This article about time horizon and asset allocation is by former hedge fund manager Lars Kroijer, an occasional contributor to Monevator. He also wrote Investing Demystified.

Previously we’ve discussed how you should choose the minimal risk asset that will form the bedrock of your portfolio. The short version: If you have high-rated government bonds available in your base currency, they will typically be the best choice. ¹

Today we will look at the time horizon of your minimal risk investment, what returns you can expect to make, and how best to buy it.

Match the time horizon

In most discussions about minimal risk investments, the assumption is you’re talking about short-term bonds. Longer-term bonds have greater interest risk (i.e. they fluctuate in value with changes in the interest rate), and it’s not clear that all investors need to take that risk.

Consider a one-month zero-coupon bond and a 10-year zero-coupon bond that both trade at 100. (Zero-coupon bonds are a particular kind that don’t pay interest, only the principal back at maturity).

Suppose market interest rates suddenly go from zero to 1%. What happens to the value of these bonds?

As you can see, the one-month bond declines only a little in value to reflect the higher interest rate of 1%. This bond matures in just a month, and at that point the bond holder will be able to reinvest their principle at higher prevailing rates if they want to.

In contrast, the 10-year bond declines to a value of around 90.5 as it reflects the higher interest rate. Clearly something that can go from 100 to 90.5 fairly quickly is riskier – even if the probability that you will eventually be paid in full has not changed.

The time horizon for the vast majority of investors exceeds the maturity of a short-term bond, however. Also, someone who is interested in maintaining a position in the minimal risk asset for five years will be taking an interest rate risk over that five-year time horizon, whether they’re buying new three-month bonds every three months, or buying a five-year bond and holding it to maturity.

Finally, the situation is dynamic. If your time horizon is such that you think five-year bonds make sense, you shouldn’t necessarily just buy a five-year bond and hold it to maturity. A year hence, your bond would only have four years to maturity and therefore no longer match your time horizon.

The best way to address these issues is not for you to constantly buy and sell bonds to get the right maturity profile (in my example selling the now four-year bond and buying another five-year bond), but rather to invest in the bonds through a product like an ETF or investment fund that trades the bonds for you.

Such funds offer exposure such as ‘Germany 5–7 years (to maturity) government bonds’, ‘UK 10–12 year government bonds’, and so on. Buying one or a couple of these products to match your desired minimal risk asset and maturity profile is a cheap and easy way to ensure you always have your chosen minimal risk exposure.

Investors with a longer time horizon should buy longer-maturing minimal-risk bonds. As a reward for taking the interest rate risk associated with longer-term bonds, you’ll typically enjoy a higher return than you’ll get from short-term bonds. ²

Go longer to reflect your investment horizon

If you need a product that will not lose money over the next year, then you can pick short-term bonds ³ that match your profile.

However if – like most people – you want a product that will provide a secure investment further into the future, choose longer-term bonds and accept the attendant interest-rate risk.

Here you should consider the time horizon of your portfolio and select the maturity of your minimal risk bonds accordingly.

If you are matching needs far in the future (such as your retirement spending) then there is certainly merit in adding long-term bonds or even inflation-protected bonds to your portfolio.

Long-term bonds compensate investors for interest-rate risks by offering higher yields. You also have the further benefit of matching the timing of your assets and needs.

You can also mix the maturities of your minimal risk assets. You may have some assets that you won’t need for decades, and others you think will be needed in five to seven years, say. In that case, there is nothing wrong with picking a couple of different products with different maturities to match that profile.

What will the minimal risk bond earn you?

Even people with only a peripheral interest in finance know that interest rates are near historical lows. Nobody should expect to make a lot of money investing in the minimal risk asset in any currency right now.

In fact, with nominal interest rates near zero, inflation means that investors in short-term government bonds will experience negative real returns.

While your $100 invested in a government bond will almost certainly become $105 in five years’ time, the purchasing power of that $105 will be less than that of your $100 today. This is, of course, still better than if you had held the $100 under the proverbial mattress for five years – in that case the purchasing power would be even lower.

