In the quest for long-term financial growth, selecting the right investment vehicle can significantly influence success. An effective strategy often involves leveraging low-cost, globally diversified funds that encompass the total market. While this approach serves as a commendable starting point, enhancing your portfolio with advanced techniques can lead to greater benefits and lower costs.
One effective method in this context is utilizing technological advancements to assist in investment decisions. Services like Betterment offer automated investing, which includes features such as tax optimization to maximize returns.
Understanding tax-loss harvesting
Tax-loss harvesting is a strategic investment practice providing a competitive edge, particularly in taxable accounts. This technique involves selling underperforming assets to offset gains elsewhere, thus reducing your overall tax burden. However, with traditional total market funds, you face a limitation: you can only liquidate the entire fund when it experiences a loss, restricting your ability to capitalize on individual asset dips.
To overcome this challenge, Betterment has transitioned from a single fund structure for U.S. equities to a more diversified approach that includes three distinct funds representing small, medium, and large companies. This strategy enables selective asset management, allowing you to take advantage of specific opportunities for tax-loss harvesting while maintaining a well-rounded portfolio.
Strategic asset location
An important factor in optimizing your investment portfolio is asset location. This concept refers to the strategic allocation of different asset types across various account types—traditional, Roth, and taxable accounts. Assets with high growth potential are often better placed in traditional accounts, allowing them to grow without immediate tax implications. The underlying strategy is to defer tax payments until retirement, when you are likely to be in a lower tax bracket.
Betterment employs a method known as Tax Coordination, enhancing the process of asset location. This automated approach maximizes after-tax returns by ensuring that investments are in the most advantageous accounts for their tax characteristics. To reap the benefits of this strategy, you simply need to open a combination of account types and follow straightforward steps provided by the platform.
Advantages of multi-fund strategies
Target date funds, popular since the 1990s, serve as a common option for retirement savings. They automatically adjust asset allocations as you approach a specified retirement date. While these funds have made investing more accessible and typically favor lower-cost options, they come with inherent limitations.
A notable drawback is the lack of flexibility. For example, if you were born in 1988 and plan to retire around 2050, your options are often confined to a singular 2050 fund. In contrast, automated investing platforms offer a plethora of portfolios to choose from, catering to specific interests such as social responsibility or innovation.
Cost efficiency through diversification
Investors can also benefit from the cost-saving potential of segmenting their portfolios. Although average expenses for target date funds have decreased, many total market funds can still be found with expense ratios below 0.1%. By breaking down investments into several funds, you can shop around for better pricing. A tiny difference in fees—measured in basis points—can accumulate into substantial savings over time. For instance, by opting for a diversified approach with funds like SPYM, SPMD, and SPSM instead of a single global fund, you could potentially save millions annually on fees.
While simple portfolios are an excellent entry point for new investors, they may not always yield the highest returns. By strategically incorporating more specialized funds and leveraging advanced techniques such as tax-loss harvesting and asset location, you can enhance your portfolio’s performance. This approach simplifies your investment journey and allows technology to do the heavy lifting, ensuring that you maximize your wealth-building potential with minimal effort.