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Can ETFs deliver a dependable income for deaccumulating investors? (Part One)

The Greybeard is exploring post-retirement money in modern Britain.

Here at Monevator, a frequent request is for a post on exploiting the low costs and diversification of ETFs to generate an income in retirement.

And being the resident Monevator writer on all things retirement, the request has naturally landed in my inbox.

That said, it arrived with a faint air of apology. Our proprietor, The Investor, knows all too well that I have nailed my flag to investment trusts as a vehicle for retirement income.

Curate’s egg

I do hold ETFs in both of my SIPPs. I’m fully open to their merits in the wealth accumulation phase of the retirement investing journey.

But for the decaccumulation1 phase of the journey, I reckon that they have their drawbacks compared to active options.

Are those drawbacks of a terminal, show-stopping nature? For some investors, probably not.

Are the drawbacks permanent, and unlikely to ever change? Once again, perhaps not.

From a standing start, ETFs have grown into a $3 trillion phenomenon in a remarkably short time. Tomorrow’s ETFs might assuage my concerns in a way that today’s fail to.

So as a thought exercise, let’s explore how a portfolio of income-yielding ETFs might work, and see how those drawbacks manifest themselves.

Low-cost passive investing

The obvious attraction of an ETF portfolio is that many ETFs are attractively low-cost in terms of the fees that charge.

Moreover, in a financial world where many charges are rising, the largest ETF providers are cutting fees.

But that cheapness comes at a price: passivity. Basically, computer algorithms do the buying and selling, slavishly adhering to an index that the ETF in question tracks.

This is great for investors gunning for capital growth, as we at Monevator have long argued.

Statistically-speaking, passive investing beats active investing over the long term – and ETFs are generally the cheapest form of accessing those passive investments.

Capital growth, yes. Income, no.

But do passive investments suit an investor gunning for income, not capital growth?

Here I think the arguments are less clear.

I personally know of no studies claiming that passive investments do outperform active investments on the income front – an omission that is naturally of extreme interest to someone contemplating a retirement that might be funded by them.

So ETFs are great if you have investments large enough so as to be able to live off the natural yield that (say) a FTSE All-Share or FTSE 250 index tracker throws off.

Or, for that matter, a passive mix of corporate bonds and gilts; passively-focused ETFs can hold baskets of these fixed-income investments, too.

But for everyone else looking to be generate a passive income in retirement, you’ll probably be wanting the ETF to do something a little racier on the income front.

Smart filtering

So what might that raciness encompass? Inevitably, it comes down to ETFs characterised not so much by ‘passive’ versus ‘active’, but as ‘dumb’ versus ‘smart’.

In other words, the computer algorithm will be buying and selling stocks with a view to making selective pre-programmed judgements on characteristics such as yield, P/E, market capitalisation, and even dividend record.

Now we’re talking!

However that smartness comes at a cost – literally. For while passive ETFs are cheap, smart ETFs are rather more expensive.

In some cases, expensive enough to be within hailing distance of a straightforward actively-managed investment trust or low-cost fund.

Train wreck

Quite apart from cost, there’s another dimension to consider. Suppose the computer gets it wrong?

It can happen. Take the hapless investors who piled into one of the very earliest ‘smart’ income-focused ETFs, iShares’ FTSE UK Dividend Plus (IUKD), extolling its smart stock-picking, low charges, and general all-round wonderfulness.

Launched in 2005, IUKD flourished for 18 months, delivering a FTSE-beating share price and a growing income. And then came the credit crunch and ensuing recession.

Suddenly, IUKD’s ‘smart’ algorithm and stock-picking process looked monumentally dumb. Piling into higher-yielding shares had caused it to overload with just those shares that were about to crash –and in some cases, burn.

Eleven years after its launch, IUKD is still underwater:

Chart showing IUKD (blue) share price versus the FTSE 100 (red) from 2005-2017

IUKD’s share price (blue) versus the FTSE 100 (red) from 2005-2017

What about the all-important income? Here again, it’s not a pretty picture. The income plunged, too:

Chart showing IUKD's annual dividend distributions since 2006

IUKD’s annual dividend distributions since 2006

As you can see, in only one year since the credit crunch – 2015 – has IUKD’s income beaten its first year’s dividend distribution.