There’s not a lot you can do about this. If you are after securities with minimal risk then the yields are just very low at the moment. At the time of writing, cash with FSCS protection may be a better option for private investors, as we discussed last time. (Over the long term, returns from cash have historically been lower than from bonds, on a market wide view).

Elsewhere, instruments that offer much higher returns come with more risk of not getting paid. Anyone who tells you otherwise is not telling you the whole story.

The chart above shows what US government bonds (so in $) will currently earn you, by maturity, both in real and nominal terms (you can easily find it for other currencies if you Google ‘£ Government bond yield curve’, and so on.).

You can see, for example, that if you buy a 20-year US government bond, you can expect to earn just under 1% real return per year . Likewise, for a five-year bond you can expect just over a zero percent real return per year. (Five-year US government bond returns yields have actually been negative for much of the recent past.)

While the outlook for generating very low-risk real returns is fairly limited at present, these are continuously moving markets. Keep an eye on them as rates change.

Nominal yields, real yields, inflation, and taxes: The previous chart also shows you the current market expectation for future inflation. (It’s the difference between the two lines.) If the markets are assuming there will be roughly 3% annual inflation in the US for the next 25 years but only around 2% for the next five years, this suggests higher inflation in the longer term. Inflation is bad for many things, one of which is tax. While the benefits you get from your investments are based on real returns and the future purchasing power of your money, you pay taxes on the nominal return. Suppose you invest $100 for a nominal return of 2% the following year. You could be liable for tax on your $2 gain, even if 2% annual inflation had eroded the real gain ⁴. Compare that to a zero inflation rate environment. With a 0% nominal and real return, your $100 would still be $100, both in real terms and nominally, at the end of the year. And there would be no gains to be taxed on!

If the previous chart gave you the sense that the return you’ll get in any one year from owning US government bonds is stable, reconsider.

The next chart shows the annual return from holding very short-term (less than one year) and long-term (more than ten years) US bonds since around the Depression.

As you can see the annual returns move around a fair deal for both kinds of bonds – but far more for the long-term bonds. This is because such bonds will move in value much more as the interest or inflation rate fluctuates. ⁵

Some takeaways from the two graphs:

• Real return expectations from these minimal risk assets are currently near historic lows.

• Returns from these minimal risk assets have fluctuated quite a bit, because of changes in inflation and real interest rates, and can reasonably be expected to do so in the future.

• You can generally expect higher returns from investing in longer-dated bonds. If that matches your investment horizon, then hold your minimum risk bond portfolio through an ETF or index fund. But be prepared that particularly for longer-dated bonds, the yearly fluctuations in value can be significant.

Buying the minimal risk asset

Because of the costs involved in trading bonds, most investors in short-term bonds have to accept that in most cases the bonds in their portfolios will not be super short term ⁶, and that you will be taking a little bit of interest rate risk as a result.

The most liquid short-term bond products like ETFs or index funds have average maturities of 1–3 years. The slight interest rate risk that comes from holding such bonds is a reasonable compromise between the theoretical minimal risk product and one we can actually buy in the real world.

For most investors with longer-term investment horizons, there are funds with different ranges of maturities like 5–7 years, 7–10 years, and so on, to suit your preferences.

How much of the minimal risk asset you should have in your portfolio and what maturities it should comprise depends on your circumstances and attitudes towards risk.

If you’re extremely risk averse, you might put your entire portfolio into short-term minimal risk assets, but you should not expect much in terms of returns. As you add more risk – mostly by adding equities – your potential returns will increase, and vice versa.

Varying the amount of minimal risk asset you hold in your portfolio adjusts the risk profile.

