INVESTMENT

The proposed allocation has been changed to maintain inflation


In improvement, we are regularly evaluating our investment strategies to help you achieve your financial goals. As part of that routine evaluation process, we recently updated our proposed portfolio allocation for targets that want to keep pace with inflation.

Our goals like Safety Net Goals or Emergency Funds are designed for an account that you can withdraw in the event of an unexpected financial situation such as a large medical bill or job loss. If your emergency money sits outside the market and is not invested, it carries the risk of losing purchasing power over time due to inflation. A major risk of this money is that it loses purchasing power over time. A key goal for such targets is to match or beat inflation, so that your dollar can hold as much purchasing power as possible over time.

We have updated our proposed allocation for targets that want to keep inflation from 15% stock to 30% stock.

Based on the updated analysis below that takes into account current yield curves and inflation expectations, we recommend that 30% of the stock portfolio be appropriately allocated to your emergency fund. The selected allocations match our assumptions regarding long-term inflation. We revise these estimates annually and our estimate for long-term inflation is still 2%. As interest rates have fallen, so has the yield on low-income assets. Now, an investor has to take a little more risk to get a return that could offset inflation.

This economic situation may change in the future as it has in the past – which is why we regularly evaluate our strategies over time.

Maintaining inflation

To determine the exact level of portfolio risk, we need two important pieces of information:

  • Expected return to the portfolio
  • Expected rate of inflation

Our current inflation estimate is 2% per year. We review our inflation estimates so that they reflect the current economic environment, which is always changing.

There are two main components to the expected return of a portfolio: the risk-free rate and the expected return of risky assets.

The yield on US Treasury bonds determines the risk-free rate. Since U.S. Treasury bonds are backed by the U.S. government, they are considered virtually risk-free. We further estimate how much additional returns we can expect from risky assets such as stocks or corporate bonds. Putting these two pieces together gives the total expected return for our portfolio.

As of January 2021, the annual yield on short-term U.S. Treasury bonds was expected to be 0.10%. This means that these bonds will produce an annual return of 0.10% until they mature, which is less than 2% against inflation based on our current inflation estimates.

With a bit more risk, Betterment seeks to improve its 0.10% risk-free investment return. Based on our asset class return estimates, we expect the total return fee for our 30% stock portfolio to be * 2.1% later, which is slightly higher than our inflation expectations.

We recommend a buffer

Unfortunately, we cannot predict the future, so the actual performance of our 30% stock portfolio may be different than we expected.

We can use history to help us understand the range of possible outcomes. At the time of the Great Financial Crisis, our 30% stock portfolio had the worst performance in the historical backtest – -22.9%. **

To help protect against a temporary market collapse, we recommend that you place an additional buffer against the down market to provide a% 0% of your target – which usually represents at least three months of normal spending.

For example, if the three-month cost is $ 10,000, we suggest you keep your goal at $ 13,000.

Why not just keep cash?

Finally, you might be wondering, “Why not just use a bank account for my emergency funds?” This is a valid question. After all, money in a checking or savings account is not subject to market volatility.

Most traditional bank accounts do not offer high interest rates to keep pace with inflation. The national average interest rate is 0.04%, which is much less than the 2% annual income we need to match inflation. This means that while the amount of cash you hold is stable, its purchasing power decreases over time.

We will help keep you on track while keeping you informed.

Setting aside funds for emergencies is the basis of any financial plan, as it provides an important cushion against unforeseen circumstances – situations that could sink you into a long-term account such as retirement.

In fact, our advisors regularly recommend that the first investment goal our clients set should be a goal to protect themselves against unforeseen expenses, such as a medical bill, or loss of income.

If you currently have a target that is allocated to our old recommended target – 15% stock – we will warn you that your allocation is now considered conservative and a more appropriate target allocation for your target is now 30% stock. Although we will not adjust your target allocation for you, you will be able to adjust your target allocation within your target in your browser or your mobile app. Before updating this, please keep in mind that taxes can have an effect. We’ll show you the estimated tax effect before you complete the changes inside your account.

We will continue to review our recommendations as the economic environment changes. Because we believe in transparency, we will keep our customers updated if the economic situation changes if we have the opportunity to offer advice and recommendations.


* We calculate the expected additional return for assets in our portfolio by applying the Black-Litterman model described in our portfolio strategy article “Computing Forward-Looking Return Input”. By multiplying these expected returns by the weight of our portfolio, we can calculate the total expected additional returns for the portfolio. We can then calculate the expected total return of the portfolio by adding the expected additional return, which is an estimate of our expected risk-free rate. In this example, we used the lowest point of the U.S. Treasury yield curve as our estimate. Expected returns estimate cost of 0.25% annual management fee and fund level, and reinvestment of dividends. Model returns may not always reflect material market or economic factors. All investments involve risk, and there is always a chance of gain as well as loss. Actual income may vary. Past performance does not indicate future results.

** Betterment Portfolio Historical Historical Performance Numbers are created based on the tracked index of each asset class in the ETF or Bacterment portfolio. These results are entirely the product of a model. The actual client experience may be materially different. Performance statistics assume that dividends are reinvested and the daily portfolio is restructured at market closing prices. Returns net 0.25% annual management fee and fund level costs. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be substantially lower. The results of backtested performance have some underlying limitations. Such results do not represent the impact of material economic and market factors on the investment advisor’s decision-making process if the advisor actually managed the client’s money. Backtested performance is also different from actual performance because it is achieved through the retroactive application of model portfolios designed to take advantage of the hidesite. As a result, models may theoretically change from time to time and the impact on performance outcomes may be favorable or unfavorable. See additional publication https://www.betterment.com/returns-calculation/.



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