A Conservative Retirement Saver Portfolio for ETF Investors
For a pre-retiree, our portfolio includes a larger--and better diversified--stake in bonds.
Exchange-traded funds may have initially appealed to fast-trading, aggressive investors, but they can work well for slow and steady types, too, including conservative investors.
The largest ETFs are utilitarian index trackers covering broad swaths of the market, just as traditional funds do. And even though ETFs can't run for cover by retreating to defensive securities or raising cash, in practice, very few traditional mutual funds do that, anyway.
The cost advantage that can accompany ETFs (or traditional index funds) can also be a boon to conservative investors. Low expenses are an even bigger performance differentiator for low-returning assets like bonds than they are for higher-return/higher-risk investments. Thus, one of the best ways to increase a more conservative portfolio's return potential is to reduce the drag of costs--fund costs, transaction costs, and tax costs. Buying and holding low-cost ETFs on a commission-free platform can help you kill all three birds with one stone.
Shorter Time Horizon = More Bonds
I used Morningstar's Lifetime Allocation Indexes to guide the investment mix of the Conservative ETF Saver Portfolio. I assumed a retirement date of 2025, so this portfolio is roughly geared toward someone age 60 or 65. I employed some of our fund analysts' top ideas to populate the portfolio.
Yet, it's not meekly positioned. It includes an equity stake of more than 50%, in recognition of the fact that the typical American who's 65 today has a life expectancy of roughly 20 years and needs the growth potential that stocks afford. As with the other portfolios, I've anchored the equity portfolio with a stake in a total U.S. stock market tracker but augmented it with a position in a small-value index. Note that I'm backing off the small-value position somewhat--as a percentage of the equity portfolio--relative to the Moderate and Aggressive ETF Saver Portfolios. That's because as time horizons shrink, so does the potential to receive a return premium from such a tilt.
As it has grown, the bond piece of the portfolio has also become more diversified relative to the Moderate Portfolio. In the Moderate Portfolio, I have employed a core bond market index tracker as the sole fixed-income holding. That's because for younger investors, the main benefit of bonds is diversification, and an extremely high-quality fixed-income portfolio is apt to do that job nicely. Nor does a person in his or her 40s--the target for the Moderate Saver Portfolio--need to spend a lot of time worrying about meeting near-term income needs or preserving purchasing power from the portfolio: He or she isn't yet in spending mode.
But those considerations become more real for people who are closing in on retirement. At this life stage, it's worthwhile to begin thinking about creating an income stream in retirement and staging that portfolio by anticipated income needs, from highly liquid securities for early retirement living expenses to higher-return/higher-risk assets to cover living expenses in the later years of retirement. (That's the major thesis behind the Bucket Approach to retirement portfolios.) It's too soon for a person with a five- to 10-year time horizon to begin carving out a cash bucket--the opportunity cost is too great. But it's not too early to think about building a bulwark against sequencing risk--the chance that you'll encounter a lousy equity market at the outset of retirement. Thus, I've added short-term bonds to the portfolio, to provide a buffer and deliver living expenses if, five or 10 years hence, the stock and/or bond markets are in the dumps.
I've also added a position in Treasury Inflation-Protected Securities to help preserve the purchasing power of money drawn from the portfolio during retirement. I went with a short-term TIPS fund here, but it wouldn't be unreasonable to use an intermediate-term TIPS fund instead.
33%: Vanguard Total Stock Market Index ETF (VTI)
5%: Vanguard Small-Cap Value ETF (VBR)
10%: Vanguard FTSE Developed Markets ETF (VEA)
4%: Vanguard FTSE Emerging Markets ETF (VWO)
30%: iShares Core Total USD Bond Market ETF (IUSB)
11%: Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
7%: Vanguard Short-Term Bond ETF (BSV)
How to Use
As with all of the model portfolios, the key goal here is to depict sound asset-allocation and portfolio-maintenance principles, rather than to blow the doors off with strong performance.
Because exchange-traded funds are ideal "set it and forget it" vehicles, I'll make changes for rebalancing purposes or when fundamental considerations dictate. It's also worth noting that this portfolio's asset allocation won't make sense for every individual approaching retirement. People who will fund most of their retirement income needs with a pension and Social Security would likely want to hold a smaller stake in bonds than is featured here, as their portfolio distributions are going to be minimal.
Investors shouldn't interpret the model portfolios as a call to reinvent the wheel when it comes to the securities in their portfolio. Traditional index funds would work just fine in place of the ETFs listed here. Moreover, investors could reasonably blend together both active and index products, while otherwise mirroring the model portfolios' allocations.
Finally, a note about tax efficiency: I'm assuming this portfolio will be held in a tax-sheltered account. But if that's not the case, investors will want to be careful with categories like TIPS, which tend to have high tax costs. They may also want to consider municipal bonds in lieu of taxable bonds, though Morningstar generally recommends traditional funds, rather than ETFs, for muni exposure.
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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