Betterment.com Review: Application Process, Updated Asset Allocation

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Updated with new asset allocations 2013. Betterment.com is an online investment tool that rolls portfolio management, trading commissions, and rebalancing into one website. I opened an account when it started with $1,000 to look under the hood. Since then, they’ve actually made several changes in response to feedback and constructive criticism.

The main attraction of Betterment is simplicity. It boils everything down to a single slider (see above) to indicate your risk preference, and takes care of everything else in the background. ETF buying, ETF selling, rebalancing, and so on. On the surface, it’s as easy as having a bank account, besides the critical fact that you can lose money!

Application Process

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Chart: Investment Returns Vary, Even Over The Long Run

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Updated and revised 2013. You often hear that stock investing is a sure thing over the “long run”. But as this chart from the NY Times and Crestmont Research shows, there is still a lot of variability involved. The matrix below visually displays the annualized returns for the S&P 500 for every starting and ending year from 1920 to 2010, adjusted for inflation, taxes, and transaction costs.


(click to enlarge)

Your actual returns depend a lot upon when you start, and also when you finally withdraw:

After accounting for dividends, inflation, taxes and fees, $10,000 invested at the end of 1961 would have shrunk to $6,600 by 1981. From the end of 1979 to 1999, $10,000 would have grown to $48,000.

“Market returns are more volatile than most people realize,” Mr. Easterling said, “even over periods as long as 20 years.”

Some further observations:
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New 401k Plan Fee Disclosures Completely Worthless?

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I’ve written about how recent fee disclosure requirements for 401(k) retirement plans have brought a spotlight on bad 401k plans and their potentially embarrassed plan sponsors.

But after reading the fee disclosure on my wife’s own 401(k) plan, I must say that I’m now thinking that maybe nothing really happened at all. Check out what mine says under “Potential General Administrative Fees and Expenses”:

Administrative Fee – Per Account When applicable, other general administrative fees for plan services (e.g., legal, accounting, auditing, recordkeeping) may from time to time be deducted as a fixed dollar amount from your account. The actual amount deducted from your account, as well as a description of the services to which the fees relate will be reported on your quarterly benefit statements.

Translation: We might charge you some fees. We might not. Helpful, eh?

There’s more:

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Vanguard Balanced Fund: The Benefit of Balancing Stocks and Bonds

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An important tenet of portfolio construction is diversifying between stocks and bonds. While poking around on Morningstar, I stumbled across a quick real-world example of how this works.

Let’s say you had $10,000 back on January 1st, 1993. Now, let’s see how that money would have grown over time until today (August 9, 2013) depending on what you invested it in. That’s means holding over a 20-year period – that’s 20 years of bubbles, crashes, euphoria, fear, and a constant flow of bold predictions and catchy newspaper headlines.

1. Vanguard Total Stock Market Index Fund, Investor Shares (VTSMX).

Let’s say you invested in this huge, popular index fund that passively tracks the entire US stock market. (See What’s Inside the Vanguard Total Stock Market Index Fund?) From afar, you may be happy with this chart. But having lived through it, I can say that it was quite a wild ride. People tend to remember the highest value of their portfolio. Your money would have grown to $37,000, only to fall all the way back to $23,000 in the Tech Bubble Crash (a 38% drop). Later, your $46,000 would have dropped 50% all the way to $23,000 during the Housing Bubble Crash. So between 2003 and 2009, your money would have gone nowhere even as inflation rose. Many people went to cash. But if you stuck it out, today you’d be sitting on a balance of $58,621.

2. Vanguard Total Bond Market Index Fund, Investor Shares (VBMFX)
Now, what if you invested in this fund that tracks the overall US bond market?

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How Spending Changes Throughout Working Life and Retirement

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Common retirement planning advice tells you to plan on replacing 70-80% of your pre-retirement income. However, this Financial Post article argues that number may be closer to 35%. Article found via k66 of Bogleheads.

