Chrissy Celaya, CFP®

How Betterment Anticipates Market Volatility—So You Don’t Have To It’s difficult to endure volatile markets when it affects your investment portfolio. Betterment has automated features in place to help address volatile markets when they occur. If you’ve ever been told to “sit tight and stay the course” when the market is dropping and your investment account is worth less than it was just moments ago, you’re not alone. Financial advisors, including Betterment, love this mantra and repeat it anytime there’s a market downturn—which every investor should be prepared to navigate at some point. But being told to do nothing when your account balance is dropping can feel like an inadequate response. And, unless your investment strategy has been designed from the ground up to anticipate and react to market volatility, you may be right. The reason Betterment advises our customers not to react or adjust their investment strategy during a market downturn is because our entire platform was designed with inevitable downturns of the market in mind. This article will cover how our investment portfolio creation process, ongoing automated account management system, and dynamic advice are designed with market fluctuations in mind, so that you can “sit tight and stay the course” and feel confident it’s actually the right thing to do. Our portfolios are constructed with market volatility in mind Betterment’s portfolio construction process strives to design a portfolio strategy that is diversified, increases value by managing costs, and enables good tax management. Ultimately, our goal is to help you build wealth. This means: Our intent is to create portfolios designed to have a better chance of making money and a lower chance of losing it. At a baseline, our allocation recommendations are based on various assumptions, including a range of possible outcomes, in which we give slightly more weight to potential negative ones, by building in a margin of safety—otherwise known as ‘downside risk’ or uncertainty optimization. So, even before you’ve invested your first dollar, your portfolio has already been designed to account for the market fluctuations you will inevitably experience throughout the course of your investment journey, including situations like the big downturns like 2008 and the more recent market crash in 2020. Furthermore, our risk recommendations consider the amount of time you’ll be invested. For goals with a longer time horizon, we advise that you hold a larger portion of your portfolio in stocks. A portfolio with greater holdings in stocks is more likely to experience losses in the short-term, but is also more likely to generate greater long-term gains. For shorter-term goals, we recommended a lower stock allocation. This helps to avoid large drops in your balance right before you plan to withdraw and use what you’ve saved. All you have to do is: Tell us what you are saving for (your investing goal). Let us know how long you plan to be invested (your time horizon). We take care of the rest. By using your personal assumptions, in conjunction with our general downside risk framework, we’re able to recommend a globally diversified portfolio of stock and bond ETFs that has an initial risk level recommended just for you. Our automated portfolio management features keep you on track during downturns How we construct our globally diversified portfolios and the risk framework we apply to each investor’s specific allocation recommendation is just the starting point. It’s our ongoing and automated portfolio management that provides an additional value-add, especially in times of heightened volatility. Our automated features like allocation adjustments over time, portfolio rebalancing, tax loss harvesting for those who select it, and updated advice when you need it, can help keep your investing goals on track during a downturn. Automated Allocation Adjustments When we ask you to tell us about your investment objective, including how long you plan to be invested for, it helps us choose the appropriate asset allocation for you throughout the course of your investment time horizon, not just in the beginning. For most Betterment goals, we usually recommend that you scale down your risk as your goal’s end date gets closer, which helps to reduce the chance that your balance will drastically fall if the market drops. This is an especially important consideration for an investor who plans to use their funds in the near term. We call this recommendation “auto-adjust” or a goal’s “glidepath”—a gradual reduction of stocks in favor of bonds. And instead of leaving this responsibility up to you, you can opt into our auto-adjust feature in eligible portfolio selections, which means our system monitors your account and adjusts your portfolio’s allocation automatically over time. Automated Portfolio Rebalancing Normal stock market fluctuations will likely cause your actual allocation to drift away from your portfolio target, which is calculated to be the optimal level of risk you