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? Rebalancing is a Betterment feature that seeks to reduce drift in your client portfolios. Betterment performs two types of rebalancing on your clients’ behalf. First, in response to cash flows such as deposits, withdrawals, and dividend reinvestments, Betterment buys underweight holdings and sells overweight holdings. Second, if cash flows are not sufficient to keep a client’s portfolio within its applicable drift tolerance, automated rebalancing sells overweight holdings in order to buy underweight ones, aligning the portfolio more closely with its target allocation. Measuring Portfolio Drift 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. Betterment and partner portfolios For Betterment constructed portfolios (excluding Betterment’s Crypto ETF portfolio*), we broadly define portfolio drift as the total deviation of each “super” asset class (put in positive terms) from its target allocation weight, divided by two. These six 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. Drift for Advisor-built Custom Model Portfolios Your firm may elect to construct a custom Model Portfolio on our platform. If so, drift for these portfolios is evaluated on the security group level, rather than at the super asset class level as described above for Betterment constructed portfolios. Betterment will calculate drift at the security group level for custom model portfolios even if the security group(s) used are pre-populated options provided by Betterment in the interface. Advisors can also set customized drift tolerance thresholds for their client’s portfolio. 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 Custom 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. *Please note: As of the date of the publication of this article, Betterment’s default drift tolerance threshold is generally 3% for stock and bond ETF portfolios, 5% for portfolios containing mutual funds, 7% for Crypto ETF portfolios, and for custom model portfolios, Advisors can set a custom drift tolerance threshold. Betterment may change the default drift thresholds without notice. Rebalancing Betterment automatically takes actions to reduce drift for your client through cash-flow rebalancing and sell/buy rebalancing, 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 customized drift tolerance and gains allowance that you’ve set when rebalancing your clients’ goals. A gains allowance can reduce eligible opportunities to reduce drift through rebalancing, because Betterment will not initiate rebalancing transactions (or will only initiate partial rebalancing transactions) in a client goal with gains in overweight securities above the gains allowance. Learn more. 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, 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. Sell/Buy Rebalancing When cash flows are not sufficient to keep your client's portfolio’s drift within its applicable drift tolerance (such parameters as disclosed in Betterment’s Form ADV), Betterment seeks to rebalance client portfolios by selling and buying assets, aligning the portfolio more closely with its target allocation. Rebalancing requires a minimum portfolio balance (Advisors can review the estimated balance at www.betterment.com/legal/portfolio-minimum). The rebalancing algorithm is also calibrated to avoid frequent small rebalance transactions and to seek tax efficient outcomes, such as preventing wash sales and minimizing short-term capital gains. As with any sell trade, our tax minimization algorithm seeks to select the lowest tax impact lots for rebalancing transactions. 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 experience higher levels of drift without rebalancing if we have no long-term lots to sell. Generally this is because the account is less than a year old, or a substantial portion of the account’s holdings have been purchased within a year. A client account with a gains allowance can also experience higher drift, since rebalancing will not recognize any gains above the gains allowance. And large positions transferred in via ACATs with embedded gains can also lead to higher drift and delay buy/sell rebalancing. If you’d like to turn off automated buy/sell rebalancing in a client’s account (so that Betterment only rebalances client’s accounts in response to cash flows), you can do so in the Clients tab of your advisor dashboard. Betterment has discretion to limit or postpone rebalancing in order to prioritize other trading activity on any given day, including days where extreme market conditions produce a higher volume of trading. To learn more about rebalancing, see our rebalancing disclosures. 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. *The Betterment Crypto ETF portfolio is composed of two ETFs that are market weighted in the portfolio, and as such, do not have geographic and stock to bond super asset classifications. See disclosures for more information. Transaction Timelines