Investing inherently involves risk, but the level of risk you undertake should always be within your control. When your financial objectives are far on the horizon, you might consider embracing riskier assets. However, as you approach your goals, a more cautious strategy may be preferable.
Betterment offers a suite of tools designed to help you manage risk and stay on course toward your financial aspirations. This guide will walk you through how Betterment provides allocation advice, determining your personal risk level, and utilizing automated tools to manage risk effectively. We’ll also examine low-risk portfolios and how they can benefit your investment strategy.
Understanding asset allocation and risk management
The adage “Don’t put all your eggs in one basket” is a fundamental principle in investing. Diversification is key to managing risk. By spreading your investments across various assets, you protect yourself from significant losses if one investment underperforms.
Asset allocation is the process of dividing your investment dollars among different types of financial assets, such as stocks and bonds. A well-balanced portfolio aims to shield you from extreme losses during market downturns while allowing you to benefit from market upswings. Betterment simplifies this process by automatically recommending how to allocate your investments based on your individual goals.
Betterment’s approach to allocation advice
Betterment’s recommendations are grounded in your financial goals. Each goal—whether it’s saving for a vacation or planning for retirement—receives its own allocation of stocks and bonds. The platform also considers your investment horizon, which is the timeline for when you need the money and how you plan to withdraw it.
For example, if you’re saving for a down payment, you might withdraw the entire investment after a decade. In contrast, retirement savings are typically withdrawn gradually over many years. If you don’t have a defined goal, Betterment uses your age to set a default target date of your 65th birthday, assuming you’ll withdraw funds like a retirement account but maintaining a slightly riskier portfolio.
Betterment’s projection model assesses possible outcomes across a range of market conditions, erring on the side of caution with a conservative allocation model. This approach aims to help you reach your goals through steady saving and appropriate allocation, rather than taking on unnecessary risk.
Determining your risk level
Your investment horizon is a crucial factor in determining your risk level. Generally, the more time you have to reach your goals, the more risk you can afford to take. As you approach your target date, Betterment’s auto-adjust feature gradually shifts your portfolio to a more conservative allocation.
You have the flexibility to choose a more aggressive or conservative approach. Betterment provides feedback on the potential implications of deviating from their risk guidance. If you opt for a riskier strategy, they’ll caution you about the potential downsides. Conversely, a more conservative choice may require additional savings to meet your goals.
To ensure you’re comfortable with the short-term risk in your portfolio, Betterment presents both extremely favorable and poor return scenarios for your selection over a one-year period. This helps you understand the potential outcomes and make informed decisions.
Automated risk management with Betterment
Betterment’s technology works behind the scenes to manage your risk through auto-adjusted allocation and rebalancing. Auto-adjusted allocation ensures that your portfolio’s ideal allocation changes as you near your goal, making adjustments efficiently and tax-friendly.
Deposits, withdrawals, and dividends help guide your portfolio toward the target allocation without needing to sell assets. If selling is necessary, Betterment’s tax-smart technology minimizes the potential tax impact by first looking for shares with losses and then selling shares with the smallest embedded gains.
Rebalancing is another crucial aspect of risk management. Over time, individual assets in a diversified portfolio drift away from their target weights. Betterment automatically monitors your account for rebalancing opportunities to reduce this drift, ensuring your portfolio remains aligned with your target allocation.
For portfolios with a cash allocation, the rebalancing algorithm first seeks to bring the cash allocation back to its target before investing in securities. This ensures that your portfolio remains balanced and optimized for your financial goals.
Reducing risk in portfolios
Investments like short-term US treasuries can help reduce risk in portfolios. Betterment includes these assets in portfolios with a stock allocation below 60%. For portfolios with no stocks, Betterment recommends investing everything in these low-risk assets to minimize market volatility.
Short-term US treasuries and high-quality bonds generally have lower volatility and smaller drawdowns. By combining these asset classes, Betterment produces a portfolio with a higher potential yield while maintaining relatively lower volatility. The yields from these assets are the actual yields of the underlying assets after fees, ensuring fair and competitive returns.
Choosing an investment portfolio is a personal decision, but it doesn’t have to be difficult. Betterment helps you select a portfolio with the right risk level for your goals and manages it efficiently. With Betterment’s automated services, you can work toward your financial aspirations with confidence, knowing that your investments are being managed effectively.
