Here at Monevator, a frequent request is for a post on leveraging the low costs and in-built diversification of ETFs [1] in order to generate an income in retirement [2].
And as the resident Monevator writer on all things retirement [3], it falls to me to respond.
In my previous article [4] I explained why I thought that ETFs weren’t necessarily the proverbial answer to a maiden’s prayer when it came to generating an income in retirement.
In particular, I highlighted the lower yields from traditional total market ETFs, and the travails of the iShares’ FTSE UK Dividend Plus ETF (IUKD). To get the most out of this article, read that article [4] first.
But I also undertook to present two example ETF portfolios.
The first portfolio would be drawn from the very biggest ETF providers. It would boast very low charges. It would aim to deliver a globally-diversified passive income, from equities and fixed income investments, of the same sort you’d expect to get from an alternative strategy such as a global investment trust [5] or fund.
The second portfolio would shop for so-called ‘smart’ income-seeking ETFs – again with a global dimension – and deliberately aim for a diversified spread of ETFs and ETF providers. The strategy – through an element of diversification – would try to minimise the downsides of ETF algorithms blowing up, à la IUKD.
It’s a small world
In this article I’m going to focus on the first of these case studies, the passive market cap index tracking income portfolio. As a bonus, I’ve created not just one portfolio, but two.
That is, two takes on the same thing, but from two different providers. The two 800lb gorillas of the ETF world, in fact: iShares (once owned by Barclays, now part of BlackRock), and Vanguard.
Between them, these behemoths control 55% of the global ETF market. They have used their scale to drive down ETF costs.
One consequence is that while iShares and Vanguard are recording year-on-year net inflows into their funds, customers are deserting the smaller (and usually more expensive) players such as HSBC, Deutsche Bank, Lyxor, UBS, and Amundi.
Both Vanguard and iShares again cut some of their fees in December – in iShares’ case following hefty cuts to its so-called ‘Core’ range of low-cost ETFs in October. Each cut strengthens the theoretical appeal of ETFs to investors wanting a retirement income, by increasing the cost gulf between the actively-managed investment trusts [6] I tend to favour, and passive ETFs.
There’s no reason why a private investor would need or want all their ETFs to come from one fund house, as I’ve done here. Indeed, it might even be considered a small notch up on the risk-o-meter, in that you’d have all your eggs in one basket in the very unlikely occurrence of one of these giants failing [7].
I’m doing it for comparative purposes. You can roll your own portfolios to suit.
A retirement income using Vanguard ETFs
Let’s start by building a passive portfolio using ETFs from Vanguard.
Owned by its customers rather than a third-party bank or other financial institution, Vanguard has – appropriately enough – been in the vanguard of the push to drive ETF costs down.
I’ve selected six low-cost vanilla ETFs, with a two-thirds equity and one-third fixed income split, as follows:
| Ticker | ETF | OCF | Yield |
| VUKE | FTSE 100 UCITS ETF | 0.09% | 3.83% |
| VERX | FTSE Developed Europe ex UK UCITS ETF | 0.12% | 2.81% |
| VAPX | FTSE Developed Asia Pacific ex Japan UCITS ETF | 0.22% | 2.83% |
| VUSA | S&P 500 UCITS ETF | 0.07% | 1.67% |
| VGOV | U.K. Gilt UCITS ETF | 0.12% | 1.60% |
| VECP | EUR Corporate Bond UCITS ETF | 0.12% | 0.38% |
Source: Author’s search of provider data.
Clearly, one can play tunes with this.
- As presented, Japan is missing. Vanguard does not yet appear to have an ETF embracing all of developed Asia Pacific including Japan, so investors wanting exposure to Japan could add Vanguard’s FTSE Japan UCITS ETF.
- Emerging markets exposure? That would be Vanguard’s FTSE Emerging Markets UCITS ETF (VFEM, on an OCF of 0.25%).
- The inclusion of Vanguard’s European-focused EUR Corporate Bond UCITS ETF? Simply because Vanguard presently has no UK-only (or even UK-mainly) corporate bond ETF offering.
Readers might also wonder why individual regional ETFs have been chosen, rather than Vanguard’s all-in-one solution, the company’s FTSE Developed World UCITS ETF. (This is denominated in dollars under the ticker VDEV, on a yield of 1.97%, and in pounds on a ticker of VEVE.)
The answer: cost. With an OCF of 0.18%, it’s a pricier option than Vanguard’s FTSE 100 UCITS ETF (0.09% OCF), FTSE Developed Europe ex UK UCITS ETF (0.12% OCF), and S&P 500 UCITS ETF (0.07%) products.
Remember that as with any other unhedged investments you make overseas, you face currency risk with foreign market tracking ETFs.
Currency risk simply describes how the fluctuating level of the pound versus other currencies will in turn cause both income and capital values to vary. This occurs irrespective of what currency your fund is denominated in (and to be clear it’s a factor with most investment trusts and other funds, too).
- Learn about currency risk and ETFs, trackers, and other funds [8].
