Rebalancing is a Betterment feature that seeks to reduce drift in client portfolios. Betterment performs two types of rebalancing on your behalf. First, in response to cash flows such as deposits, withdrawals, and dividend reinvestments, we buy underweight holdings and sell overweight holdings. Second, if cash flows are not sufficient to keep your portfolio drift 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.
Cash Flow Rebalancing
This method involves buying or selling when cash flows into or out of your portfolio happen. Cash flows (such as deposits, dividend reinvestments or withdrawals) can be used to rebalance your portfolio. Fractional shares allow us to allocate these cash flows with a level of precision.
Inflows: You are rebalanced whenever you make a deposit, including when you auto-deposit or receive dividends in your account. We use the inflow to buy the asset classes you are currently underweight in, reducing your drift. The result is that the need to sell in order to rebalance is reduced, which in turn reduces capital gains and tax implications. With sufficient inflows, the need to sell is eliminated.
Outflows: Outflows (e.g. withdrawals) are likewise used to rebalance, by first selling asset classes which are overweight. Once we have sold all asset classes that you are overweight in, we strive to sell all asset classes equally to keep you balanced. We employ a sophisticated lot selection algorithm called TaxMin within asset classes to minimize the tax impact as much as possible in taxable accounts.
Sell/Buy Rebalancing
Over time and due to market movements, the value of various holdings within your portfolio move up and down, drifting away from their target allocation. The difference between the target allocation for your portfolio and the actual weights of your holdings in your current portfolio (i.e., their actual allocation) is called portfolio drift. If cash flows have not been sufficient to keep your portfolio’s drift within its applicable drift tolerance (such parameters as disclosed in Betterment’s Form ADV), we rebalance by selling and buying. For Betterment constructed portfolios (excluding the Crypto ETF portfolio*), we evaluate the drift of your holdings through the lens of six “super” asset classes: US Bonds, International Bonds, Emerging Markets Bonds, US Stocks, International Stocks, and Emerging Markets Stocks.
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. For example, it’s possible for your portfolio to remain in a drifted state without sell/buy rebalancing if you have no long-term lots to sell (usually due to the account being less than a year old) and there is an absence of cash flows. Since short-term capital gains are taxed at a higher rate than long-term capital gains, we can achieve better after-tax outcomes by simply waiting for those lots to become long-term before rebalancing, if it's still necessary at that point.
You can review the estimated minimum portfolio balance necessary to enable rebalancing, and if you’d like to turn off automated sell/buy rebalancing so that we only rebalance your portfolio in response to cash flows (e.g. deposits, withdrawals, or dividend reinvestments) and not by reshuffling assets already in the portfolio, please contact us. For additional information, review our rebalancing disclosures.
Allocation Change Rebalancing
Manually adjusting the target allocation will also trigger a rebalance. This sells securities and could possibly realize capital gains. Moreover, if you change your allocation even by 1%, you will be rebalanced entirely to match your new desired target allocation, regardless of tax consequences. As with all sell trades, we will utilize TaxMin to reduce the tax impact as much as possible, and you will see a Tax Impact Preview before finalizing the change.
*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.
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