Planning for retirement can be a taxing endeavor, but exchange traded funds (ETFs) can help ease the burden. Benefits of using ETFs for retirement planning include diversification, low costs and ample exposure to income-generating products such as bond and dividend funds. Investors who are at or near retirement that are not intimately familiar with ETFs should talk to a financial professional regarding how to properly use these investments as retirement vehicles.
An All Index ETF Portfolio
Typically, investors that are planning for retirement are looking to reduce their risk profiles and part of that objective includes limiting or eliminating single-stock risk. In this case, index ETFs, or those funds that track a broad index such as the S&P; 500 or the MSCI EAFE Index, are particularly useful. Index ETFs, particularly those that are comprised mainly or entirely of U.S. stocks, often feature low expense ratios. Saving on fees adds to an investor’s overall returns. Additionally, the diversity offered by index ETFs helps investors avoid the volatility of more concentrated sector or country-specific funds.
Bonds are viewed as an essential part of retirement portfolios, but that does not mean investors need to focus solely on U.S. Treasuries. In fact, higher yields can be had without incurring significantly higher credit risk. In addition to those ETFs that track an index of U.S. Treasuries, retirement investors should consider ETFs that offer exposure to high-grade corporate bonds or sovereign debt of low credit risk countries. Regarding ETFs that track foreign bonds, retirement investors looking to keep risk to a minimum should stick with those countries with AA or AAA credit ratings.
Bonds Part II
Another favorite destination within the bond world for many retirees is municipal bonds. That is the case for multiple reasons. First, high-grade municipal bonds are, broadly speaking, conservative investments. These bonds, issued by states, cities and towns to pay for an array of public works projects from new roads to new schools, are only marginally more risky than Treasuries, but usually feature higher yields. Additionally, many municipal bond ETFs pay monthly dividends, providing for a dependable, steady stream of retirement income. Another reason investors love municipal bonds is that the interest on many of these bonds is exempt from federal and state income tax.
Although conventional wisdom holds that retirees should be reducing their exposure to equities, that does not mean they should not own any stocks at all. However, when retirees do own stocks, those stocks should be dividend payers so that the investor has alternative avenue for income in addition to say Treasuries and municipal bonds. Retirement planners have plenty of options when it comes to dividend ETFs and due to the increased competition in this corner of the ETF space, expense ratios are falling. Additionally, some ETF sponsors have sought to differentiate their dividend funds from rivals by moving to monthly from quarterly payouts. As is the case with municipal bonds, monthly dividends from stock ETFs can help retirees gain another dependable income option.
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