should be taking on. We call this process portfolio drift, and though a small amount of drift is perfectly normal—and a mathematical certainty—a large amount of drift could expose your portfolio to unwanted risks. When the market fluctuates, not all of your investments are shifting to the same degree. For example, stocks are generally more volatile than bonds. As you can imagine, a period of sustained volatility could mean a significant shift in how your portfolio is actually allocated, relative to where it should be. Left unchecked, this drift could be harmful to your portfolio’s performance, which is why at Betterment our portfolio management system provides ongoing monitoring of your portfolio in order to determine whether rebalancing is needed. While we generally use any cash inflows, like deposits or dividends, and outflows, like withdrawals, to help rebalance your portfolio organically over time, when a significant market drop occurs, there might be a need to sell investments that have appreciated and buy investments that have depreciated, in order to adjust your portfolio back to its optimal allocation. Consider an instance where the value of your stock investments has dropped significantly and now your bond investments are overweighted relative to your stocks. Our rebalancing system might be triggered to correct the drift. Not only would our automated rebalancing seek to ensure your portfolio’s allocation is realigned relative to its target, it would also mean buying stocks at their currently cheaper price point, setting you up nicely for any market recovery. Furthermore, if effective rebalancing does require selling investments in a taxable account, the specific shares to be sold are selected tax-efficiently. This is designed with the aim that no short-term gains are realized. We never want the tax impact of maintaining proper diversification to counter the benefits of applying our risk framework. Automated Tax Loss Harvesting Tax Loss Harvesting is a feature that may benefit you most when the market is volatile. After all, if there aren’t any losses in your account, we can’t harvest them. Our automated TLH software monitors your account for opportunities to effectively harvest tax losses that can be used to reduce capital gains that you have realized through other investments in the same tax year. This can potentially reduce your tax bill, thereby increasing your total returns, especially if you have a lot of short-term capital gains, which are taxed at a higher rate than long-term capital gains. And, if you’ve harvested more losses than you have in realized capital gains, you can use up to an additional $3,000 in losses to reduce your taxable income. Any unused losses from the current tax year can be carried over indefinitely and used in subsequent years. Keep in mind, however, that everyone’s tax situation is different—and Tax Loss Harvesting+ may not be suitable for yours. In general, we don’t recommend it if: Your future tax bracket will be higher than your current tax bracket. You can currently realize capital gains at a 0% tax rate. You’re planning to withdraw a large portion of your taxable assets in the next 12 months. You risk causing wash sales due to having substantially identical investments elsewhere. Our dynamic financial advice works for you during market fluctuations Much like the automated features described in the section above, the advice we give our customers is dynamic and updates automatically based on many factors, including market performance. Just as your car’s GPS recommends the best route to take to reach your destination, Betterment recommends a tailored path toward reaching your financial goals. And just as the GPS updates its recommended route based on road conditions and accidents, we update our advice based on various circumstances, such as a market downturn. In addition to recommending a starting risk level tied to your specific objective, we also estimate how much you need to save. In the case of a really big market drop, we might advise you to do something about it, such as make a single lump-sum deposit, which will help keep your portfolio on track. Recognizing that coming up with sizable excess cash can be tough to do, we’ll also suggest a recurring monthly deposit number that may be more realistic. And, if it’s early on in a long-term goal, it’s unlikely you’ll need to change anything significantly, because you still have a lot of time on your side. Conclusion The path to investment growth can be bumpy, and negative or lower than expected returns are bound to make an investor feel uncertain. But, staying disciplined and sticking to your plan can pay off. Betterment’s investing advice has been purpose-built with all the worst and the best the market may throw at us in mind by focusing on three key elements: intentional portfolio construction, automated portfolio features, and advice that reflects market conditions. Feel confident that Betterment’s hard at work, for you, so that you can truly sit tight and stay the course.