Dashed expectations

Investors hoping for a steadily-rising income stream, of the sort that many investment trusts deliver year on year – with a good number of investment trusts boasting a rising dividend for several decades – will have been bitterly disappointed.

Not only has their capital been seriously eroded, but their income is down both in absolute terms and in relative terms – that is, relative to what they might have expected from either a purely passive ETF, or an actively managed investment trust or fund.

The good news? Thanks to the low cost of an ETF, investors in IUKD will have paid a TER/OCF ongoing expense ratio of just 0.40%.

This, of course, is significantly cheaper than the 0.42% TER/OCF ongoing expense ratio charged by (say) the City of London Investment Trust, which has raised its dividend every year for 51 years.

And, which since the end of 2006, has delivered capital growth of 28%, versus the FTSE 100’s more modest 14%.

Sarcastic? Moi?

Striving for the dream

So is the dream of income-investing through ETFs dead?

Well, IUKD is a sample size of one. Other ETF managers have presumably learned from the experience, as will have iShares. The past is no guide to the future and all that.

So next time, in my next post, I’ll sketch out two different ETF portfolios, each intended to exploit ETFs’ virtues in a slightly different way.

One will go for the very biggest ETF providers, and the very lowest charges, and aim to deliver a globally-diversified purely passive income – from equities and fixed income investments – of the sort that you’d expect from a global investment trust or fund.

And being invested in ETFs, you’d expect to achieve that with lower fees.

The second will shop for ‘smart’ income-seeking ETFs, again with a global dimension. I will deliberately aim for a diversified spread of ETFs and ETF providers – following the logic that the algorithms will (hopefully) be sufficiently different so as to minimise the possibility of them all blowing up at the same time, à la IUKD.

Will either of them be attractive enough so as to force me to change my mind, Maynard Keynes-style?

You’ll have to wait and see.

Note: You can read all Greybeard’s previous posts about deaccumulation and retirement.

  1. That is, the spending bit! []

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{ 77 comments… add one }
  • 51 Naeclue February 17, 2017, 8:26 pm

    @Greybeard said “The good news? Thanks to the low cost of an ETF, investors in IUKD will have paid a TER/OCF ongoing expense ratio of just 0.40%.

    This, of course, is significantly cheaper than the 0.42% TER/OCF ongoing expense ratio charged by (say) the City of London Investment Trust, which has raised its dividend every year for 51 years.”

    Did you really mean to say that? I would not call 2bps “Significantly” cheaper. Apart from that, has it ever occurred to you that you may have been falling into the trap of survivourship bias?

    I would also add that “raised its dividend every year for 51 years”, would not necessarily have meant a lot during the high inflation period of the seventies. What happened to the inflation adjusted income for say the first 10-11 years and for that matter, what went wrong 52 years ago? Over the last 30 or so years, due to the very favourable sequence of returns, someone could have taken an inflation adjusted 4% every year from a FTSE Allshare tracker and still have more inflation adjusted capital than they started with, so it should have been relatively easy for a UK equity income IT to do something similar (before charges and taxes). Even if dividend income had been unfavourable at times, there are some simple techniques that fund managers can use to convert capital to income.

    Problems with the equity income IT approach would show up when sequence of returns are unfavourable, as they would have been from the mid 60s to mid 70s. How did equity income ITs as a group get on then? I appreciate you may not know the answer, I certainly don’t.

    IUKD, smart-beta/factor ETFs, etc. are really just active strategies that have been computerised. I don’t see the justification for buying those either. At least, not at a TER of 0.4% when you can get an allshare tracker for 0.07% or lower. Fund managers will create products they think they can sell. That does not make them sensible investments.

  • 52 The Investor February 17, 2017, 8:29 pm

    @naeclue — He was being ironic.

    @HelfordPirate et al — You see? It’s just relentless.

  • 53 Stefan February 17, 2017, 8:40 pm

    @magneto Great comment! IUKD and City of London IT operate in totally different ways. The risk of dividend fluctuation is much higher with IUKD because it doesn’t hold reserves to raise dividends even in hard times.

