Over a lifetime of investing, soon-to-be retirees may
find themselves with a hodgepodge collection of mutual funds. When combining
them together to see the asset allocation for the total portfolio, this
collection of funds may be far away from what the retiree has in mind or finds
acceptable. As well, these funds may have been purchased from a variety of
brokers (none of whom was familiar about the other funds already in the
portfolio), and may have high annual fees and loads, and which may have deeper
underlying fees associated with the transaction costs and high turnover of
actively managed funds. High turnover also leads to higher taxes. As John Bogle
teaches, all of these costs work together to prevent investors from getting
their fair share of the returns offered by the markets.
For many, it may make a lot of sense to sell these
miscellaneous funds and essentially start over with a company that provides
low-cost diversified index funds, such as Vanguard. (This is not a paid
advertisement and there are other companies which could be used too, but as I
am a customer of Vanguard, I am most familiar with their offerings and will use
them for my discussion).
With a few hours of effort, the paperwork can be filled
out open a Vanguard account and to transfer IRA assets there. For taxable
accounts, matters are more tricky as selling the old funds may trigger large
taxes on capital gains. In this case, the process may have to be gradual and
may have to wait for years where the marginal tax rate will be lower. Also, be
careful if some of those old funds charge loads when sold.
The idea of moving the assets to Vanguard is to get
your finances organized. Get your assets into a few low-cost and diversified
index funds to give you exposure to US stocks, international stocks, and bonds.
I can’t tell you an appropriate asset allocation, as this depends on your
personal circumstances and your capacity and tolerance to accept portfolio
volatility. But I can explain some of the different approaches you can use to
put together a portfolio with Vanguard funds. A well-diversified portfolio can
be obtained with anywhere from one to five funds.
For a lot of the following cases, there are also
similar ETFs, and Vanguard also offers even lower-cost Admiral shares for those
with sufficient assets invested. But to simplify the discussion, I will only refer
to the regular mutual fund offerings.
Here are 6 different strategies to consider when building
a retirement income portfolio with Vanguard mutual fund offerings:
(1) Vanguard Target Retirement Date Funds: This
approach offers a one fund set-it-and-forget-it approach. With a set target
date, Vanguard automatically adjusts the asset allocation over time to reduce
volatility and provide income as the target date approaches and passes. Funds
range in 5 year increments from Target Retirement 2010 (VTENX) to Target
Retirement 2060 (VTTSX). They also have another fund called Target Retirement
Income (VTINX) which you can purchase separately. About seven years after the
target date, the other funds are rolled into the Target Retirement Income Fund
anyway. Of the various approaches I’m describing, this is the only approach
which includes a TIPS component. However, this is also a one-size-fits-all
approach, and you do have to decide if their idea for an appropriate asset
allocation for retirement income matches your own ideas about this.
(2) Total Market Index Funds: This approach is a bit
more complicated than the target date funds, because it requires you to own
multiple funds and to continue monitoring your asset allocation, to rebalance,
and to decide from which funds to withdraw. But for those who are more
interested to manage their investments, this piece-by-piece approach does
provide greater flexibility to customize your asset allocation so it fits your
personal circumstances better. If you have very little interest in following
your investments, this is not the approach for you. There could be other
possibilities as well, but three basic funds which could be used to build a portfolio
with this approach are the Total Stock Market Index Fund (VTSMX) for US stocks,
the Total International Stock Index Fund (VGTSX) for international stocks, and
the Total Bond Market Index Fund (VBMFX) for US bonds.
(3) LifeStrategy Funds: These are a series of balanced
portfolios with fixed allocations of low-cost index funds with different
underlying objectives. They are similar in nature to target date funds, except
that the asset allocations do not change over time. These funds also provide a
way to get more aggressive or conservative asset allocations than the
one-size-fits-all target date funds. These funds basically provide an
alternative way for having Vanguard take care of the rebalancing for a broadly
diversified portfolio of the total market index funds described in (2). Options
include LifeStrategy Conservative Growth (VSCGX), LifeStrategy Growth (VASGX), LifeStrategy
Income (VASIX), and LifeStrategy Moderate Growth (VSMGX).
(4) Managed Payout Funds: These are a new patent-pending
approach taken by Vanguard, which pays distributions based on dividend income,
capital gains, and possibly some return of capital. They can provide a source
of retirement income, aim to preserve or grow principal, and each payout fund
has a slightly different focus. The Vanguard Managed Payout Distribution Focus
Fund (VPDFX) seeks to preserve capital by providing income from dividends and
capital gains, though in years with portfolio losses some of the payout may
come from principal. Currently (as of July 23, 2012), each share pays out 0.56%
of its share price per month. The Managed Payout Growth and Distribution Fund (VPGDX)
aims to preserve the inflation adjusted value of initial capital and currently
pays out 0.39% of its share price per month. The payout is lower in part
because the capital preservation needs are higher. Finally, the Managed Payout
Growth Focus Fund (VPGFX) is more focused on preservation and currently pays
out 0.22% of its share price per month. Due note that there are no guarantees
associated with their income and growth objectives, and while these can provide
a good approach to obtaining retirement income, they are still relatively new
and complicated, and you should definitely study more about this option. The
Vanguard webpage notes potential complications with taxes, use in tax-deferred
accounts, and also issues with not matching the IRS required minimum distribution
rules for tax-deferred accounts. To be honest, with the higher fees and newness
of the Managed Payout Funds, I would be a bit more cautious myself about using
them at this point, but they are worth watching and knowing about.
(5) Dividends and Interest: Though it is rational to
focus on a total returns perspective and not worry about whether some income
comes from principal, many retirees may feel more comfort by spending only
dividends and income from their portfolio. With this approach, they may like
funds which tend to provide more of such dividends and income, even if that
means that capital gains may be less in a bull market. The Vanguard High
Dividend Yield Index Fund (VHDYX) is a stock fund indexed to higher-than-average
dividend stocks. The Vanguard High-Yield Tax-Exempt Fund (VWAHX) may be good
for a taxable portfolio and focuses on higher yielding municipal bonds (which
also have higher credit risk).
(6) The Classics: These are two low-cost but active (rather
than indexed) funds with long histories and a balanced approach, either of
which could serve as a core holding in the retirement income portfolio.
Wellesley Income (VWINX) is a balanced fund which focuses on dividend stocks
(1/3) and investment-grade bonds (2/3). The Wellington Fund (VWELX) began in
1929 and is the oldest balanced fund with stocks (2/3) and bonds (1/3).
The bottom line
I think you can’t really go wrong with any of the
outlined approaches here. To make a final decision, two important considerations
are what your appropriate asset allocation is, and also how actively involved
you wish to be in managing your investments.