5 Common Roth Conversion Mistakes Learn more about Roth conversion benefits—for high earners and retirees especially—and common conversion mistakes to avoid. IRAs, as you may already know, have two popular flavors among others: Traditional IRA: Anyone can open and contribute to one, but one of the Traditional IRA’s primary appeals to investors is the ability to deduct contributions to it from their taxable income, a benefit the IRS phases out at certain income thresholds. Roth IRA: Contributions to a Roth IRA aren’t tax-deductible—you’re investing with “post-tax” dollars—but when it comes time to withdraw from the account, those withdrawals will generally be tax-free. The IRS also restricts access to a Roth IRA based on income. We go into more detail on the basics of IRAs and their respective pros and cons elsewhere. For this article, we’ll focus on the process of converting funds from a Traditional IRA to a Roth IRA—also known as a Roth conversion or, in some cases, a “Backdoor Roth”—why investors might consider one, and five common mistakes to avoid when executing one. But first, a disclaimer: Roth conversions come with all sorts of tax-centric complexities. We wouldn’t be writing this article if they didn’t. We’re not a tax advisor, nor can we provide tax advice for your specific situation, so we strongly recommend you consult one before deciding whether a Roth conversion is right for you. Why consider a Roth conversion in the first place? Before we dive into the potential tripups of a Roth conversion, let’s look at a couple typical reasons someone might consider one: You make too much money. Because the tax benefits for both of these IRA types are restricted by income, some high earners can neither deduct contributions to a Traditional IRA nor contribute directly to a Roth IRA at all. They can, however, contribute to a Roth IRA indirectly. If you have a Traditional IRA, you’re currently allowed to contribute to it first, then convert those contributions into a Roth IRA afterwards, even if your income exceeds the limits, in what some people call a “Backdoor Roth.”  You want to avoid a Traditional IRA’s Required Minimum Distributions in retirement. The IRS requires that once you reach a certain age, you must begin taking Required Minimum Distributions (RMDs) from your Traditional IRA every year, regardless of whether you want or need to. That means, in turn, that you pay taxes on any of those distributions that haven't already been taxed. A Roth IRA doesn’t require minimum distributions, so for some future retirees this could be advantageous. Five common Roth conversion mistakes to avoid Converting outside of your intended tax year You must complete a Roth conversion by a year’s end (December 31) in order for it to count toward that specific tax year’s income. Keep in mind this is different from the IRA contribution deadline for a specific tax year, which (somewhat confusingly) bleeds into the following calendar year. As we’ve mentioned before, Roth conversions require careful planning on your part (and ideally your tax advisor) to determine how much you should convert, if at all, and when. Converting too much Speaking of, the question of how much to convert is a crucial one. Blindly converting too much could push you into a higher tax bracket. A common strategy used to avoid this is called “bracket filling.” You determine your income and how much room you have until you hit the next tax bracket, then convert just enough to “fill up” your current bracket.  Of course, it can be difficult to determine your exact income. You might not know whether you’ll get a raise, for example, or how many dividends you’ll earn in investment accounts. Because of this, we highly recommend you work with a tax advisor to figure out exactly how much room you have and how much to convert. You no longer have the luxury of undoing a Roth conversion thanks to the 2017 Tax Cuts and Jobs Act. As a side note, you can squeeze more converted shares into your current bracket if the market is down since each share is worth less in that moment. To be clear, we don’t recommend making a Roth conversion solely because the market is down, but if you were already considering one, this sort of market volatility could make the conversion more efficient.  Withdrawing the converted funds too early When making a Roth conversion, you need to be mindful of what is called the “five year rule” regarding withdrawals after a conversion. As we mentioned earlier, you’ll typically pay taxes on the amount you convert at the time of conversion, and future withdrawals can be tax-free. After making a Roth conversion, however, you must wait five tax years for your full withdrawal of your converted amount to avoid taxes and penalties.   Notably, this countdown clock is based on tax years, so any conversion made during a calendar year is deemed to have taken place January 1 of that year. So even if you make a conversion in December, the clock for the five year rule starts from earlier that year in January. One more thing to keep in mind is that each Roth conversion you make is subject to its own five year period.  Paying taxes from your IRA Paying any taxes due from a conversion out of the IRA itself will make that conversion less effective. As an example, if you convert $10,000 and are in the 22% tax bracket, you’ll owe $2,200 in taxes. One option is to pay the taxes out of the IRA itself. However, this means you’ll have only $7,800 left to potentially grow and compound over time. If you’re under the age of 59 ½, the amount withheld for taxes will also be subject to a 10% early withdrawal penalty. Instead, consider paying taxes owed using excess cash or a non-retirement account you have. This will help keep the most money possible inside the Roth IRA to grow tax-free over time. Keeping the same investments Conversions can be a great tool, but don’t stop there. Once you convert, you should also consider adjusting your portfolio to take advantage of the different tax treatment of Traditional and Roth accounts. Each account type is taxed differently, which means their investments grow differently, too. You can take advantage of this by strategically coordinating which investments you hold in which accounts. This strategy is called asset location and can be quite complex. Luckily, we automated it through our Tax Coordination feature. Pairing asset location with Roth conversions can help supercharge your retirement saving even further.