In the simplest scenario, where you only choose between the minimal risk asset and a broad equity portfolio, you could weigh the balance of those two according to the desired risk. The minimal risk bonds would have very little risk, whereas the equities would have the market risk. How much risk you want in your portfolio would be an allocation choice between the two (in a future post I will discuss adding corporate bonds). ⁷

For some investors, putting 100% of their money in the minimal risk asset is their optimal portfolio. This would be appropriate if you are unwilling to take any risk whatsoever with your investments – and if you accept this means very low expected returns!

Summary

• If your base currency has government bonds of the highest credit quality (£, $, €) then those should be your choice as the minimal risk asset.

• If your base currency does not offer minimal risk alternatives, you have the choice of lower-rated domestic bonds where you take a credit risk, or higher-rated foreign ones where you take a currency risk. Keep in mind that any domestic default would probably happen at the same time as other problems in your portfolio, and your domestic currency would probably devalue. That would render foreign currency denominated bonds worth more in local currency terms.

• If you want the lowest risk you should buy short-term bonds. If you have a longer investment horizon, then match the maturity of your minimal risk bond portfolio with your time horizon. You will have to accept interest rate risk, even if you avoid inflation risk by buying inflation-linked bonds.

Video on your low risk portfolio allocation

Here’s a video that recaps some the things I’ve discussed in this article. You will also find other relevant videos on my YouTube channel.

Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating any to medical research. He also wrote Confessions of a Hedge Fund Manager.

1. Private investors may also want to consider cash as part or all of their minimal risk asset allocation. Please see my previous article for more details. This article will focus on the traditional minimal risk building block – high rated government bonds.[↩]
2. There are cases where the yield curve is reversed and shorter-term bonds yield more than longer-term ones, but these cases are less frequent.[↩]
3. Or cash. See the previous article on the minimal risk asset.[↩]
4. i.e. The purchasing power a year hence would still be $100 in today’s money even if the nominal amount had become $102.[↩]
5. The market view of credit worthiness will also have played a role.[↩]
6. Imagine the scenario where you want to hold one-month government bonds. Tomorrow the bonds are no longer one-month to maturity, but 29 days. Is this ok? How about 2 days hence? How much you are willing for the maturity to deviate from exactly 30 days is up to you, but in reality there is a trading and administrative cost associated with trading bonds. It would simply not be feasible to stay at exactly 30 days to maturity at all times.[↩]
7. Certain corporate bonds trade with lower risk premiums than many governments. The view is that these corporate bonds are lower credit risk than many governments – not hard to believe – and although they do not have the ability to print money, nor do governments in the eurozone. The reason I believe that you should not consider these bonds as the minimal risk asset is more practical. Compared to government bonds, the amount of corporate bonds outstanding for any one company is minuscule and you would probably not be able to trade them as cheaply and liquidly as government bonds.[↩]

Yes, this is the inevitable post on the upcoming General Election. I won’t mind at all if you skip to the links below.

Like most of you, I spent Easter wondering why there’s so little political debate in our lives these days. Such a cosy consensus! Everyone just getting on with the important things in life like laughing, cooking good food, dancing, comparing low-cost investment platforms, and curing cancer.

Thank goodness Theresa May divined again the mood of the nation and called a snap General Election.

Less than a week in and politics is already all we’ve heard about since. Which hardly makes a change from the past 10 months. (How I chortle when I think back to readers telling me the EU Referendum was old news and to move a week after the vote. One problem with people being newly engaged in politics is many of them don’t understand how it works. See also D. Trump.)

The months since the Brexit result have been interesting. While I can make my excuses for why the economy hasn’t missed a beat – specifically the delay in triggering our formal exit – the reality is I was wrong-footed by its ongoing strength. (I console myself that I at least had the flexibility to see that as early as September.)

Will my longer-term misgivings prove equally wide of the mark, too? Economically it will be hard to tell. I was never predicting doom – that’s a straw man, really – rather worse than we would have otherwise had. Socially and culturally, how bad things get may depend on how far politicians go in implementing the self-destructive Will Of The People.

