Every basis point counts in this low-yield world. That's especially true for retirees, who need steady returns from their portfolios.
In this respect, exchange-traded funds (ETFs) can help. They often have management expense ratios (MERs) of less than half a per cent and provide diversified access to multiple markets and asset classes.
Consider these two strategies from the experts: one basic, and the other off the beaten path.
Keep it simple
This is the KISS strategy: Keep it simple, smarty-pants. Retired investors don't need a lot of funds to create a sustainable portfolio, says Alan Fustey, vice-president and portfolio manager with Index Wealth Management in Winnipeg. Nor do they need specialized income products. Instead, retirees can get by with two equity ETFs and one fixed-income offering.
How much retirees allocate to any one fund should be based on their appetite for risk. But given the low returns on bonds, they will generally need a higher equity allocation than they would have in the past to get through 20 years or more of retirement, Mr. Fustey says.
Horizons S&P/TSX 60 Index ETF: This fund provides exposure to Canada's largest firms on the Toronto Stock Exchange and charges an industry-leading low MER of 0.03 per cent. Another plus: Because this fund uses a total return swap (a derivative) to track the index, dividends and distributions are reflected in the net asset value of the ETF unit price, and so no real income is generated, making it a tax-efficient option for non-registered, taxable accounts. "The shortcoming of the TSX 60 ETF is it's based only on Canada, a very small share of all the stocks in the world," and the investments are highly concentrated in metals, minerals, oil and gas and banks, Mr. Fustey says.
Vanguard FTSE All-World ex Canada Index ETF: To expand your portfolio's scope, this Vanguard offering is about as diversified as you can get for the cost. Covering developed and emerging markets, it follows about 2,900 stocks in 43 countries with a MER of 0.28 per cent. "The Vanguard All World is basically everything other than Canada," making it the ideal companion for the Horizons fund above. The drawback is its value can be affected by the performance of the Canadian dollar relative to other currencies. "That's the general risk of owning anything outside of Canada," Mr. Fustey says. "The dollar is going to fluctuate, affecting the value of your investment."
BMO Short Corporate Bond Index ETF: A retirement portfolio isn't complete without fixed income. But this offering puts a different spin on the traditional fixed-income ETF because its distributions aren't paid out as cash. Instead, interest is reinvested, increasing the net asset value (and market price) so investors "don't have to deal with small cash distributions" if that's a concern, Mr. Fustey says. (Although this might lead one to assume the ETF is a good choice for a non-registered account, like the Horizons fund above, the BMO fund generates real, taxable interest, so it is more suitable for an RRSP.) An upside is that it provides diversified exposure to Canadian corporate bonds, which yield slightly more than government issues, and its holdings' short-term duration protects investors from significant capital losses if interest rates rise. "If rates go lower, however, it will underperform a long-term corporate bond fund," he says. More than anything it serves as a good portfolio stabilizer when equity markets fall because its underlying investments generally increase in value.
Off the beaten track
If generating consistent income is the chief concern – and it is for many retirees – consider looking beyond plain-Jane government-bond and dividend ETFs, says Robyn Graham, managing director of wealth management and portfolio manager with ETF Capital Management in Toronto. The following options may not be on the radar of many investors, but they can offer a steady yield along with a little capital growth along the way.
BMO Canadian High Dividend Covered Call ETF: This ETF uses an options strategy, selling calls to yield steady income in addition to dividends. "This low-risk strategy generates premiums for the portfolio, enhancing the ETF's overall yield by sacrificing some of the upside potential," Ms. Graham says. Moreover it can be combined with other covered call ETFs that invest in U.S. and other markets for increased diversification. The downside is a covered call strategy involves limited capital growth because you're "giving someone else the right to purchase" the investment if it hits the agreed upon strike price, she says. "The investor gets some upside, but the upside has a ceiling."
iShares U.S. Telecommunications ETF: A defensive strategy for investors seeking equity exposure, it pays a steady yield – around 2.5 per cent – while its holdings are generally less affected by falling markets. The fund also "has a smaller-cap focus than some of the other picks in the sector, and offers an attractive yield while retaining decent spreads and good liquidity," Ms. Graham says. As an equity-based investment, pricing can be volatile, though not as much as other sectors. But the ride may still be too bumpy for some retirees to stomach.
Vanguard REIT ETF: This ETF has it all for income investors: a steady yield, a low MER, diversification and liquidity. Paying about 4.3 per cent in distributions, it offers exposure to a variety of U.S. real estate opportunities, including commercial, hotel and health care by tracking the performance of the MSCI US REIT Index. Additionally, its MER is only 12 basis points compared with the sector average of more than 1 per cent. The drawback is investors' quest for yield has pushed up valuations. Its share price, for example, trades at about 30 times earnings, so it certainly isn't overlooked by the market. But Ms. Graham says its price has come down in recent weeks, possibly "providing a better entry point for those looking for diversification in their income portfolio."