Essentially, the author segregates your income to “regular” spending and temporary “investment” spending that won’t continue into retirement. Regular consumption includes food, transportation, home and car maintenance, and insurance. Temporary spending include a mortgage, child-related costs, work-related costs, and retirement savings. The idea is that in retirement your house will be paid off and your kids will be financially self-sufficient, so those “investment” expenses will go away and you’ll need less money than you may think.

Here’s an illustration of how this would break down for a theoretical couple that bought a house at 30, had kids at 35, and retires at 65.


(click to enlarge)

Now, it’s easy to get hung up on how this chart doesn’t accurately reflect your life. It’s not supposed to! Instead, imagine for yourself what this chart might look like for your situation. For example, my parents definitely kicked up their savings rate post-kids and pre-retirement. For us, we had our highest savings rate pre-kids. You may need 20% of your current income, or you may need 80%. This is one place where a rule-of-thumb just isn’t useful.

I would note that the article doesn’t really mention health insurance or other health-related costs, possibly because it is a Canadian newspaper. Also, young people in the US probably spend at least a few years paying down college loans. Finally, some folks will need to account for new post-retirement spending that might pop up like travel and other costly recreational activities.

Yale Professor Subtly Threatens High-Cost 401(k) Plans

Speaking of how to deal with bad 401(k) plans… Yale Professor Ian Ayres decided to write letters to thousands of 401(k) plan sponsors that have high costs and fees according to data from website Brightscope. I’m totally paraphrasing and adding humor (although I already found it amusing), but Ayres basically wrote:

“Hey.

I’m a Yale Law prof. Your 401(k) plan ranks among the most expensive. I’m writing a paper about how expensive plans suck money from employees. You do know that you have are required by law to act solely in the interest of participants, right? Oh, by the way, I’m going public with your company name in Spring 2014. You might want to make some changes to your plan before then.

Have a nice day!”

You can read a PDF scan of one of the letters here. Here is a draft of his paper titled “Measuring Fiduciary and Investor Losses in 401(k) Plans”.

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Should I Still Contribute to a Bad 401(k) Plan?

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Along with other factors, new fee disclosure requirements for 401(k) plans have brought a lot of attention recently on “bad” 401(k) plans. These are plans with little or no employer match, higher-than-average fees, and/or limited investment choices.

I’ve gotten a few questions from readers who wonder if they should stop contributed to their subpar plans completely? As with most things, the answer depends. But here are some factors that I’d consider first.

Can You Save Better Elsewhere?
Depending on your situation, it may be better to put money away in other tax-advantaged vehicles like a Traditional or Roth IRA instead of your 401k/403b/similar plan. If you plan on socking away $5,000 a year, that is under the IRA annual contribution limits. Alternatively, if you have self-employment income you can look into a SEP-IRA, SIMPLE IRA, or Self-Employed 401k plan where you can choose the custodian.

Bad 401(k) Now, Awesome Rollover IRA Later?
According to the Bureau of Labor Statistics, the median employee tenure is less than 5 years. Even workers in “management, professional, and related occupations” had median tenures of 5.5 years. In other words, these days people don’t stay in their jobs very long. (Of course, some people may stay in their jobs for 30 years.)

When you switch jobs, you’re free from the bonds of your crappy 401k plan and can roll it over to a new provider with low fees and great investment options. Very few plans are so bad that you wouldn’t endure five years of mediocrity in exchange for 20-50+ years of precious tax advantages.

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MMB Retirement Portfolio Update – June 2013

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Here’s a mid-2013 update of our retirement portfolio, including employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. The purpose of this portfolio is to eventually create income and enable financial freedom.

Target Asset Allocation

Since my last update, I made a minor change to our target asset allocation by removing Emerging Markets as a separate added weighting as it now includes some huge companies and comprises nearly 20% of the Total World ex-US (Total International) asset class.

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Non-Traditional Retirements, or DIY Sabbaticals

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NPR Morning Edition featured a story today about non-traditional retirements: Seeing The (Northern) Light: A Temporary Arctic Retirement. Instead of waiting until 65, Winston Chen decided to stop working for an entire year mid-career and moved his family to a small Norwegian island in the Arctic Circle with only 180 residents.