    This is a fundamental difference between the two securities and investors need to decide if it matters (and how much they are willing to pay for lower risk). I hope future posts include this information because it’s a good way of explaining ITs vs ETFs.

  • 54 Naeclue February 17, 2017, 9:33 pm

    Sorry, irony lost on me. Possibly an early sign of senility, time to buy some ITs?

    I do agree with the main thrust of the article. If someone

    1) Was wedded to the idea of matching the income produced from investments to their spending;
    2) Wanted more than the natural yield of the market;
    3) Did not want to take an income by selling/rebalancing across assets;

    then semi-passive high yield ETFs (and similar OEICs) would lead to an income stream that would likely be too volatile. At present only ITs have the flexibility to hold an income reserve and use it to smooth out distributions.

    My concern and clearly that of others is that the higher costs, risk of poor performance and the risk that the income may not keep up with inflation may outweigh the ITs income-smoothing benefit.

  • 55 Jed February 17, 2017, 10:11 pm

    @naeclue I know what happened to Investment Trusts during the 70s. Up untill the 1980s Inv trusts were not allowed to advertise unlike unit trusts. They were a backwater because very few people knew they existed and discounts of 50% were not uncommon. UK focused Inv trusts generally tracked the market however over a ten year period virtually none beat the FTSE All Share. Yields on the income focused trusts were around 14%. However another factor depressing the demand for share holdings and Investment Trusts was punitive Capital Gains Tax and tax on dividends.

  • 56 The Investor February 18, 2017, 2:09 am

    @Naeclue — Your concerns and points are fair enough. You have aired them before on articles about ITs for income. My grievance is I specifically asked people to desist from making the point repeatedly on a post about something else. And my contention is that we effectively will never get a conversation going for those that *do* want to use ITs for income, because every time we post on it, we get this kind of response. As said earlier up the thread, it’s off-topic IMHO for this article.

    I appreciate it’s to some extent a limitation of the blog format / calendar / etc. (And also my rather capacious memory, combined with OCD tendencies.) It’s hard to “move on” and consumption of the content isn’t linear. But it’s frustrating. Hence I am going to have to do something Draconian I think, at least as an experiment. (Probably a zero tolerance policy on off-topic comments, which will I will delete regardless of standalone merit, rather than suspending comments to begin with. Maybe that will work.)

  • 57 dearieme February 18, 2017, 2:49 am

    I wonder whether there could be a natural distinction according to where you hold your assets. For example, I can imagine ITs and REITs being suitable in an ISA, throwing off dividends to be paid out monthly or quarterly. Meantime one might have ETFs (and even ETCs?) in a pension where you anyway may expect to sell some each time you make a drawdown decision. And if selling looks unattractive you instead draw cash from your high-interest current accounts, regular savers, Premium Bonds, and whatever other devices you’re using t0 try to avoid near-zero interest payments.

  • 58 Jed February 18, 2017, 11:01 am

    @greybeards, in your next post you are going to sketch out two etf portfolios for income,as a suggestion why not also include a portfolio of Investment Trusts. Then going forward we can see how each performs on the income front etc.

  • 59 Mr optimistic February 18, 2017, 12:33 pm

    I prefer Investment Trusts to ETFs and this article has made me wonder why. First off there are some proven trusts which have real people standing behind their performance. Bankers IT has charges comparable to an ETF and is a solid payer. Once you are down to 20 basis points charge difference or so I am happy enough to pay the difference.

    In terms of income versus selling units, well there is the emotional bias accrued of having invested for years with a view to accumulation, and the age old view of avoiding ‘digging into capital’. There is also the issue of choosing what to sell. There is plenty of discussion here about buying decisions, selling must just be as difficult.

    I am now in just the position this blog was aimed at, so thanks and I look forward to the next article. Personally I am looking at HSBCs global strategy portfolios as perhaps a middle way.

  • 60 PC February 18, 2017, 1:00 pm

    Thanks for another thought provoking article. On balance I’m suspicious of investment trusts or anything else that promises smoothing because I suspect it comes at a cost, to me.

    Please don’t turn off the comments – this is one of the rare places on the internet where the comments are well worth reading, even if they do stray off topic sometimes. It really puts me off when the comments are turned off, although I appreciate I don’t have to moderate them.

