Using Betterment

How Portfolio Rebalancing Works to Manage Risk for Your Clients Portfolio rebalancing, when done effectively, can help manage risk and keep your clients on track to pursue the expected returns desired to meet their goals. What is rebalancing? Over time, the value of various holdings within a diversified portfolio moves up and down, drifting away from the target weights that help achieve proper diversification. Over the long term, stocks generally rise faster than bonds, so the stock portion of your client's portfolio will likely go up relative to the bond portion—except when you rebalance the client’s portfolio to target the original allocation. Clients may also transfer in assets from outside Betterment that are not part of the target portfolio strategy and/or allocation. The difference between the target allocation for your client's portfolio and the actual weights in your client's current portfolio (e.g. their actual allocation) is called portfolio drift. Measuring Portfolio Drift Betterment and partner portfolios We broadly define ETF portfolio drift as the total deviation of each super asset class (put in positive terms) from its target allocation weight, divided by two. These super asset classes are US Bonds, International Bonds, Emerging Markets Bonds, US Stocks, International Stocks, and Emerging Markets Stocks. Here’s a simplified example, with only four assets: Target Current Deviation (±) U.S. Bonds 25% 30% 5% International Bonds 25% 20% 5% U.S. Stocks 25% 30% 5% International Stocks 25% 20% 5% Total 20% Total ÷ 2 10% A high drift may expose your client to more (or less) risk than you intended when you set the target allocation. Taking actions to reduce drift is called rebalancing, which Betterment automatically does for your client in several ways, depending on the circumstances, and with an eye on tax efficiency. If you choose to take advantage of Betterment’s tax smart transition features, we will aim to respect the drift tolerance and gains allowance that you’ve set when rebalancing your clients’ goals. Learn more. Considerations for Custom Model Portfolios Your firm may elect to construct a custom Model Portfolio on our platform. If so, drift for these portfolios is calculated on the security group level, even if the security group(s) used are pre-populated options provided by Betterment in the interface. For reference, security groups are groupings of ETFs that include a primary ticker, and may include secondary and/or IRA secondary tickers designed to help avoid wash sales and allow for tax-loss harvesting opportunities. This means that for Model Portfolios, drift is calculated as the total deviation of each security group (put in positive terms) from its target allocation weight, divided by two. Considerations for DFA Mutual Fund Portfolios Certain firms on the Betterment for Advisors platform have access to Dimensional mutual funds for their models. In a DFA mutual fund portfolio, we calculate drift on a per-asset basis. This means that for DFA portfolios, drift is calculated as the total deviation of each holding (put in positive terms) from its target allocation weight, divided by two. Cash Flow Rebalancing This method involves buying or selling when cash flows into or out of the portfolio happen. Cash flows (such as deposits, dividend reinvestments or withdrawals) can be used to rebalance your client's portfolio. Fractional shares allow us to allocate these cash flows with precision. Inflows: When a client makes a deposit or receives a dividend, we use the inflow to buy holdings that are currently underweight, reducing their drift. The result is that the need to sell in order to rebalance is reduced. Whenever client drift is higher than normal (generally 2% or higher), we calculate the deposit required to reduce the client's drift to zero, and make it easy for them to make the deposit. Although we show the deposit amount needed to bring drift back to 0%, smaller deposits also help reduce drift. Outflows: Withdrawals (and other outflows) are also used to rebalance, by prioritizing selling holdings that are overweight. We employ a sophisticated ‘lot selection’ algorithm called TaxMin to minimize the tax impact in taxable accounts while reducing overall portfolio drift. Sell/Buy Rebalancing In the absence of cash flows, we rebalance by selling and buying, reshuffling assets that are already in the portfolio. When cash flows are not sufficient to keep your client's portfolio’s drift within a certain tolerance, we sell just enough of the overweight holdings, and use the proceeds to buy into the underweight holdings to reduce the drift to zero. Sell/Buy rebalancing is generally triggered whenever the portfolio drift reaches or exceeds 3%, unless you set a custom threshold for your client. Once an account balance is at or past the minimum threshold, our algorithms check your client's drift approximately once per market day and rebalance if necessary. Note: In addition to the higher threshold, we built in another restriction into the rebalancing algorithm for taxable accounts. As with any sell trade, our tax minimization algorithm seeks to select the lowest tax impact lots, and stops before selling any lots that would realize short-term capital gains when possible. Since short-term capital gains are taxed at a higher rate than long-term capital gains, we can achieve higher after-tax outcomes by simply waiting for those lots to become long-term before rebalancing, if it's still necessary at that point. As a result, it’s possible for your client's portfolio to stay above the 3% drift if we have no long-term lots to sell. Almost always, it’s because the account is less than a year old. In this case, we recommend rebalancing via a deposit to avoid taxes. The Portfolio tab of a client’s goal will show your client know how much to deposit, as described above, to rebalance via cash flow. If you’d like to turn off automated buy/sell rebalancing in a client’s account, you can do so in the Clients tab of your advisor dashboard. Please note that for advised clients on our Betterment For Advisors platform, the drift threshold is 5% for portfolios that contain mutual funds. For custom model portfolios, advisors can set a custom drift threshold. Allocation Change Rebalancing Changing your client's target allocation by moving the allocation slider and confirming the change could also cause a rebalance. When you update a client's portfolio strategy and/or asset allocation, Betterment will give you the option to select one of our three tax-aware migration strategies. Depending on which option you select, this could result in selling securities and could possibly realize capital gains. As with all sell trades, we will utilize our tax minimization algorithm to help reduce the tax impact. Additionally, before confirming the allocation change, you can review the potential tax impact of the change with Tax Impact Preview. Transaction Timelines