TABLE OF CONTENTS
- What is goal-based investing?
- Goals and Investment Accounts at Betterment
- A. Retirement Savings
- B. Retirement Income
- C. Safety Net
- D. Major Purchase
- E. General Investing
- How to Set Effective Goals Using Betterment
- Mapping Out Your Financial Picture
Goal-based investing. The idea is prized among financial advisors—and our team at Betterment—but to the everyday investor, it’s often difficult to put into practice. After all, being clear about the purpose of one’s savings can be a challenge. You might start saving for one reason, then decide halfway through your progress that the money is really for something else. Or, you might have so many goals you want to save for, you don’t know where to start.
Often, people are stuck in a single-savings-account mentality, where your figurative pot of gold is for any and all savings goals—with no distinct purposes articulated.
For many investors, goal-based investing takes a lot of discipline and even more introspection. Without the right tools in place, it can be difficult to keep your goals on track. At Betterment, we’re working to make setting and attaining your financial goals a natural and straightforward experience. In this article, we’ll guide you through how goal-based investing works at Betterment and how we’ve designed Betterment accounts to put your goals into action.
What is goal-based investing again?
Goal-based investing is the best way we know to help you set a personalized financial plan with investments that are aligned to help you fulfill that plan over the long-term. You can think of goals as the building blocks of a plan. When you set goals for your investments, you’re identifying what personal purpose you have for your money, and what you want to achieve. As your advisor, Betterment uses this information to recommend the right level of savings and proper mix of investments to help you reach your goals. The best investment plans consist of a prioritized set of personal goals, so you decide on which goals to focus on first to inform your investment behavior.
Goal-based investing is based on a technique used by institutional investors called “asset-liability management,” which aims to match future assets with future expenditures. In other words, goal-based investing seeks to ensure that you have enough money when you plan to spend it in the future.
The trouble with this notion of goal-based investing is that you may not think of your money in terms of goals, and even if you do, it’s likely that your goals aren’t always clearly defined. A goal like, “I want to buy a boat or house sometime in the future” isn’t specific enough to inform good numerical planning.
If you were an advisor, imagine how challenging it would be to help somebody plan when he or she isn’t quite sure what they want or when they want it. It’s not unlike helping a friend or family member stick to a budget: If they never set a clear cap for their budget, it’s hard to say how much spending is too much spending. From our perspective as your advisor, the best way to help you set a good plan is to help you give your goals as much definition and detail as possible, then determine how they stack up together.
What does a goal look like at Betterment?
When you really think about it, the essence of a goal is your intention to make a future expenditure. For example, you want $50,000 for a future down payment on a house. Or, $300,000 for future payments on your child’s college tuition. Or $100,000 of annual retirement income for 30-40 years. Any future expenditure can be an investment goal.
Betterment’s Goals and Investment Accounts
At Betterment, we aspire to help you build a personalized financial plan built on goals that reflects what it really feels like to save and spend money. Within your Betterment account, every investment goal you set has a target amount and target date(s) for which you desire to meet you goal. Within each goal is at least one investment account, depending on the type of goal you set. Investment accounts at Betterment include a variety of legally-defined account types, like taxable accounts (what other investment companies might call brokerage accounts), individual retirement accounts (both Roth and traditional), SEP IRAs, joint taxable accounts, and trusts. Different goal types may contain different investment account types. Currently, we have five types of goals:
- Retirement Savings – for those saving for retirement
- Retirement Income – for retirees making withdrawals
- Safety Net – for growing an emergency fund
- Major Purchase – for making a future expenditure
- General Investing – for investing when you’re not sure of the specific future expenditure
When you sign up with Betterment, you can set up one or more of these goals for your investments. For any existing goal, you can change your goal type in the Plan tab of your Betterment account. You will see an option on the right that reads “Advice type: Edit” that leads you to the option to update your goal type.
What we try to do—and we’re constantly working to improve—is to help you set your goals well while also advising you on the right accounts and investments you’ll use to help reach your goals. We recommend customizing the names of each of your goals to set your personal purpose for each.
Here’s a breakdown of the default range of stock allocation advice, By goal type:
|Type of goal||Most Aggressive Recommended Allocation
(typical start of term, depending on age)
|Most Conservative Recommended Allocation
(typical end of term, depending on age)
|Anticipated term||Cash-out assumptions|
|Up to 50 years||Shift to a Retirement Income goal at the target date|
|Retirement Income||56% Stocks,
|Up to 30 years||Steady drawdown with dynamic withdrawal rate until target date|
|Safety Net||15% Stocks,
|Targets date of achieving desired balance||Up to full liquidation at any time|
|General Investing||90% Stocks,
|Recommendation is based on investor age||No liquidation|
|Major Purchase (House, Education, Other)||90% Stocks,
|Between 1 and 30 years||Full liquidation at target date|
Each of these investment goals requires a different strategy—that is the quintessence of smarter investing. Betterment’s automated advice and technology builds a unique investment portfolio for each of type of goal. Underpinning each type of goal is a customized stock-to-bond allocation recommendation, which is designed to automatically adjust (in most cases) to help you reach your goal without taking on unnecessary risk.