  • 61 Naeclue February 18, 2017, 1:37 pm

    @Mr Optimistic, I aim to just sell and/or buy once per year when I reballance. It is not onerous.

    On the specifics of the article, IUKD does look incredibly risky. If someone wanted to increase the income yield of their portfolio something like the Vanguard UK Equity Income fund looks better as it appears to track the allshare much more closely and is much more diversified. The Vanguard All-World High Dividend Yield ETF also seems to be better constructed, with very wide diversification across 1,196 stocks. The Vanguard funds are cheaper than IUKD as well and due to the way they are constructed should result in lower portfolio turnover. I still think they would be higher risk (and cost more) than market trackers, but not quite as much as IUKD.

    Going for Vanguard would still not solve the income volatility problem though. Someone would need to handle this themselves, which starts to complicate matters. How much income reserve should be kept and where should it be invested, etc. I cannot really see this being a great alternative to someone who just wants an easy time. In which case ITs are really the only way to go other than paying a broker to manage your portfolio (God forbid). At least with ITs, if the income does not grow as expected, the pain should be spread over a few years, giving time to adjust spending downwards, instead of coming as a large shock.

    If I were to go down the IT route, I would spread across a large number of them as the differences in performance is wide. According to the AIC web site, the UK equity income funds with 10 year histories have TRs between 14.3% and 168.7%. City has been one of the better ones at 104.6%, but with my luck I would not be at all surprised if it ended up towards the bottom in 10 years time if I bought it now.

  • 62 The Investor February 18, 2017, 1:40 pm

    @PC — There will in theory be a cost, in terms of a lower total return. But see this article:


    Re: Comments, I’ve just posted my thoughts in an epic waffle this morning. 🙂 I am going to try harder moderation first.

    It’s going to be tricky, though. Your comment — and this one I’ve just written — would probably qualify for deletion under my new thinking.

    Why? Because this whole thread has become another discussion about the merits of income in retirement and of income trusts, crowding out the 10-15 on-topic comments about the mechanics of choosing between ITs for income or ETFs. That latter discussion has not bloomed.

    This has happened 3-4 times in a row with posts on this topic. It’s frustrating and sub-optimal.

  • 63 The Investor February 18, 2017, 1:42 pm

    p.s. Any further comments on — um — comments should please be posted on today’s article about them:


  • 64 Mr optimistic February 18, 2017, 2:06 pm

    @Naeclue. Better stay on topic here…..Point I was trying to make re selling is that I will have maybe two SIPPs when I have sorted it out, plus three ISA’s. Each holds a range of investments. There isn’t a lot of science behind them in terms of managing the whole lot as a portfolio. However if I want to raise 10k which investment do I sell? Should I try and keep the balance the same and if I do that it multiplies up the trades and cost.

    It don’t want to spend my retirement as an ersatz wealth manager particularly and it’s hard enough managing the asset allocation side of things without also fretting about which things to sell periodically.

    There are certainly plenty of IT’s and, from my research, I have been surprised at how many ETFs are not available in distributing form.

    One last thing, I reckon keeping 5 years worth of cash is too much in many cases. Say 5 years of top up income, to add to other pensions, is 8k. pa that’s 40k which now isn’t contributing and is at the mercy of inflation, and at say 2% yield is reducing your income in all years by £800 or 10% of what you need based on these numbers. Nice if you can afford it

  • 65 Grumpy Old Paul February 18, 2017, 2:47 pm

    I strongly agree with your comments. In 2010, @TheInvestor posted http://monevator.com/investment-income-trust/ . Rest assured, the following is in no way an attack or criticism. The performance of the investment trusts in capital terms (Share Price) over 10 years is interesting:

    Temple Bar Investment Trust PLC 45.10%
    The City of London Investment Trust Ord 31.20%
    Murray Income Trust PLC Ord 25p 2.20%
    Merchants Trust PLC – 12.10%
    Edinburgh Investment Tst plc 45.60%

    Figures from Trustnet/Google. For comparison.
    HSBC FTSE 100 Index C Inc 14.70%

    I quote these examples solely to reinforce the point @Naeclue makes in his final paragraph about the differences in performance between trusts.

