One of the often debated topics that advisors quarrel over is the right strategy to transition your portfolio from an accumulation and growth phase to an income and retirement phase. The "perfect mix" is likely a combination of your risk tolerance, income needs, and investment experience. No matter how you ultimately handle your asset allocation transition, I think most would agree that ETFs are an excellent way to position yourself with a low-cost and flexible investment vehicle.
Your first step will likely involve rolling over your 401(k) where you have a limited number of investment choices into an IRA at a brokerage where your investment menu is virtually boundary-free. While the initial euphoria of being able to invest in nearly any asset class is exciting, the reality is that most investors will then be sitting on a pile of cash with no clear plan of action.
Your first step should be identifying select ETFs that will provide both income and capital appreciation potential. Several equity-income related ETFs that I like are the Vanguard Dividend Appreciation ETF, the iShares International Select Dividend ETF, and the iShares High Dividend ETF. Each of these funds offers a unique approach to selecting dividend-paying common stocks both at home and abroad. They can be used as diversified core holdings from which to build around with select fixed income or high-yield themes.
To balance out the equity portion of your portfolio and offset volatility, I recommend adding some central fixed income ETFs that will provide a steady monthly income stream. The Pimco Total Return ETF is an excellent actively managed bond fund that has the ability to adapt to changing interest rate dynamics through its security selection and asset allocation process. Another fund to consider is the iShares Intermediate Credit Bond Fund, which is a highly diversified basket of corporate and government debt with an effective duration of just over four years.
Finally, it may behoove your retirement game plan to consider a non-traditional asset class such as the iShares US Preferred Stock ETF. This ETF offers a unique basket of preferred stocks that carry both equity and debt characteristics. One of its most alluring qualities is an annual yield of 5.38% and beta of just 0.35 to the S&P 500 Index. Oftentimes alternative asset classes can be an excellent way to increasing the yield on your portfolio while simultaneously offering non-correlated returns.
The most important decision you will likely have to make is choosing how you want to structure your portfolio to take advantage of these opportunities while protecting your capital from large declines in value. Investing in retirement is about making sure that your savings can stretch through your lifetime and potentially leave a legacy for heirs.
More conservative investors may opt for a larger allocation to fixed income while minimizing the equity sleeve of their portfolio. While this may expose the portfolio to greater interest rate risk, that can be mitigated by lowering the effective duration of the underlying holdings and carefully selecting strategic bond funds. On the flip side, those more comfortable with volatility can opt for a more balanced allocation between stocks and bonds in their portfolio.
One of the benefits of using ETFs for your retirement accounts is the ability to set trailing stop losses on every position to guard against any unforeseen bumps along the way. By having a sell discipline in place, you can sleep well at night knowing that your capital is protected from any pernicious declines. If those stops are triggered, you can move to cash and evaluate additional opportunities as they develop or wait for the dust to clear before re-entering the market.
Read more from David Fabian, Managing Partner at FMD Capital Management:
2014 ETF Income Investing Ideas: Part 1 – Bonds
2014 ETF Income Investing Ideas: Part 2 – Dividend Equities
2014 ETF Income Investing Ideas: Part 3 – Alternative Strategies