For each of these goal types, we provide a recommended maximum and minimum stock allocation, based on your term, while making certain cash-out assumptions. But we also, give you the tools to adjust the dial, if desired, for a more aggressive or more conservative allocation in any goal type. You can also select additional portfolio strategies that are not generally recommended but may be more personalized to your views.
Retirement Savings Goals
For retirement savings goals, our retirement planning methodology enables investors to work toward their goal using multiple accounts—including those held outside of Betterment (such as your spouse’s accounts) but synced into the goal. The reality is almost every future retiree will have multiple accounts—IRAs, 401(k)s, 403(b)s, HSAs, and/or taxable investment accounts—that help them achieve their retirement savings goal. So, we developed our methodology to match reality as closely as possible.
You can read more about how this retirement planning advice works here. In addition, retirement savings goals can utilize Tax Coordination, Betterment’s approach to asset location, which aims to lower your taxes on retirement savings by keeping the highest-tax assets in tax-advantaged account types and the lower-tax assets in taxable accounts.
When you have 20 or more years until you retire, we recommend 90% stocks. Our advice reduces your recommended risk level over time until your retirement date, where it shifts to a 56% stock allocation. Then, when you have arrived at your retirement age, you can make the shift to the next goal type, Retirement Income, which we developed to serve your needs in retirement.
Example of Allocation Advice for Customer Retiring at Age 65
Figure above shows an example that assumes the customer is planning to live until age 90.
Retirement Income Goals
Once you reach retirement and start making withdrawals, Betterment’s smart retirement withdrawal process recommends an appropriate allocation for where you are in retirement and recommends a regular withdrawal amount from your goal. Our methodology considers a number of factors to suggest a safe liquidation target or withdrawal amount:
- Current balance
- Desired monthly income amount
- Minimum acceptable income level
- Desired certainty about not falling beneath minimum income level
- Conditional life expectancy
For example, a 65-year-old male has a remaining life expectancy of nearly 18 years, according to projections used by the Social Security Administration.¹ That is 18 years over which he will be both liquidating his portfolio but also growing his assets to support future years of consumption. With regards to the stock allocation, we seek to:
- Continue to grow your portfolio while in retirement
- Lower portfolio risk as you are further into retirement
Safety Net Goals
A Safety Net goal is one of the highest priority goals we recommend for investors. It’s slightly different from other goals because we assume the money may never be needed—but when it is, we assume a substantial portion of the balance will be liquidated all at once.
Currently, a goal for your “safety net” or “emergency” fund contains just one account at Betterment. Your account in a Safety Net goal will be taxable, as there are no tax-advantaged accounts for general personal savings. Juxtaposed to this goal, you may also sync an external savings account if you would like to see this account included in your balance.
Betterment’s allocation advice for Safety Net goals is conservative and does not adjust automatically over time, holding at 15% stocks, 85% bonds continuously. We recommend you add a 15% buffer to the balance to help preserve the minimum balance you need to have available. Our 15% stock portfolio’s worst performance in a historical backtest would have been -11.4%, between the timeframe of May 2008 and November 2008 (source: Betterment data).**
Allocation Advice for a Safety Net Goal
Major Purchase Goals
For a major purchase—such as saving for a car, a house, or even your child’s education—Betterment enables one account for each goal. With any major purchase, an investor usually anticipates liquidating all at once when they reach their goal, usually for a short- or medium-term period of investing.
Thus, Betterment’s allocation advice is more conservative for these goals than that of retirement goals. Since we expect you to fully liquidate your investment at your intended goal date, Betterment automatically shifts your allocation to low stock percentages as you near your goal date in line with our advice, unless you set your own allocation or turn off automatic allocation adjustment.
Allocation Advice for a Major Purchase Goal
While Betterment is designed to help you execute goal-based investing, we understand that there are plenty of investors who aren’t sure about their goals, and might have part of their savings invested with no clear purpose. Many investors have a clear understanding for some of their goals, but for haven’t yet sort through the precise purposes for all other investments.
For these investors, Betterment offers goals that are classified as “general investing” and contain just a single account. Since you can still personalize the name, allocation, and portfolio strategy in these situations, we still call them goals within your account, but our allocation advice on these goals has fewer assumptions than the advice for the distinct goal types above.
You can consider general investing goals to be the utility players within your account, where the priority is wealth creation because you have no specific plans for a liquidation event in the future. This makes goals of the “general investing” type generally appropriate for objectives like long-term savings where you might plan to transfer wealth to the next generation or convert your assets into a trust account at a later date.
