3 ETFs for a Retirement Shift

08/31/2016 10:00 am EST

Focus: STRATEGIES

David Fabian

Managing Partner, FMD Capital Management

Money manager and ETF expert David Fabian discusses the challenges faced by investors as they shift from more growth-oriented investments into more conservative, income-generating retirement vehicles. Here, the editor of The Flexible Growth & Income Report highlights three favorite ETFs well-suited to this transition.

Steve Halpern:  Joining us today is David Fabian, money manager at FMD Capital, ETF expert and editor of The Flexible Growth & Income Report. How are you doing today David?

David Fabian:  I'm wonderful Steve.  Thanks so much for having me back.

Steve Halpern:  Now today we're going to discuss retirement portfolios.  Specifically the need for those reaching retirement age to begin shifting for more growth oriented investments to a more conservative stance focused more on income and capital preservation.  Could you walk us through an overview of this process that somebody should be considering when they retire?

David Fabian:  Absolutely.  You know most investors through the growth phase of their life through their 30s and 40s and 50s all the way up until their 60s are generally focused on saving and investing their money through inflationary assets like stocks and the like so that they can grow their wealth over time.

But as you get closer and closer to retirement into your 60s and 70s and 80s, most people are transitioning to a little bit more conservative portfolio and they're more than likely; you know, they're leaving their jobs.  

Maybe they have some independent income streams like social security or pensions or possibly even rental property or something along those lines, but they're more than likely going to need to generate some sort of income stream from their portfolio or draw down some of the assets that they have over a period of time.  

Most people talk about sort of the 4% rule where if you can count on withdrawing 4% of your portfolio a year you're going to be in pretty good shape, but investors have to have a strategy to be able to do that, so some of the funds we're going to be talking about today address those concerns.

Steve Halpern:  Now the low interest rate environment in recent years certainly must be adding challenges to this overall strategy.  Could you touch on the difficulties of the low rate environment and what you expect for interest rates looking ahead?

David Fabian:  Absolutely.  You know, what happens in a low interest rate environment is a lot of investors start to reach for yield.  They typically go a little bit outside their comfort zones and we saw this in 2015 where junk bonds, master limited partnerships, and leveraged loans, closed-end funds -- they all went through a contractionary phase -- where they dropped anywhere from 10% to 20% depending on the high yield index of choice, because we saw a big deflationary move in oil prices, and that sort of filtered down to other areas of the credit market.  

When investors in a low yield environment sort of step outside their normal comfort zone and step up to something that, you know, when a 10-year treasury bond is yielding 1.5% all of a sudden they see an asset class that's yielding 5, 6, 7 or even as high as 9% that's a very attractive thing for a lot of retirees.

But they have to understand that a higher yield also equates to a higher degree of risk -- risk in capital fluctuation over time and volatility.

So I think a lot of investors have sort of stepped outside their normal bounds of risk taking and that can again lead to nervousness and it leads to fluctuations in the principal values, and of course interest rates in general because we're at such historic lows.

Investors that are going to be retiring in the next five to 10 years certainly have to have a different mindset when they're looking at their portfolio, and being a little bit more cautious in how sensitive their portfolio is to interest rates if we started to see a different cycle develop.

We went through a period over six months, a year, or two years where we were in more of a rising interest rate environment or a flat interest rate environment, that's going to cause some problems for a lot of people that are overly exposed to interest rate risk.

Steve Halpern:  Now, in a recent report you covered a trio of exchange traded funds that you say represent unique ways to add income and diversification to a retirement portfolio.  The first of those is Vanguard High Dividend Yield ETF (VYM).  What's the attraction in this position?

David Fabian:  Every retiree, I believe, should still have some level of stock exposure in their portfolio -- and VYM is actually a conglomeration of high dividend yielding stock.  It's certainly nothing outside the norm.  We're talking about stocks like Microsoft (MSFT), Exxon Mobil (XOM), Johnson & Johnson (JNJ), and AT&T (T).  

I've talked about this ETF a lot and it's a fund that I own for my wealth management clients at FMD Capital Management, but basically VYM is about 400 high yield stocks across nearly every sector of the economy, so you've got some energy stocks, you've got technology stocks, consumer staples, and basic material stocks.  

You've got a little bit of everything in there.  It's almost like the S&P 500 of sort of the dividend universe so it gives you some correlation with the stock market and it gives you a nice dividend yield as well.  

Currently the fund is yielding about 3.1%.  Dividends are paid quarterly to shareholders so it's extremely diversified, pays a very nice dividend, keeps you correlated with the stock market, and it also has a very low expense ratio as well.  

The expense ratio in VYM is only nine basis points.  As many people know, Vanguard has extremely low expenses and we try to use a lot of their funds in our modeling and things like that because they're so cost effective.  

Steve Halpern:  Next you suggested a SPDR DoubleLine Total Return Tactical ETF (TOTL).  Can you tell our listeners a little about this fund?

David Fabian:  Certainly.  TOTL is another fund that we've talked about quite a bit both here at the MoneyShow and in other places.  I do own again this one for my clients.  TOTL is an actively managed ETF run by Jeffery Gundlach at DoubleLine Capital who many people know.  

He's on TV and radio and financial media quite a bit.  He's sort of known as the bond king of the 21st century so to speak, and Gundlach takes a very risk managed approach with this type of portfolio.

It's a multi-sector bond fund so it owns a little bit of everything out there.  It owns mortgage securities.  It owns Treasuries.  It owns some high yield bonds.  It owns some investment grade corporate bonds and even a little bit of emerging market debt.

But one of the advantages of TOTL is that it has a lower average duration than a typical index like the Barclay's U.S. Aggregate Fixed Income Index, so you're going to get less sensitivity to interest rates.  If we were in more of a rising rate environment TOTL would more than likely have less volatility than the Barclay's Aggregate Index.  

Right now it's paying a yield of about 2.8%.  Income is paid monthly to all of the shareholders in the fund and I believe that this is the type of fund that could be a very good core holding for ETF investor's portfolios over the next five years or so.

Steve Halpern:  Now finally you suggest the Vanguard Short Term Corporate Bond ETF (VCSH).  What's the story with this fund?

David Fabian:  Well as I mentioned at the beginning of the interview, a lot of investors really start to shift in retirement to a more conservative mindset.

A lot of people like to have a little bit more cash on hand.  Maybe they want to sort of back off some of the interest rate risk in their portfolio but they still want to generate a little bit of a yield, and VCSH is one opportunity to do that.  

This is an ETF again from Vanguard, owns very short term investment grade corporate bonds, and a very diversified portfolio.  I believe there are over 1000 holdings in this ETF.  

It only charges an expense ratio of about 10 basis points, but the advantage is you're still getting a little bit of a yield as well.  You're getting about a 1.7% yield.  It has an effective duration of about 2.8 years so again, fairly on the lesser sensitive side interest rates than a typical aggregate bond fund or the like.  

You do have some credit risk in this fund if we were to get into more of a credit contraction-type of environment, but because most of the stocks or most of the bonds are based on high quality companies and above investment grade companies, I believe that this is going to be a good fund to own.

And again, it's a little bit more on the conservative side and I think that plays well in a retirement oriented portfolio.

Steve Halpern:  Again, our guest is David Fabian of The Flexible Growth & Income Report.  It's always fascinating to hear your thoughts.  Thank you so much for your time today.

David Fabian:  I appreciate it Steve.  Have a great day!

By David Fabian, Editor of The Flexible Growth & Income Report

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