    I have to declare an interest: in the near future I’m going to have to sort out an income stream for someone close to me using a share of the proceeds from a house sale and the individual concerned is neither well-organised not financially savvy. I’m minded to use an IT portfolio since it seems to be the best option for a ‘fire and forget’ portfolio to generate a relatively high starting income with the probability/possibility of increasing with inflation. However, I’m also inclined to wait until the next crash and thereby benefit from both a high initial percentage dividend yield and high discounts.

    Having said all that, I have a number of concerns regarding much of the discussion of investment trusts over the years. There has been a tendency to treat ITs as a ‘magic path’ to riches appreciated only by the initiated.

    Firstly, I would certainly concede that until relatively recently (pre-RDR and earlier), most investment trusts were much cheaper than broadly equivalent unit trusts; I’m old enough to remember 5% front-loaded charges and 1.5% annual charges being typical for ITs. But this is is no longer true although some platforms offer better deals for ITs.

    Having conceded that, the criticisms are as follows:

    a) Too little emphasis on diversification

    Even if you’re creating an IT portfolio mainly for dividend income, surely you still need to diversify by asset class and geography .

    b) Too little mention of manager risk

    Just as with unit trusts, you can’t assume that a manager with a cracking performance record will continue to do well, especially if she has an investment style which falls ‘out of favour’. Investment trust managers are human: they fall ill (physically and mentally), age and die like the rest of us. Note that Jo of Curtis, of City and London,
    has been in post for over 25 years – reassuring but he won’t go on for ever.

    Therefore, when choosing an IT for a particular asset class/geography, surely one should diverse across of a number of trusts within that sector to minimise manager risk.

    c) Over-exposure to individual shares

    Given that the FTSE 100 is heavily concentrated in the top 10 shares by market capitalisation, and that most UK-based IT investors will presumably want a heavy home bias for an income portfolio to avoid currency risk, there is a an obvious risk of over-exposure to a handful of shares and and a couple of sectors

    d) Little or no discussion of rebalancing an investment trust portfolio.

    I hope the above comments are not deemed ‘off-topic’ and look forward to responses.

  • 66 Mr optimistic February 18, 2017, 2:58 pm

    Not certain I understand some of this.
    A) yes but there are plenty of ITs
    B) too little mention? That’s what the active V passive thing is all about isn’t it?
    C) yep, especially if you chase ‘UK’ equity income so need to diversify as per a)
    D) rebalancing is rebalancing isn’t it, what’s to discuss with respect to ITs ?

  • 67 david m February 18, 2017, 10:51 pm

    My view is that investment trusts are preferable to ETF’s, especially where the objective is income and income growth.

    A key point is the demonstrable track records of capital and income growth. The annual accounts of the individual trusts give a ten year track record. The AIC has on it’s website performance for the past twenty years and dividend records back to the 1970’s. You can go further back by referring to Companies House filings. By contrast ETF’s and income focussed ETF’s have little history.

    I think Greybeard could usefully compare the investment trusts he has previously listed against the ETF approaches he is now preparing.

  • 68 dearieme February 19, 2017, 3:46 pm

    @Mr optimistic: OK, say your retirement income is indeed DB pension, State Pension, and £8k p.a. from a DC pension. If you don’t think it would be wise to hold £40k cash, by what other means would you protect yourself from share market volatility?

    Remember that the way you recommend has to be practical for people who are getting less sharp intellectually, less patient, less energetic, and less up-to-date technologically with each year that passes.

  • 69 magneto February 21, 2017, 12:25 pm

    Trustnet had an interesting angle on this issue :-


    The following quote is food for thought when comparing ITs with higher yield ETFs.

    “By paying part of your dividend out of capital, managers of trusts can avoid being forced to hold onto high yield stocks that might cut their dividends in the future to maintain their own pay-outs

  • 70 Anon February 23, 2017, 10:54 pm

    Very interesting topic this. A while ago I helped out a relative invest a six-figure lump sum for income and did find myself bemoaning the lack of a one-stop-shop from Vanguard. Yes I know in theory absolute return is the only thing that matters and gains are as good as divis/interest (tax treatments aside), but in practice this needed to be truly “fire and forget” and hands-off. In the end, a requirement for monthly income rather constrained the choices (for the curious, funds ended up in PKMONR, K1DVCM, FICNRM, LGMMII, MFAABA, K1AAAD, FCPT… the latter – F&C’s commercial property trust – is the only trust there). We’ll let it run for a few years before reviewing. To me (a VLS fan), it’s horribly active and the fees eat what could have been some more income… but the alternative was for them to hand it all over to a wealth manager who’d have taken most of yet another percent to probably invest it in things charging much the same.

