Investing wisely is essential for building lasting wealth. One effective strategy involves using low-cost, globally diversified total market funds. However, investors can enhance their strategies by utilizing additional tools. Automated investing platforms, such as Betterment, can significantly improve portfolio management efficiency, particularly through tax optimization.
Tax-loss harvesting is a primary benefit of automated investing. This process involves selling an investment at a loss to offset gains elsewhere in the portfolio.
By carefully selecting similar assets to replace the sold investment, investors can maintain their market position while reducing tax burdens. However, total market funds can limit this strategy, as the entire fund must incur a loss before tax-loss harvesting can be applied.
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Understanding the advantages of diversified funds
To address the limitations of total market funds, Betterment employs a nuanced approach by utilizing multiple funds that represent various sizes of U.S. companies, including small, medium, and large-cap stocks. This structure not only offers more flexibility in managing portfolios but also allows for targeted tax-loss harvesting opportunities. If one fund experiences a dip, investors can execute a swap with a similar investment, preserving their overall strategy while capitalizing on market fluctuations.
Asset location optimization
An important aspect of portfolio management is asset location, which refers to the strategic placement of investments across different types of accounts, such as traditional IRAs, Roth IRAs, or taxable accounts. For instance, investments expected to grow significantly may be more beneficial in a traditional account, where they can accumulate tax-free until retirement. This approach allows for deferring tax payments until potentially entering a lower tax bracket.
Betterment’s method of Tax Coordination further refines this practice, helping investors maximize returns by efficiently distributing assets to minimize tax liabilities. By opening any combination of investment accounts, investors can leverage this sophisticated strategy to enhance portfolio performance.
Exploring target date funds and their limitations
Target date funds have become popular in retirement planning, offering a straightforward solution for those saving for the future. Introduced in the 1990s, these funds have become a common choice for 401(k) plans due to their automated rebalancing features. However, they come with limitations, particularly the lack of customization options available to investors.
For example, a person born in 1988 planning to retire around 2050 may find themselves limited to a single target date fund. In contrast, Betterment offers an extensive range of portfolios, including specialized options focusing on social responsibility and innovation, providing greater control over investment strategies.
Cost efficiency in fund management
While expenses associated with target date funds have decreased over time, many investors can still benefit from further cost reduction by selectively investing across various funds. For instance, while a single global stock fund might charge around 6 basis points, breaking down a U.S. stock allocation into three separate funds could significantly reduce costs. This meticulous approach to fund management could lead to substantial savings; Betterment’s clients holding nearly $20 billion in U.S. stocks could save approximately $7.6 million annually by choosing lower-cost funds.
Starting with a simple portfolio is a good entry point for many investors, but it may not always yield the best returns. By leveraging multiple investment vehicles and employing strategies like tax-loss harvesting and asset location optimization, investors can enhance overall efficiency. Automated investing platforms make these complex strategies accessible, allowing individuals to focus on growing their wealth with minimal effort.