As Brexit-fan Merryn-Somerset Webb writes in the FT this weekend [Search result]:

The rise of populist sentiment (which we can define as parts of the electorate asking for things that mainstream politicians think are both stupid and impossible) pretty much never leads to populist policies being implemented (they are often indeed stupid and impossible).

But it does have a long and useful history of changing the direction of mainstream politics.

Merryn deserves plaudits for being one of the Liberal (-ish) Elite who came out for Leave before the vote, and whose predictions to-date have been better than most.

She is also one of those who believe May called the election to strengthen her hand against the Brexit extremists in her own party. Get this done properly, Merryn argues, and we can have a fairly decent trade deal, fairly free movement of people (with tougher welfare caps), an acceptable exit bill, and the all-important regaining of parliamentary sovereignty.

I hope Merryn continues to be right. And the pound has already rallied on this sort of thinking, reversing some of the windfall gains I talked about when I suggested it might be time to investigate currency hedged ETFs back in January.

Deciphering the new doublespeak of politics

But whatever kind of Brexit we ultimately get, as I’ve said before I don’t think the ends – of which taking back full control of UK law was by far the most legitimate – will justify the means.

The dog whistle politics, the NHS bus boast, the telling people they can have what they can’t.

So even if people like me should be pleased the Prime Minister has called an election that could ultimately lead to a softer Brexit, the ratcheting up of the populist rhetoric in her speech is another black mark on the UK’s political record.

Savvier people than me are keeping tabs on this stuff. The New Statesman published an annotated transcript of May’s speech that dissected its Orwellian rhetoric before noting:

Sometime in the 17^th century, Louis XIV is said to have told a gathering in Paris, “L’etat, c’est moi” – I am the nation.

Whether he ever actually uttered that phrase is disputed, but it sums up his unshakeable belief in the divine right of kings – that there was no difference between the interests of France and those of himself.

Well: today we learned that Theresa May feels exactly the same. To convince the world she has brought Britain together, she must find a way of dismissing those who disagree as somehow illegitimate. Opposing her is opposing Britain. Voting for anyone but the Tories is thus unpatriotic.

I wouldn’t mind so much, except she’s going to win in a landslide.

The theme was also taken up by Steven Poole in The Guardian. The author of the prescient book on deceptive language Unspeak wrote that:

May’s speech announcing the election was, paradoxically, profoundly anti-democratic.

“At this moment of enormous national significance, there should be unity here in Westminster, but instead there is division,” she complained. “The country is coming together, but Westminster is not.”

This rather charmingly combined a totally made-up fact (the country is coming together) with a bizarre whine that parliamentary democracy is functioning as it should.

Any persistent total unity in an elected assembly, after all, would signal that it had been hijacked by a fascist.

If there were no “division” in Westminster, we would find ourselves in a de facto one-party state, in which the wisdom of the dear leader is all – a vision of “strong leadership” at which Vladimir Putin would nod sagely.

Poole noted it’s a speech that Lenin would be proud of. Which makes the Daily Mail take ironic as well as depressing:

When this cover went viral many people assumed it was a parody, which shows how far we’ve traveled (down) in a few months.

Panic the ballot box

This is supposed to be a General Election about a range of issues. But barring some kind of campaign trail gaffe it’s going to be Brexit, Brexit, Brexit.

Needless to say the Labour party opposition is so poor that even avowed floating voters like me despair. A tactical voting spreadsheet spread like wildfire across my left-leaning Liberal Elite echo chamber. It purported to explain how to vote to get the Tories out of power.

But I am torn. Labour are sort-of pro-Brexit anyway. I take Merryn Somerset-Webb’s point (also made by others, of course) and I’d ideally want a softer Brexit. Particularly when I see the likes of Jon Redwood posting on Twitter:

I can't breathe pic.twitter.com/OEPR2h4gzI

— Jeremy Vine (@theJeremyVine) April 21, 2017

True, I could vote for the Liberal Democrats if I took this ‘second referendum’ at about-face value. But where I live my vote would be wasted. Meanwhile my local Labour MP is thankfully more New Labour than Corbyn’s Old Labour, I’m in a swing seat – and playing game theory with May’s secret motivations only gets me so far.

