You can tell an investment product is going to be a hit when you instantly see a huge and hungry market for it.
The new Vanguard Retirement Income ETF Portfolio, which makes its debut on Wednesday, is designed to pay predictable amounts of monthly income to retirees. To underscore this purpose, the ticker symbol is VRIF. V is for Vanguard and RIF is a play on registered retirement income fund, which is where people have all, most or some of their retirement savings.
A big question with RRIFs, and it’s more pressing than ever, is what do you stick in your account to generate income to live on in retirement? We have an aging population of investors who are going to be saddled with low interest rates for a long time. Dividend-paying stocks are going to be essential, but how do you pick the ones that will provide reliable income rather than grief to investors?
VRIF attacks the problem by bundling eight Vanguard equity and bond funds (the stocks-bonds mix is 50-50) into a single package designed to pay monthly income targeting a real-world 4-per-cent yield. “That is what clients will get in their pocket, or bank account,” said Scott Johnston, head of product for the Americas at Vanguard.
Dividends and interest income will account for about 60 cents per $1 of income, with capital gains providing the other 40 cents. Basically, Vanguard will strategically sell holdings that have risen in price to top up dividends and interest. This approach highlights the fact that this is an ETF designed for generating income, not for growing your money.
You could build and manage a portfolio of individual ETFs or stocks and bonds to accomplish the same total-return approach of VRIF, but some exacting work is required to ensure you get the income you need.
Vanguard does it all for you in a cost-effective way. The management expense ratio for VRIF is projected to be 0.31 or 0.32 per cent – that’s not the cheapest fee in ETF-land, but it’s a fair value. The cost of the eight underlying funds is included in the published MER, as is the practice with fund-of-fund ETFs. One additional cost is the brokerage commission to buy and sell an ETF or stock.
At a time when the investment industry is prying up every rock in sight to find new ways to generate bond-beating income, the components of VRIF come across as basic or even bland. In a 50-50 mix of stocks and bonds, the fund holds Canadian, U.S. and international stocks (including a minuscule 1 per cent weighting in emerging markets), plus bonds.
There are no preferred share, high yield bond or emerging market bond funds, or use of a covered call strategy, where financial instruments called derivatives are used to augment income. Mr. Johnston said these securities can add risk to a portfolio as well as higher levels of income. “What we have with VRIF is a simple, broadly diversified portfolio – that is it.”
VRIF is the latest iteration of one of the most popular types of ETFs – the balanced ETF, also known as asset allocation ETFs. Since Vanguard introduced the category in January, 2018, it has attracted $4.5-billion from DIY investors and advisers who understand that low-cost, index-tracking investments are a prime way to build long-term wealth.
An additional benefit of VRIF is tax efficiency in non-registered accounts. Only 50 per cent of a capital gain is taxable, and dividends benefit from the dividend tax credit.
There’s nothing particularly exotic about VRIF’s total return approach to generating a payout targeting 4 per cent, but it does raise the question of what happens when there aren’t enough capital gains to augment dividends and bond interest. Vanguard says it would use a return of capital in such situations, which it expects to do (in other than negligible amounts) roughly one in every 10 years.
Return of capital in non-registered accounts can be an annoyance to investors and a sign that a fund’s holdings are unable to deliver the promised level of income. A return of capital is an amount above and beyond the usual kinds of income from bond interest, dividends and capital gains. A return of capital is not taxed when you receive it, but it reduces the cost of an investment and thus increases your capital gain when you sell.
VRIF, like many equity ETFs, may also use trace amounts of return of capital to ensure that identical amounts of income can be paid every month. This is necessary because dividend stocks pay quarterly and bonds pay semi-annually.
If you’re a retiree managing investments to produce income, ask yourself this: How have you found the challenges of the past year, and how confident are you that you can navigate the next 12 months? If you’d like help, it’s now at hand. Expect competing products shortly.
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Rob Carrick