The whole family got to do many things they’d never do otherwise. Financially, they offset their mortgage by renting out their Boston home completely as-is for a year to another family on a temporary work assignment. His wife Kristin was able to get a job teaching elementary school in Norway for a year, as it was a remote area that needed teachers. They could keep expenses low as the tiny village had no need for a car, no malls, and no restaurants. One of his pursuits ended up being an iPhone app that took off and now supports their entire family, although that wasn’t the goal.

The inspiration came from the TEDtalk “The power of time off” by designer Stefan Sagmeister. Here’s a screenshot (sorry for the poor quality) illustrating the traditional working timeline: learn for 25 years, work for 40 years, then retire for 25 years.

A commenter pointed out that this shows that our society seems to feel that education is for the young, work is for the middle-aged, and leisure is for the elderly. But what if you decided to snip 5 years from those retirement years and sprinkle them between your working years? This is essentially the idea of sabbaticals, usually associated with tenured professors taking a paid year off from their usual teaching and research duties. Every 7 years, Sagmeister completely shuts down his popular design shop for an entire year.

Both Sagmeister and Winston Chen add that if you do this, you shouldn’t just give yourself a year of nothing and expect to figure it out along the way. At the minimum, you should make a list of all the things that you want to try and/or accomplish (Chen’s included oil painting, photography, reading, learning Norwegian, and learning how to play the ukulele). Both broke it down into a daily schedule as well (Chen’s is below).

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How Our Interests Change As Get We Closer To Retirement

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Stephen Wolfram, of Mathematica and WolframAlpha fame, used his natural language analysis tools to crunch through a huge set of Facebook data. The results are some interesting visualizations, including a series of charts about how the popularity of a topic varies with age. For example, both men (blue) and women (red) post increasingly more about career and money topics between ages 15 and 30. After that, interest levels stay pretty much constant for the next 30 years. I suppose it’s because virtually all of us are still working until then. :(

Here’s the chart for family and friends; I wonder if the drop in the 20s is due to a focus on finding a partner? Other than that, the gap between men and women seems pretty constant.

A growing gender differential occurs in terms of health-related topics. No wonder us guys don’t live as long. ;)

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Your Entire Financial Life in One Deceptively Simple Chart

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Time for fun with charts! A famous chart in the early retirement community is The Crossover Point from the book Your Money or Your Life, which shows that you’ve reached financial independence when your investment income equals your monthly expenses:

Fellow blogger Adrian of 7million7years also shared a related chart from Chris Han of Quora, where wealth is the shaded area between your income and expenses:

Specifically, if you plotted all your income and expenses over time, the shaded area between would the amount you’ve saved your entire financial life. Bigger shaded area, bigger nest egg.

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Fidelity Freedom Funds Review: Avoid High Cost Target Date Retirement Funds

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Updated and revised. Fidelity Investments does a lot of things well, but their Fidelity Freedom series of target-date retirement funds is not one of them. I’ve been warning people about these funds since 2006, although recently they’ve been getting some heat due to their overall underperformance. Assets in the Freedom funds have been dropping, while the assets in Vanguard’s Target Retirement funds have been increasing quickly. Here’s why the underperformance is not about the glide path, but about the structure and fees.

This post is a bit long, so here’s a roadmap of what I’m going to try and show:

(1) The goal of owning actively-managed mutual funds is to beat their passive benchmark. Pick the winners and not the losers. The problem is that Fidelity Freedom funds hold so many different funds with overlapping holdings, that in the end they basically own everything. It’s exceedingly difficult for them to accomplish such outperformance. Thus, over time their performance before fees is likely to simply match that of their benchmark.

(2) Due to their higher expenses, this means that their net performance after fees (what investors actually get) will be very likely to underperform the their benchmark. Over long periods of time, the amount of underperformance will closely match the amount of management fees charged.

(3) This expected underperformance is confirmed by looking at their historical performance over the past 3, 5, and 10 years.

(4) Instead, investors should look for low-cost index funds to replicate the benchmark give the best chance of higher performance. Options are explored.

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