    I do wonder what the ideal low-cost passive vehicle for “deaccumulating” income seekers would look like. Before the VLS funds came along, no doubt the passive fans would have said “well you can just rebalance yourself”, and yet the VLS funds clearly appeal to a huge customer base. More recently Vanguard have added the interesting Target Retirement Date funds… what is less clear to me is what you’re supposed to do with them after that retirement date… buy an annuity? Live off the (meagre) bond income? Reinvest in equity income? It’d be interesting to see what Vanguard came up with as a passive offering in this space; I think their current equity income / high-yield funds are more value than income plays, and they’d really need to up the divi payment frequency (and smooth it) to at least quarterly and ideally monthly to be useful to people like my relative.

    I do find income trusts like City and Merchants interesting. But mainly see them as something to pick up cheap when they go on a big discount when the markets hit a jittery patch; that makes it hard to plan to use them though.

  • 71 The Greybeard February 23, 2017, 11:19 pm

    @Grumpy Old Paul and @ Anon: Thank you for your interesting, informative, and on-topic posts. I am sure that serious and engaged readers of these posts will find them useful, and if they spark further debate, so much the better.

    @Mr Optimistic: Care to post a link to those HSBC’s global strategy portfolios? I’m sure people would find them interesting.

  • 72 Mr optimistic February 28, 2017, 9:52 pm


    A bit discouraged after phoning HSBC and hauling through 7 numbers as advised by them to try and find out the duration of the bond fund.

    Aviva have recently launched a range of aims funds too. Looks like the industry is waking up to the wave of decumulation clients coming their way.

  • 73 arty March 23, 2017, 11:51 am

    I hope the brouhaha over the comments didn’t put you off putting up part 2 – looking forward to it.

  • 74 The Greybeard March 23, 2017, 12:01 pm

    Don’t worry — part 2 is in progress.

  • 75 Nigel Root April 22, 2017, 11:28 am

    Thank you for the article. I would like to raise a question please. If investments give us growth and income, after tax, isn’t the investor in a similar position with either growth or income – he/she is better off – and can spend the gain? Surely the only difference is that it feels wrong to sell some shares/units to realise the capital gain, whereas it feels OK to spend the income? This then leaves us with two real differences, that some collective investments (unit trusts/mutual funds/ETFs) are more diversified than others, and some charge more fees than others so we should concentrate on these.

  • 76 andrew ranshaw March 27, 2018, 3:12 pm

    I always believed that when a dividend paying share went ex divi the share price fell to reflect the value of the dividend ‘egg’ which was about to pop out. So there is no way to take dividend income without depleting capital because the market depletes the capital on investors behalf by decreasing the value of the shares held whenever a dividend is paid out.
    As far as equities are concerned the difference between investing for income and growth is mostly psychological, the greater concern should be that a focus on investing for income will produce a more concentrated and less diversified portfolio than a total market approach.
    Comparing the return of managed funds to broad indexes, whether the funds are Investment Trusts or open ended funds is meaningless unless one includes the dismal performance of all the funds which were closed because no one would buy them due to poor performance. Fund managers do not retain embarrassing funds and their records in public view so no realistic comparison between broad indexes and managed funds can be made because the history of managed funds is full of holes.

  • 77 The Rhino November 18, 2019, 4:13 pm

    On the subject of ETFs for decumulation, I wonder if anyone knows of a tool similar to the AIC Income Builder (https://www.theaic.co.uk/income-finder/income-builder) for ETFs? Obviously, that one is for ITs only.

    I know the perceived wisdom is that dividend dates shouldn’t be important as you should smooth over with a pot of cash, but it is still a handy tool nonetheless? Would be nice to have a similar visualisation for ETF income.

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