- Read up on currency hedged ETFs [9].
In general, the ETFs cited in this article and most commonly offered to UK investors are Irish-domiciled1 [10] rather than hailing from the United States.
Irish-domiciled will be most familiar to UK-based investors, but readers should note that there are circumstances where (according to what I’ve read—I’m no tax specialist) United States-domiciled ETFs are subject to a lower overall tax take [11].
A retirement income using iShares ETFs
Now, let’s now look at building a similar portfolio using ETFs from iShares. Here’s a similar table to the Vanguard table, in identical order, following the same logic of a regional equity focus, and a one-third allocation to fixed income.
| Ticker | ETF | OCF | Yield |
| ISF | iShares Core FTSE 100 UCITS ETF | 0.07% | 3.86% |
| EUE | iShares EURO STOXX 50 UCITS ETF | 0.35% | 3.36% |
| IPXJ | iShares MSCI Pacific ex‑Japan UCITS ETF | 0.60% | 3.19% |
| IUSA | iShares S&P 500 UCITS ETF | 0.40% | 1.35% |
| IGLT | iShares Core UK Gilts UCITS ETF | 0.20% | 1.85% |
| SLXX | iShares Core £ Corporate Bond UCITS ETF | 0.20% | 2.91% |
Source: Author’s search of provider data.
As with the Vanguard portfolio, there are a few points to note, in addition to the broad principles laid out above.
Chief among these is that iShares’ touted low costs aren’t necessarily all that much use to income investors wanting an easy life, especially when ill or inform in old age. That’s because some of iShares’ lowest-cost ETF products—from its ‘Core’ range—aren’t available on an income-paying basis.
Instead, with the low-cost ‘Core’ range, the income is often (but not always) rolled up into the price – effectively turning them into what the investment fund world calls accumulation units [12], rather than income units.
iShares’ attractive-looking Core S&P 500 tracker, for instance, is available with an eye-catching OCF of just 0.07%, but if you want an actual income, you’ll have to either periodically sell some of your capital, or buy an iShares ETF under a different ticker that does offer income – in this case, iShares’ IUSA iShares S&P 500 UCITS ETF (not iShares Core S&P 500 UCITS ETF), which comes with a much heftier OCF of 0.40%.
So, in each case above – bearing in mind that this is an article focusing on an ETF-derived natural income in retirement – I’ve listed ETFs that actually do pay out an income.
Diehard ETF proponents of passive investing, of the persuasion that regularly appear in the comment sections on these articles, may not see periodic selling of ETF capital (at the market’s lows, as well as its highs, as required) in order to generate an income to be a problem.
Each to their own, but that strategy is obviously outside the scope of this article – and would render the table above incompatible with the Vanguard one I listed earlier for comparison purposes.
That said, should investors be interested in the ‘sell to create an income’ strategy, here are the ETFs in question:
| Ticker | ETF | OCF |
| CSSX | iShares Core EURO STOXX 50 UCITS ETF | 0.10% |
| CPXJ | iShares Core MSCI Pacific ex‑Japan UCITS ETF | 0.20% |
| CSPX | iShares Core S&P UCITS ETF | 0.07% |
Source: Author’s search of provider data.
Passive ETFs in retirement: the bottom line
So what conclusions can we draw from this discussion?
To my mind, there are four:
- The income to be expected from such a portfolio of passive ETFs is lower than that offered by leading income-centric investment trusts – but so too are the fees.
- In the case of individual ETFs, it is possible to draw a more favourable comparison between ETFs and investment trusts: Vanguard’s FTSE 100 VUKE ETF, for instance, offers an almost identical yield to that of City of London Investment Trust (one of the lowest-priced on the market), but at a cost that is just one-fifth of City of London’s 0.43% OCF. That said, while their investment universes overlap, they are not identical.
- ETFs aren’t as simple as is sometimes made out. Which geography or index to track, currency risk, and tax regime – even getting the right ticker – all serve to complicate life. (Investment trusts present some of these challenges too, and they usually won’t insulate you from say currency risk on your underlying holdings. But trust managers can do some of the work for you, and they can use their trust’s income reserves to smooth some of the ups and downs when it comes to the income you receive.)
- Vanguard’s ETFs are more ‘income-friendly’ than iShares’ ETFs: for investors wanting income and low costs, Vanguard looks like the place to go.
If this route is appealing to you, then you may also want to read up on using cash buffers to stabilize your retirement income [13] from ETFs.
In my next post I’ll see what a basket of Smart Beta-style ETFs might deliver for income seekers.
Note: Data variously sourced from Vanguard, iShares, Morningstar, the Financial Times, and Hargreaves Lansdown. Do catch up on all Greybeard’s previous posts about deaccumulation [3] and retirement.
- Then-chancellor George Osborne pledged to abolish stamp duty for shares purchased in exchange-traded funds in 2013 to try to encourage the growth [18] of UK-domiciled ETFs, but so far the industry has failed to respond with new UK-based launches. [↩ [19]]