See what we recommend for risk-averse ETF investors.
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By Christine Benz | 04-12-11 | 06:00 AM | Email Article

"I liked your retirement portfolios, but wish you had included some ideas for us exchange-traded fund investors."

This and other e-mails like it began hitting my inbox shortly after the publication of my model portfolios for retirees, which featured model retiree portfolios composed of traditional mutual funds.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

It's a great question, because ETFs have many features that make them ideal for retirement savers. Many ETFs have nice, low costs--a particularly important attribute for investors who are devoting a sizable share of their portfolios to cash and fixed-income investments. Given that these asset classes' long-term absolute returns may be lower than stocks', keeping expenses down can significantly improve your take-home return.

And though transaction costs can be an Achilles' heel for active ETF traders, as you may pay commissions to buy and sell your shares, they're apt to be less of an issue for retirees. That's because many retirees are investing large sums all at once--via company retirement-plan rollovers--and don't plan to make substantial additional contributions to their accounts. Of course, retirees may pay commissions when they need to sell shares to cover living expenses, but many of the major brokerages are offering commission-free ETF trades on many funds in their lineups. In short, the total costs associated with building and holding an all-ETF portfolio may still be lower than maintaining a portfolio consisting of conventional no-load mutual funds.

There's also performance to consider; while some active fund managers have done a superb job of limiting downside volatility over time, active funds in aggregate haven't made a compelling case for themselves, particularly on a risk-adjusted basis. (That doesn't mean that it's impossible to pick active funds that can outperform, however, as our Analyst Picks' batting average shows.)

Morningstar research also indicates that ETFs have the edge over traditional mutual funds when it comes to tax efficiency. Of course, there's no avoiding taxes if you pocket an income or dividend distribution from an investment, whether it's from an ETF or some other vehicle. But for those who are holding ETFs inside taxable accounts, our analysis of the data indicates that ETFs have done a very good job of limiting taxable capital gains--a better job, in fact, than conventional index mutual funds, which are quite tax-efficient in and of themselves.

Finally, because retirees are interested in many other activities besides overseeing their portfolios, ETFs' ease of use is a huge benefit. Nearly all ETFs track market benchmarks, so it's easy to assemble a portfolio that precisely matches your target asset allocation and to rebalance it when it gets off track. Without active managers in the mix, you won't have to worry about issues like management changes or the chance that an active bet will skew your portfolio in one direction or another. You can also readily assemble a well-diversified portfolio with very few individual ETFs--a key advantage if you're looking to reduce your portfolio-monitoring time as well as the amount of paperwork flowing into your house.

With all of those benefits in mind, we put together some ETF-focused model portfolios for retirees and pre-retirees. Today's article showcases the conservative version. It's appropriate for very risk-conscious retirees with a time horizon (estimated life expectancy) of 10-15 years. Thus, stability and preserving purchasing power are key goals for this portfolio. (Please see our related model portfolios for moderate and aggressive ETF investors, as well.)

In-Retirement Portfolio: Conservative

Holding
 
Allocation %
Vanguard Mega Cap 300 Index
 
13
Vanguard Mid Cap ETF 
 
4
Vanguard Small Cap ETF 
 
2
iShares MSCI EAFE Index 
 
5
Vanguard Emerging Markets Stock ETF 
 
1
iShares Barclays TIPS Bond 
 
25
Vanguard Short-Term Bond ETF 
 
13
SPDR DB Int'l Gov't Infl-Protected Bond 
 
4
iShares Barclays MBS Bond 
 
10
iShares iBoxx $ Inv Grade Corp Bond 
 
16
Cash
 
7
Total
 
100

 

Securities mentioned in this article

Ticker

Price($)

Change(%)
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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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Morningstar - 2011/04/12 - A Conservative ETF Portfolio for Retirees - <a href="http://www.morningstar.com/articles/author/30-christine-benz.aspx">Christine Benz</a>
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