A Moderate ETF Portfolio for Retirees
See what we recommend for risk-averse ETF investors with a 15- to 20-year time horizon.
Just when I think I've seen the most arcane exchange-traded fund ever (iPath U.S. Treasury Steepener (STPP), anyone?), the industry surprises me with an even more nichelike offering. Given that so many ETFs seem determined to cater to the fast-trading, too-smart-for-their-own-good crowd, it would be hard to blame sober investors for reflexively dismissing the whole universe.
But as I noted in last week's column, ETFs aren't just for gunslingers and in fact boast some attributes that make them ideal for retiree portfolios. Many have low costs, of course, and the advent of commission-free trading on many ETF platforms is another plus. Low all-around costs are key for folks at all life stages but especially for retirees, many of whom are sinking ever-larger shares of their portfolios into lower-returning fixed-income assets and cash.
True, the index-versus-active question may not be entirely settled (for a taste of just how much it's not settled, or to join the fisticuffs yourself, read the comments below my colleague Mike Breen's recent article). But I think it is safe to say that low-cost ETFs' expense edge will help them deliver competitive--if not better--returns versus the average active fund over time. And Morningstar research also indicates that ETFs have the edge over traditional mutual funds and even index mutual funds, when it comes to tax efficiency. That's a valuable attribute already, but it's set to become even more beneficial given that capital gains rates are set to head up in 2011.
Finally, I see ETFs' ease of use as a huge benefit for retirees, most of whom no doubt have better things to do with their time than assembling and monitoring their portfolios. With just a handful of investments, it's easy to assemble a basket of investments that precisely mirrors your target asset allocation and to rebalance when it gets out of whack.
With all of those benefits in mind, I've been rolling out some ETF-focused model portfolios for retirees and pre-retirees. Today's article showcases the moderate version. It's appropriate for retirees with a time horizon (estimated life expectancy) of 15-20 years. Thus, stability and modest growth are key goals for this portfolio.
In-Retirement Portfolio: ModerateHolding Allocation %Vanguard Mega Cap 300 Index 20Vanguard Mid Cap ETF (VO) 7Vanguard Small Cap ETF (VB) 3iShares MSCI EAFE Index (EFA) 7Vanguard Emerging Markets Stock ETF (VWO) 1.5iShares Barclays TIPS Bond (TIP) 20Vanguard Short-Term Bond ETF (BSV) 11SPDR DB Int'l Gov't Infl-Protected Bond (WIP) 3iShares Barclays MBS Bond (MBB) 8iShares iBoxx $ Inv Grade Corp Bond (LQD) 13.5Cash 6Total 100
To provide an asset-allocation blueprint, I've used Morningstar's Lifetime Allocation Indexes, which in turn rely on the research of Ibbotson Associates, a division of Morningstar. Think of these allocations as a starting point: Users should feel free to tweak them based on their own situations, risk tolerances, and time horizons.
As with last week's conservative portfolio, I've leaned heavily on the insights of Morningstar's ETF analysts for their best ideas for populating an ETF portfolio. That team produces Morningstar's ETFInvestor newsletter, which also includes two model portfolios--the Hands-Free Portfolio, a long-term strategic portfolio, and the Hands-On Portfolio, featuring a more tactical-allocation approach. Note that these portfolios include holdings from multiple providers such as Vanguard and iShares, but it's possible to get fairly close to these portfolios' asset allocations using ETFs from Vanguard or iShares only.
A Total-Return Approach
This moderate ETF portfolio stakes less than half of its assets in stocks and holds the rest in a combination of cash, Treasury Inflation-Protected Securities, and other bonds. As with last week's portfolio, it's not set up to deliver a current income stream, though it definitely kicks off some income. Instead, the assumption is that investors will use a total-return approach and periodically shift some of their investment assets to cash to fund current living expenses. (For a discussion of income versus total return and the merits of each, read this helpful thread.)
As with last week's conservative ETF portfolio, this portfolio doesn't take the total bond market route in an effort to avoid a giant weighting in government bonds. Instead, it includes separate holdings dedicated to corporates ( iShares iBoxx $ Investment Grade Corporate Bond (LQD)) and mortgage-backed bonds (iShares Barclays MBS Bond (MBB)). Together, these two funds replicate the securities in a total market bond index fund, except they exclude the government-bond exposure. (Those seeking a more streamlined, hands-off portfolio that's agnostic about the current market environment could also use a total bond market index fund like Vanguard Total Bond Market (BND).) However, it's worth noting that the portfolio doesn't eschew government bonds altogether. It includes a 20% stake in iShares Barclays TIPS Bond (TIP) and Vanguard Short-Term Bond ETF (BSV). For additional inflation protection, it also includes a smaller position in SPDR DB International Government Inflation-Protected Bond (WIP), giving it exposure to inflation-protected bonds issued by foreign governments. Inflation-conscious investors might also consider a small slice of commodities or even precious metals exposure, but they should bear in mind that these investments have some limitations, as I discussed in this article.
On the U.S. equity side, I've again modeled the holdings on ETFInvestor's Hands-Free Portfolio and have included three distinct funds. One could obtain similar market exposure via a broad market index portfolio such as Vanguard Total Stock Market ETF (VTI), but our portfolio has a modest emphasis on mega-caps, which look relatively attractive to our equity analyst team right now.
The Role of Cash
As with last week's portfolio, this one does include cash, but it's not here to fulfill investors' income needs; rather, it's here to improve the portfolio's overall risk/return characteristics. The amount of cash you hold will be highly dependent on your personal situation: your spending needs, whether you're receiving income from other sources, and the size of your overall portfolio.
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Publishes January 2010
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.