Improving your ETF Portfolio - Betterment

bee

One of Betterment’s central objectives is to help investors achieve the best possible take-home returns. At the most fundamental level, we do this through the allocation advice we provide for every portfolio. However, another key component of performance is the investment vehicles we use in our portfolio. They are an essential—but often overlooked—element in maximizing the risk-adjusted, after-tax, net-of-costs return for our customers.

In the following piece, we detail Betterment’s investment selection methodology, including:

Why we use exchange-traded funds (ETFs)
Why expense ratios are not the whole story
How Betterment estimates an investment vehicle’s total annual cost of ownership (TACO).

etf-portfolio-selection-methodology

WABAC

Interesting that they put so much emphasis on value in their IRA portfolio. After browsing around a little I never found much info on why they emphasize it now, or if that could change later.

Sven

There are time and places for everything, including ETFs, index funds, active managed mutual funds, and others. Investors need to decide for themselves what work for them.

msf

A good promo piece, generally informative. Though as it is written to promote Betterment's service, it tends to gloss over some things, and hype others.

management strategies like tax loss harvesting require liquid securities that trade more than once a day.

Really? You can't strategically harvest tax losses using mutual funds that trade only once a day?

[TACO = Total annual cost of ownership]

TACO = “Cost-to-Trade” + “Cost-to-Hold”

Cost-to-trade is generally influenced by ... Bid-ask spread: The difference between the price at which you can buy a security and the price at which you can sell the same security at any given time.

Missing is how the bid-ask spread (a one time cost) is annualized. A figure could be computed by multiplying the spread by Betterment's turnover rate, i.e. how often it turns over your portfolio in a year. But there's no mention in the article about Betterment's turnover rates.

On the flip side, ETFs have turnover. So the ETFs have trading costs which aren't included in their ERs. Spread, market impact, and commissions.

Still, all these costs are implicitly incorporated into the TACO because they affect an ETF's tracking difference: Tracking difference is the underperformance or outperformance of a fund relative to the benchmark index it seeks to track.

cost-to-hold represents the annual costs associated with owning the fund and is generally influenced by these two factors:

1. Expense ratios ...
   
2. Tracking difference ...

Just as an ETF's trading costs are implicitly counted via the fund's tracking difference, so is an ETF's ER. So it looks as though ERs are getting double counted in Betterment's "cost-to-hold" calculation: explicitly, and implicitly as part of the tracking difference. More likely, Betterment is just glossing over terms, using them as convenient, not as it defines them. (It omitted ER in its list of factors that could cause tracking differences.)

Because a fund’s NAV total return includes fund expenses, tracking difference typically is negative for index funds

Vanguard: Understanding tracking difference and tracking error

The point is that one shouldn't take pieces like this too seriously. This is a pretty good one as far as marketing "white papers" go, but it's still that.

WABAC

Sven said:

There are time and places for everything, including ETFs, index funds, active managed mutual funds, and others. Investors need to decide for themselves what work for them.

Or figure out how to find, or hire, good advice. Betterment's advice sales pitch is geared at people younger than me judging by the buzz words they use.