Older adults likely began their investing careers before exchange-traded funds existed and have stuck with traditional mutual funds.
But as retirement approaches, many investors look at their portfolios with a fresh set of eyes and make adjustments.
And the more I work with in-retirement portfolios, the more I like ETFs and traditional index funds for several reasons:
1) Index Funds and ETFs Lend Themselves Well to Cash Flow Extraction
For retirees who are using income distributions from their investments to help cover living expenses, the small fees levied by index funds and ETFs ensure that more of those payouts flow to them.
For total-return-oriented retirees who are rebalancing (trimming appreciated securities) to meet living expenses, index funds and ETFs also work well. These are typically pure plays on a given asset class, making it simple to identify which assets to scale back to deliver the retiree’s cash flow and restore the portfolio to its target asset allocation.
2) Maintenance Is a Cinch
In addition to simplifying cash flow extraction, index funds and ETFs also do well in limiting a retiree’s oversight obligations.
Many retirees have better things to do than monitor news about their holdings. Retirees employing index funds do need to watch their total portfolios’ asset allocation mixes, but most core-type index funds and ETFs change little on an ongoing basis.
Moreover, because index-tracking ETFs and funds track a benchmark rather than trying to beat it, manager changes matter much less than with active funds.
3) Controlling Portfolio Risk with Index Funds and ETFs
Many retirees prize risk controls, and people sometimes say that active funds “earn their keep” in down markets.
While mild-mannered active equity funds, especially those focused on valuation and quality, might help lower a portfolio’s overall risk, the most dependable way to reduce a portfolio’s loss potential is by adjusting the stock-and-bond mix, not the underlying holdings.
4) The Tax Efficiency Stakes May Be Higher
Taxes are another area where index funds and ETFs shine in retirement. Equity index funds and especially ETFs are incredibly tax-efficient relative to their actively managed counterparts.
Managing for tax efficiency is important at every life stage, but most important in retirement. Investors’ portfolios are often largest right before and during retirement, when the share held in taxable accounts also tends to peak.
5) A Lower-Return Portfolio Cries Out for Low-Cost Products
Holding more cash and bonds tends to lower a portfolio’s return potential; keeping expenses low helps ensure that investors keep more of their returns.
Assume a retirement portfolio consists of a 10 percent cash position, 40 percent in bonds, and 50 percent in stocks and earns 5 percent on an annualized basis over the next decade. If an investor pays 0.75 percent in expenses, her return shrivels to 4.25 percent; she has ceded 15 percent of her gains. But if she can limit expenses to 0.10 percent per year, her take-home return is 4.90 percent; she surrenders just 2 percent of her return.
By Christine Benz of Morningstar
The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