While you can have multiple general investing goals, we often find that Betterment customers who might be using general investing goals could decrease unnecessary risks by using a more precise goal type. In general investing goals, our automated advice recommends a range of allocations from a maximum of 90% stocks to a minimum stock allocation of 55% stocks, depending on your age and how close you are to age 65.
Allocation Advice for General Investing
How to Set Effective Goals Using Betterment
As explained above, Betterment works hard to help you set goals in realistic ways that match your actual savings habits. To align with our research on goal-based investing, it’s important to understand what makes for an effective goal.
One framework to thoughtfully determining a prioritized set of goals is called the S.M.A.R.T. approach. S.M.A.R.T. stands for:
Make your goal specific
A specific goal is one with a clear description and a well-articulated set of circumstances. For example, if you’re saving for a child’s college education, a goal that is specific might look like the following on paper:
“My goal is to pay for my child’s total higher education costs (including graduate school if chosen, room and board, social events/clubs, and any other fees).”
By stating how many of the possible education costs you’re planning to pay for (i.e. “total”), the goal statement above provides much more information about the size and shape of the future expenditure.
Make your goal measurable
Making a goal measurable means that you can tell how close you are to achieving the goal using numbers. Generally, this means quantifying the specific information you know about—setting an accurate estimate of the total of the expenditure you expect to make. Here’s what a measurable goal looks like using our example:
“My goal is to save a total of $800,000 to pay for all three of my children’s total higher education costs.”
The total expenditure should account for all the factors that went into making your goal specific, but it should turn the various social and philosophical decisions you’ve made about your goal into a numerical sum. You should also account for taxes in setting a precise, measurable goal.
Ensure your goal is attainable
As you define a specific and measurable goal, you should make sure it’s actually attainable. Attainable goals are future expenditures you actually have the capability to achieve. For instance, if you make $80,000 in a year, saving $800,000 over five years is not attainable because even if you could save 100% of your income, you’d still come up short of your goal amount. However, if you have more time to save or if you make more money each year, then perhaps the goal could be attained.
Consider whether your goal is realistic
A goal is realistic if you have the time, resources, and discipline to achieve it. Generally, your goals will only be realistic if you take into account the other goals you have in your life. For example, when saving for college education, you probably will also need to invest for your retirement. If you don’t align and prioritize your goals, you may end up being less able to save as regularly or as much as you’d like—which lowers your chances of achieving either goal.
Any goal should be time-limited
The last step in developing a S.M.A.R.T. goal is to make sure the goal is time-limited—i.e. Every goal needs a deadline or target date. Just as measurable goals quantify the total expenditure you expect to make, time-limited goals quantify the time you have to reach that expenditure amount. In most cases, you should try to set goals as far in advance as possible. For instance, rather than waiting until you have three children that will be going to college, it’s a good idea to start saving as soon as you start planning a family.
A time-limited goal should also consider how frequently you can plan to contribute to the goal. Will you save a portion of every paycheck? Or will you save just once a year? An effective time-limited goal might read like the following:
“My goal is to save a total of $800,000 over 18 years (by [due date]) to pay for all three of my children’s total higher education costs by putting aside at least $1,500 per paycheck per month.”
Use Betterment’s Goals to Map Out Your Financial Picture
By using a framework like the S.M.A.R.T. approach to set each of your investment goals, you’ll push yourself to think broadly about all the factors of life that affect your financial future while ensuring each and every goal is quantifiable and feasible.
Remember that it’s okay to use estimates or set educated guesses when creating goals you’re not quite sure of. In many cases, such as retirement or college savings, you might need additional research and external resources to predict how much money you’ll actually need to reach all the specific criteria of your goal. In getting started saving for a goal, it’s always better to be approximately right than to have no goal at all.
If you set reasonable, customizable goals using the goal types available to you in your Betterment account, you’ll get savings and investment advice on each of the building blocks of a solid financial plan. Additional assistance with identifying your goals is available to Betterment Premium customers.
** Please see https://www.betterment.com/resources/betterment-historical-performance/ and https://www.betterment.com/returns-calculation/ for more details on how we calculate historical performance. Please note that this figure is based on back-tested data. Backtesting is the process of evaluating a strategy, theory, or model by applying it to historical data and calculating how it would have performed had it actually been used in a prior time period. They do not represent the results of actual trading but were achieved by means of the retroactive application of a model designed with the benefit of hindsight. Backtested performance is hypothetical and does not represent actual performance and should not be interpreted as an indication of such performance. All back-tested performance has a chance for loss and/or profit. Furthermore, clients should be aware that the potential for loss (or gain) may be greater than demonstrated in the backtests. This back-test is based on actual data, and includes the application of Betterments 25 basis points management fee and fund level fees. This assumes reinvestment of dividends, and daily portfolio rebalancing.