The most stressful moment in a lifetime’s investing comes when you convert your retirement savings into income you can live on.
You’ll need to pick stocks, bonds or funds and mix them in such a way that you contain financial market risk while generating enough income to meet your needs for life. This balance was hard to achieve even before the pandemic cranked the level of investing complexity to extreme levels via low bond yields and volatile stocks.
The exchange-traded fund business has long offered products to help investors turn retirement savings into monthly retirement income, but this category has until recently been a quiet one. The game-changer is the new Vanguard Retirement Income ETF Portfolio (VRIF), which is built on the idea of blending stocks and bonds to produce monthly distributions that target a 4 per cent return after fees on an annualized basis.
VRIF has some quirks that make it unique, notably the targeted payout. But its No. 1 competitive selling point may be the clear, mission-defining name. Competing ETFs usually have the phrase monthly income in the name, but they don’t zero in on the retiree demographic and thus may be overlooked.
Let’s fix that with a comparison of VRIF against five other ETFs that investors can use as an alternative to individual stocks and bonds for generating monthly income for retirement. Note: Some of these alternatives are best used as a part of a diversified portfolio and not the entire portfolio. VRIF could in theory be the only thing you hold in your retirement portfolio.
The five VRIF alternatives were drawn from a recently published ETF handbook produced by National Bank Financial. A total of 977 TSX-listed ETFs were covered, including 13 with a focus on monthly income. That list of 13 was reduced to five for this column by focusing on monthly income funds with assets of $20-million or more (see accompanying chart). Here’s how VRIF’s five competitors compare in a few key areas:
VRIF uses a 50-50 mix of stocks and bonds, which pre-pandemic would have looked quite normal for retirees. Now, with bond yields in the basement, such a large bond weighting may seem high to some investors. If you’re looking for a monthly income ETF with more of a tilt to stocks, the BMO Monthly Income Fund (ZMI) has a 60-40 mix of stocks and bonds. The Purpose Multi-Asset Income Fund (PINC) has 65 per cent in stocks, including a small weighting in preferred shares, and about 35 per cent in bonds and cash.
The iShares Canadian Financial Monthly Income ETF (FIE) deserves to be singled out here because it has just 10 per cent of its holdings in bonds and because it, unlike the other funds examined here, is a sector fund and thus not broadly diversified. FIE strictly holds securities issued by banks, insurance companies, investment dealers and other financial firms.
High bond weightings still need to be scrutinized if you’re a safety-conscious investor. To help generate yield, the First Trust Global Risk Managed Income Index ETF (ETP) has roughly one-quarter of its assets in high yield and emerging market bonds. Overall, the fund has the majority of its assets in fixed income.
“You can’t understate the importance of fees when what you need is income,” said Daniel Straus, head of ETF research and strategy at National Bank Financial. “Higher fees act as a headwind on the income you collect.”
Here’s the math: Underlying yield from the assets in a fund minus the fund’s management expense ratio give you the actual yield investors get. Unfortunately, monthly income ETFs have so far avoided the intense fee competition seen in other ETF sectors. MERs for the five funds examined here range from 0.61 to 1.02 per cent, which compares to an estimated 0.31 per cent for VRIF.
VRIF’s monthly payments are calibrated to produce a payout equivalent to 4 per cent of the issue price on an annualized basis, after fees. “The 4 per cent target is probably reasonable in the eyes of many,” Mr. Straus said. “As you inch away from that 4 per cent marker, you have to start making some bargains in terms of the risk you’re willing to take on.”
You can see how higher yields and higher risk go together in the five alternative VRIF alternatives. FIE has the highest yield, and the worst loss for the year through Sept. 30. That’s the downside of its narrow sector focus on the financial sector, even when most assets are held in banks and insurance companies.
VRIF’s monthly distribution will be recalibrated once a year to get back to that targeted – not guaranteed – distribution rate. Expect VRIF’s payouts for the most part to be a blend of bond interest, dividends from Canadian, U.S. and international stocks, plus capital gains generated through strategic selling of holdings that have risen in value.
Other funds distribute a mix of bond interest, Canadian dividends, U.S. and international dividends and return of capital. ROC payments are not taxed in the year you receive them in a non-registered account, but they reduce the cost of an investment and thus increase your capital gain when you sell. As the term implies, an ROC payment is essentially getting part of your capital back.
The asset mix of a monthly income ETF is a has a big impact on its tax-efficiency on a non-registered account. A 50 per cent weighting in bonds, as VRIF has, means half the distributions received by investors will be treated like regular income.
Dividends from Canadian companies qualify for the dividend tax credit, but not those from companies based internationally. VRIF has a 9 per cent weighting in Canadian stocks.
XTR has roughly 30 per cent of its assets in underlying ETFs that pay dividends from Canadian stocks, whereas ZMI has about 15 per cent exposure to Canadian stocks. The sector-specific FIE is tax-friendly in a non-registered account in that it mostly holds Canadian dividend-paying preferred and common shares.
You can compare the various types of income that go into monthly distributions by looking at ETF company fund profiles online (there should be a “distributions” tab to click on). Mind the return of capital if you have a taxable account.
It’s pretty standard for monthly income ETFs to have a return of capital component in their monthly payouts – it helps them pay out identical amounts of income every month. PINC, XTR and ZMI have made a return of capital a significant part of their distributions in recent years. VRIF expects to use a return of capital to meet its income payout targets once every 10 years on average, and small amounts of ROC are possible in any given year.
If you’re an investor who seeks income above all and puts a low priority on growth, your research is incomplete if you don’t at least consider VRIF. But you do have alternatives offering more yield, more risk and more variety of holdings.
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