Two years ago, Vanguard launched a suite of asset allocation ETFs that changed the game for DIY investors in their accumulation years. These balanced ETFs provide low-cost, global diversification, and automatic rebalancing with just one fund.
Today, Vanguard announced another evolution in the asset allocation ETF space with a new product aimed at retirees in the decumulation phase. The Vanguard Retirement Income ETF Portfolio, or VRIF, uses global diversification and a total return approach to provide steady monthly income at a target payout rate of 4% per year.
| ETF | TSX Symbol | Management fee | Target annual payout |
|---|---|---|---|
| Vanguard Retirement Income ETF Portfolio | VRIF | 0.29% | 4% |
Saving for retirement is by far the number one objective for investors and Vanguard believes that space is well covered with their now flagship products like VEQT, VGRO, and VBAL. An investor in his or her accumulation phase could simply move down the risk ladder, switching from VEQT to VGRO to VBAL as they get closer to retirement age.
But what to do with your ETF portfolio in retirement? It’s a question I get every time I mention the benefits of investing in asset allocation ETFs. Prior to today, the answer was to sell ETF units as necessary to meet your spending needs or rely on smaller, quarterly distributions of around 2% per year.
With VRIF, investors get a predictable monthly income stream (targeted at 4% per year) to help meet their regular spending needs and not have to worry about rebalancing and/or selling ETF units.
Indeed, you could think of VRIF as the retirement equivalent of VBAL.
Vanguard Retirement Income ETF Portfolio (VRIF)
VRIF is a single-ticket income solution. It’s a wrapper containing eight underlying Vanguard ETFs that offer global exposure to more than 29,000 individual equity and fixed income securities.
Related: Top ETFs and Model Portfolios in Canada
Here’s a look under the hood of VRIF:
| Asset class | ETF | Weight |
|---|---|---|
| Canadian equity | VCN | 9.0% |
| Canadian aggregate fixed income | VAB | 2.0% |
| Canadian corporate fixed income | VCB | 24.0% |
| Emerging markets equity | VEE | 1.0% |
| U.S. fixed income (CAD-hedged) | VBU | 2.0% |
| U.S. equity | VUN | 18.0% |
| Developed ex North America equity | VIU | 22.0% |
| Global ex U.S. fixed income (CAD-hedged) | VBG | 22.0% |
Here is the geographic breakdown of VRIF’s holdings:
- Canada – 35%
- United States – 20%
- Developed ex North America – 44%
- Emerging markets – 1%
VRIF focuses on a total return approach using an approximate asset allocation of 50% equity and 50% fixed income. This approach allows the portfolio to payout from capital appreciation in years when the portfolio yields fall below the target.
A total-return approach is more tax-friendly because VRIF can distribute from capital appreciation. In that case, only the difference between the cost basis and the sale price is taxed. Meanwhile, the full dividend distribution from underlying securities is taxable.
Vanguard highlights the transparency of VRIF and its underlying holdings, saying because its building blocks are clear, you always know what you’re investing in and why, adding that regular monitoring and rebalancing helps maintain exposures across key sub asset classes and risk levels.
VRIF’s 0.29% management fee (before taxes) is roughly one-third the cost of any comparable monthly income mutual fund in Canada. Costs matter, especially to retirees with sizeable portfolios who are looking to keep more of their returns and protect their investment base.
I spoke with Scott Johnston, head of product at Vanguard Canada, about the launch of VRIF and got the chance to ask him some questions about the new product.
He said the success of Vanguard’s asset allocation ETFs were a big part of the background on creating VRIF. Both investors and advisors were looking for the simplicity of a balanced ETF, but something that could deliver regular and stable income to help achieve retirement income goals.
Investors with a keen eye will notice that the underlying holdings of VRIF don’t generate 4% income. Mr. Johnston says with the total-return focus, VRIF will naturally pay out about 60% of its distributions through interest and dividends, with the remaining 40% coming from capital appreciation.
I asked if that would lead to the dreaded ‘return of capital’ and Mr. Johnston said that would only be expected to occur one out of every ten years.
“VRIF has a 5% annual return target,” he said.
One benefit of VRIF’s total return approach and transparency with its underlying ETF holdings is that it doesn’t have to chase yield to meet its distribution target. Rather than guaranteeing a fixed return for the long term, Mr. Johnston says Vanguard will adjust VRIF’s target distribution once per year to meet its objectives.
“In the current low interest rate environment, there is increased interest in higher-yielding products and narrow sectors. Investing in these products (and their riskier asset classes) might be appealing in the short term, but it could lead to capital loss over the longer term as these products experience more performance and distribution volatility during periods of market turbulence.”
VRIF is also tax efficient enough to hold in both taxable and tax-sheltered accounts. This aligns with the idea that an asset allocation ETF like VBAL is also appropriate to hold across all accounts. VRIF, as the retirement equivalent of VBAL, would then be appropriate as a single ticket holding across all accounts in retirement.
When asked about Vanguard’s approach to holding CAD-hedged versions of U.S. and Global fixed income, Mr. Johnston says their considerable research has shown that the risk return is improved when hedging foreign income back to Canadian dollars. That way it’s not subject to the potentially volatile movements of foreign currency.
Final Thoughts
I’m excited to see Vanguard launch an asset allocation ETF aimed at solving one of the more difficult problems in retirement planning: How to derive income from an ETF portfolio.
VRIF is a low cost, globally diversified, single ticket solution for retirees to earn a predictable and tax efficient stream of monthly income. VRIF can be held across all accounts, making it a true game changer for retirees looking for income from a simple and easy-to-manage solution.
Now, ETF investors don’t have to worry about the complexities of selling ETF units or relying on smaller, quarterly distributions to generate their retirement income needs. Simply convert your portfolio to VRIF to get a 4% annual payout target with a 5% annual return target.
Thanks to Vanguard Canada for the early preview of the VRIF. Let me know your thoughts on the new retirement income solution VRIF in the comments below.
