The world of investing can be daunting. Betterment aims to simplify this process through its structured approach to portfolio creation. This article examines the methodology that forms the backbone of the diverse portfolios offered to investors. By leveraging systematic decision-making and empirical evidence, Betterment ensures clients can optimize their investments and achieve their financial aspirations.
At the core of Betterment’s offerings is the Core portfolio, which serves as the foundational model for all investment strategies.
From this core, various adjustments accommodate specific investment goals, whether focusing on value investments, engaging with innovative technology sectors, or adhering to Socially Responsible Investing (SRI) principles. The following sections will explore the components of Betterment’s portfolio construction.
Table of Contents:
Global diversification and asset allocation
A key principle in investing is achieving an optimal asset allocation that balances risk and return. This concept is often illustrated by the efficient frontier, showcasing portfolios that yield the highest expected return for a given level of risk. Betterment’s strategy aligns with the principles of Modern Portfolio Theory, proposed by economist Harry Markowitz, emphasizing the importance of analyzing assets based on their contribution to the overall portfolio rather than in isolation.
To create a globally diversified portfolio, Betterment employs a range of exchange-traded funds (ETFs) representing various asset classes. The primary classes included are:
- Stocks: U.S. stocks, international developed market stocks, and emerging market stocks.
- Bonds: U.S. treasury bonds, inflation-protected bonds, municipal bonds, and international bonds.
Historically, stocks are known for their volatility but also provide a hedge against inflation over time. Despite past challenges, such as economic downturns, long-term trends indicate that developed market stocks typically outperform bonds when considering risk-adjusted returns. Emerging market stocks, although volatile, add a layer of diversification that enhances the global reach of Betterment’s portfolios.
Exclusions and considerations
While Betterment aims for comprehensive market representation, certain asset classes are excluded from its portfolios. Specific commodities and natural resources are omitted due to their low contribution to the portfolio’s risk-adjusted returns. Real Estate Investment Trusts (REITs), often promoted as distinct asset classes, are not explicitly included; however, real estate exposure is maintained through stock sector allocations.
Prior to 2026, Betterment’s management was benchmark agnostic, meaning that global stock and bond indices were not factored into the portfolio optimization process. Recently, the approach has evolved to incorporate a custom benchmark that aligns with Betterment’s investment philosophy, enhancing the ability to calibrate exposures across global assets.
Optimizing portfolio performance
Portfolio optimization is a critical aspect of Betterment’s investment methodology. This involves fine-tuning the asset mix to maximize potential returns while managing risk levels appropriate to each investor’s tolerance. Unlike traditional models that offer limited risk categories, Betterment’s strategy allows for customization across 101 distinct stock-bond risk levels.
The optimization process employs capital market assumptions (CMAs), which include estimates of expected returns, volatilities, and correlations among asset classes. While historical averages can inform decisions, they may not accurately predict future outcomes. Instead, Betterment utilizes the Capital Asset Pricing Model (CAPM) to derive expected returns based on the relationship between risk and return.
Constrained optimization techniques
To achieve optimal asset allocation, Betterment generates numerous simulations of expected returns over a 15-year horizon, applying constraints to ensure the portfolio remains aligned with its custom benchmark. This technique ensures that allocations are balanced and do not deviate significantly from the benchmark’s composition, safeguarding against concentrated risk in any particular asset class.
At the core of Betterment’s offerings is the Core portfolio, which serves as the foundational model for all investment strategies. From this core, various adjustments accommodate specific investment goals, whether focusing on value investments, engaging with innovative technology sectors, or adhering to Socially Responsible Investing (SRI) principles. The following sections will explore the components of Betterment’s portfolio construction.0
At the core of Betterment’s offerings is the Core portfolio, which serves as the foundational model for all investment strategies. From this core, various adjustments accommodate specific investment goals, whether focusing on value investments, engaging with innovative technology sectors, or adhering to Socially Responsible Investing (SRI) principles. The following sections will explore the components of Betterment’s portfolio construction.1
