See how you can raise high-quality, low-cost funds to fill your portfolio.
Many are working on creating a single betment portfolio. We are spreading this showcase of investment team work into three parts.
Part 1 explores how to allocate customer investments at a high level, and Part 3 (coming soon) shows how to process thousands of transactions each day to keep your portfolio humming.
And here in Part 2, we may zoom in on topics that may be a little more relevant to everyday investors and choose the actual investment itself. If asset allocation is like refinement to recipes, today’s topic of fund selection is about sourcing high quality, low cost ingredients.
And for that, we turn to another kind of market.
Josh Shrair specializes in Betterment’s shopping capital markets, choosing funds to fill each allocation of portfolio. His line of work looked a little different decades ago when his step dad worked as a trader on Wall Street. At the time, this level of attention to portfolio construction and fund selection was usually only for the super wealthy. But now, Josh and his team are navigating the rapidly expanding universe of investment on behalf of everyday investors.
Why buying funds isn’t necessarily so simple
On the one hand, the recent explosion of investment options has been fantastic for investors. Intensifying competition reduces costs and begins access to newer, more niche markets.
But more choices lead to more complexity. Get priority building blocks in your portfolio with Exchange Traded Funds (ETFs), transparency, tax efficiency, and cost reductions. They bundle hundreds, sometimes thousands, sometimes thousands, sometimes thousands of individual stocks and bonds. But even ETFs are multiplying at high speed. In 2024 alone, 723 new releases were launched, bringing the total to around 4,000.
To explain this abundance, let’s say your asset allocation is looking for accumulation of “large cap” stocks, meaning companies worth more than $10 billion. Almost 500 ETFs live in this particular corner of the ETF universe. You can narrow that group down to 30 based on the specific exposure we are looking for, such as the “index” of the largest American companies in the US, such as the S&P 500. However, due diligence is rare.
While some ETFs tracking the S&P 500 follow faithfully, other ETFs can apply their own spins and open up investors to unintended exposure.
Just as important, their costs are everywhere, and higher fees can erode your profits in the long run. As such, SPDR funds are currently the main way in our core portfolio to achieve large capstock exposures. It offers low cost (0.02%) to hold and low cost of trade (0.03%) at the time of writing), resulting in a lower overall cost of ownership.
“Buying investments is a bit like buying a car,” says Josh. “The total cost is much higher than the sticker price.”
How to calculate total cost of ownership
Part of our role as a fiduciary, those who are obligated to act legally in the best interests of our clients is to conduct a deep, unbiased assessment of the ETFs used in their portfolios. Josh and the team’s usage process is completely “open architecture.” This means that you are not obligated to use funds from any particular provider. Instead, we strive to choose the best one from a cost and exposure perspective.
It helps it Betterment itself does not make money, manage it or sell it. This means that when it also acts as a fund manager, it avoids the inherent conflict of interest that some advisors face. These companies can tempt their customers to direct their funds even when better alternatives exist.
That’s why we take pride in the due diligence behind our fund’s choice. It starts with a “cost of ownership” scoring methodology. The factors that are the factors that contribute to the two types of cost mentioned above: the cost of “holding” or owning a fund, also known as the cost ratio, and the cost of trading it.
As shown in part 3 of this series, the portfolio is not static. The deposit will come in. The drawer disappears. Rebalancing is done regularly.
All this requires daily trading, so the cost of these transactions is important for the return on your investment. The cost of trade is also known as “spreading bids,” or the markup that traders expect when selling shares. It’s the way they make money, and it’s similar to wholesalers and retailers like Costco. The bigger the fund, the smaller the margin the traders can live on.
What we’re looking for these value buys is how we can deliver a globally distributed portfolio with just a small portion of the alternative costs in today’s market. And we didn’t finish our shopping. Our priority funds are renewed multiple times throughout the year.
Ready to buy
There is much more to the way funds are selected, especially when it comes to funds that are not tied to a specific index but instead are made from scratch. Some fund managers, like Goldman Sachs, who Josh worked early in his career, have fused both approaches with a “smart beta” strategy. Such a portfolio offers along with better collections.
But let’s pretend that our tote bags are full for this series. We are ready to check out. It’s time to meet the team behind every deal at Betterment.
