Betterment: Overpriced simplicity

By Felix Salmon
December 13, 2010
Sean Park is so excited about Betterment that he bought a stake in the company:

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Sean Park is so excited about Betterment that he bought a stake in the company:

Betterment allows anyone to quickly, easily and without mystery manage asset allocation and risk budgeting using a simple, multi-asset class portfolio. No hassle, no time wasted, no blizzard of trade confirmations. The first time I saw it, I immediately wanted to be able to manage all my cash balances using their platform.

Except Sean Park is a sophisticated venture capitalist, and Betterment doesn’t manage cash balances. Instead, it manages investments. Basically, it provides an easy way of sweeping money out of your checking account and into your Betterment account, where it’s then invested across eight different ETFs. Betterment does most of the asset allocation; you just tell the company how much you want invested in Treasuries and how much in stocks, and they will do the rest.

This is a handy little service — but the amount that Betterment charges — 0.9% per year — is way too much, especially since it comes on top of the expense ratios of the underlying ETFs, which net out at 18.2bp for stocks and 17.5bp for bonds. In these days of ultra-low interest rates, buying a bond fund and then paying out 107.5bp per year in expenses is likely to leave you with a negative real return, and quite possibly could leave you with a negative nominal return as well. Or, to put it another way, right now it makes very little sense to have Betterment manage your bond funds and charge you a 90bp fee for the privilege: you might well be better off just keeping your money in a savings account, where there’s no risk of a nominal decline.

The idea behind Betterment — that investing should be very easy and simple at the front end, even if there’s lots of complicated stuff going on at the back end — is a good one. And I look forward to the time when banks offer Betterment-style services to their depositors, making it easy and painless to save money. I’m sure those banks could learn a lot from what Betterment is doing, and even maybe license some of their technology. But it only really becomes attractive when it’s free. And when, at the very least, it gives some kind of an option to invest internationally and in credit — two enormous asset classes that Betterment completely ignores. I’m pretty sure that Sean Park, for one, would never find it genuinely attractive in its current incarnation.

Update: Betterment’s CEO, Jon Stein, responds in the comments, and he sure knows the way to a blogger’s heart — by referencing an old blog entry which even I’d forgotten about:

I agree with you that we should offer our customers exposure to international stocks. Our users are all US-based, and so are naturally overweight US. We plan to add international exposure soon, and perhaps a real-estate component or credit component, as well. All of these asset classes are components of the “market portfolio” – and would be represented in the “everything bagel” that you talked about in a previous post. It’s that everything bagel that we’re working toward – it takes time to make it just right.

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I think Fidelity already does this with their Smartcash account. I use it because they reimburse ATM fees, enabling me not to bank at anything bailed out by US taxpayers, but I definitely remembering them offering it.

Posted by Eastvillagechic | Report as abusive

It’s good that Betterment has essentially merged the steps of transferring money and investing it (I do not know of a way to combine both steps with a low-cost account at the various brokerages or fund supermarkets), nut the ETF portfolio is quite appalling considering that their asset allocation is supposed to be part of the selling point.

The lack of other asset classes can be an issue, but more important is the terrible overlaps entailed by their US investment allocations. Russell Mid-Cap owns essentially the 201st-1000th largest equities in the US, which means it overlaps hugely with the S&P 500, rather than providing a complementary mid-cap holding. The DIAMONDS ETF follows the DJIA, which is nearly nonsensical as an index but also overlaps entirely with the S&P 500 (but it gives you that massive IBM overweight you always wanted!). It’s as if they didn’t even put an ounce of research into the methods of the various indexes they chose to fill out the portfolio.

Posted by BKay | Report as abusive

So I click on the Sean Park link to see who he is, and in the second sentence, he uses the words, “super exciting”, in that order. Right away, I would discount any advice this guy has to provide, and I would avoid doing business with any company he is connected to. I just can’t trust someone who says things like that.

Posted by OnTheTimes | Report as abusive

Jon Stein here, Founder and CEO of Betterment.

We are working to make smart investing more accessible, giving sophisticated investors a set-and-forget alternative to hard-to-manage brokerage and fund accounts, and offering traditional savers a conservative path into investing.

We launched six months ago with a fee of 0.9%, which is less that the average mutual fund fee, less than the average investment advisor fee, and a lot less than the hidden spread banks charge on customer deposits. And we have no transaction fees and no minimums. So, from our perspective, we’re already offering a good deal. However, I agree with you that it could look expensive to some users, since many of them aren’t used to paying asset-based management fees for services like rebalancing, allocation advice, customer service, and ETF monitoring. That’s why soon we’ll be tiering our fee, offering lower fees for higher-balance accounts, since it doesn’t cost us 100 times as much to manage $100,000 as it does to manage $1,000, and seems only fair.

I agree with you that we should offer our customers exposure to international stocks. Our users are all US-based, and so are naturally overweight US. We plan to add international exposure soon, and perhaps a real-estate component or credit component, as well. All of these asset classes are components of the “market portfolio” – and would be represented in the “everything bagel” that you talked about in a previous post. It’s that everything bagel that we’re working toward – it takes time to make it just right.

Thanks for your interest in our new product and please keep in touch. I think you’ll really like where we’re headed.

Posted by jonstein | Report as abusive

Many fee-only investment advisors I know who work exclusively in the index space charge between 50-75bps for their human service. Hell, I charge 75bps and include personalized financial planning. Many brokerages do something similar for next to nothing. While a great idea (and I say this as someone whose business model is threatened by the idea), Betterment is charging WAY too much for what they do.

Curious where and how the client funds are custodied…

Posted by martin66 | Report as abusive