deficits. First, Betterment compares their performance during a theoretical stretch of time to that of a high fee advisor, instead of comparing to an index. If you compare betterment to a low cost index fund such as Vanguard’s Total Stock Market Index Fund Admiral Shares (VTSAX), the index fund outperformed Betterment. So his point is well taken that while they would have outperformed a typical financial advisor, a cheap and simple alternative (as advocated by Jim Collins) would have outperformed both. Just because you’re better than a bad option doesn’t mean you’re best in class. When you add their fees to the low expense ratios for the ETF funds they choose (he cites .09% for 100% equities), your net fees go up to .24-.44%. This is less than 1% plus loads from the financial advisor, but the savings are less than initially advertised. It’s also complicated by needing to coordinate any assets outside of Betterment (if you sell a specific ETF in a taxable account with Betterment but buy a substantially similar equity in a tax-protected account outside of Betterment, your tax losses are disallowed). In other words, to benefit from tax-loss harvesting you need to hold all assets in betterment. For a schmoe like me with his 401k at Vanguard, I’ll have to cross-check every betterment tax loss to see if it’s disallowed by wash sale rules. It’s worth reading his full analysis to get the granular details, but as always, I tip my hat to a passionate advocate for financial independence.
Betterment’s Just Not That Into Me
Yesterday I received an abrupt email explaining that fees are going up across the board.
0.35% on accounts under $10k (with auto-deposit)
0.25% on accounts $10k to <$100k
0.15% on accounts > $100k
0.25% on all accounts up to $2 million
No fee on the balance above the initial $2 million
Instead of my low .15% fees, I’ll now pay .25% effective this June. No grandfathering in of early believers like me. No feedback from customers like me. Just boom, we’re more expensive. Betterment previously took on competitors like Wealthfront by charging lower fees for higher tier investors; with their new fee structure, that competitive advantage has been eliminated.
I had a live online chat with a representative who empathized, but could offer no explanation for the sudden change of heart. Even Mr. Money Mustache, who has taken a heap of crap for his willingness to publicly believe in the company, felt his trust had been violated.
Love on the Rocks Ain’t No Surprise
In a sense, this experience simply accelerated a nascent plan to move my investments in their entirety to Vanguard. I’m relieved to say this is motivated less by righteous indignation than the fact that I've become a do-it-yourself investor, and I'm ready to assume full accountability for both my mistakes and successes. As of this posting, I've initiated an in-kind transfer of both our Roth IRAs and our taxable funds from Betterment to Vanguard. I deserve a place that treats me well, keeps fees stable and predictable over time, and values my business enough to either involve me in their decision-making or explain (with adequate lead time) any drastic changes that will impact me financially.
What are my take home lessons from this costly financial affair?
Financial Literacy for The Newly Minted Physician