I have voted Conservative in the past (I’ve voted for all the main parties) but I have no appetite for a right-wing coronation right now.

Many people like me will  be playing this sort of mental Jenga in this election. Hardly ideal.

It’s not the economy, stupid

What are the personal finance and investing consequences?

I joked to a friend a couple of weeks ago that the Conservatives might have to call a General Election if their ‘no mainstream tax rises’ pledge proved crippling in the face of bad Brexit. I can’t help wondering if the fiasco over National Insurance in the recent Budget helped tip May’s hand towards the red button.

Some Tory hardliners are already panicking at the prospect of tax rises to come, but the reality is the pledge itself was a panicked move in the last election. Governments need to be able to adjust the tax base at the best of times, and the next few years are unlikely to be that.

But again, who really knows? Perhaps if the talks drag on for five years, the pound stays low-ish, and we stay in a fast-recovering EU for much longer than expected then the economy will continue to boom. Not much use if you’re a poorer Brexit-voter facing rising prices caused by the weak pound and a falling real income, true, but not so bad for the majority of Monevator readers.

No, much like the past year or so, the frontline of this battle will be fought on emotional territory, not economic matters – whatever people on either side of the fence may believe about their cold-headed analysis of the facts.

Divided we fall

I will admit that I’ve had to learn a few things in the post-EU Referendum climate. I thought I was ahead of the game in noticing how inequality was setting up fault lines in our society. However I underestimated the emotional divisions wrought – or at least brought out – by globalization.

In particular I hadn’t noticed what’s since been well-documented – to massively oversimplify the deep differences between those who believe that you should get up and go, and those who think we should stick to what we know and support those who do so.

Both impulses have their place in fashioning a society that works. But it was (and is) much easier for me to empathize with Claudia, an Eastern European immigrant and reader who despaired that having traveled to an unfamilar country to crowd into over-priced accommodation far from her job and a plane ride from her friends and family and now working long days at the sharp end of the service industry, she was being scapegoated as part of the problem by people who won’t move from one ex-industrial town to the next.

Claudia wrote:

I think we can agree that these relatively low-paid service jobs will not magically move up to Northern England after Brexit, hence the poor people there who were willing to vote out immigrants of the UK because they supposedly make everything worse, will actually have no gain out of the situation.

As somebody who left home for London and who has swapped careers/industries twice to keep myself moving forward, I’m still on the same page as her.

Yet months of reading has helped me understand better those who don’t like the direction that society is going. The people who are upset or alienated by the rate of change, the erosion of previous values, by too many unfamiliar voices or faces on their High Street, or by the opaque (if in my view concrete) benefits even to them of globalisation and integration.

The trouble is there’s not much to be done with this new understanding. I now see better that people can feel that way, but that still doesn’t make their argument logically correct as far as I’m concerned. And they would say the same about me.

I don’t believe Brexit can deliver what many of those people want deep in their hearts. It’s near-impossible, short of some new Dark Ages that reverses at the least technological progress and I doubt they’d really want that. Perhaps stopping immigration and erecting trade barriers would soften the blow emotionally (although not economically) but it probably still wouldn’t be enough.

Yet even in its softest form, Brexit will leave the other half like me unhappy.

It’s like we’re in a marriage where one partner has confessed to an affair and we’ve decided to make a go of staying together, but something has changed forever.

A landslide win could give Theresa May the mandate – and votes – to overwhelm the extremists on the fringes of her party and deliver some sort of workable Brexit.

[continue reading…]

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

And as the resident Monevator writer on all things retirement, it falls to me to respond.

In my previous article 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 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 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 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.

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.

• Read up on currency hedged ETFs.

In general, the ETFs cited in this article and most commonly offered to UK investors are Irish-domiciled ¹ 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.

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, 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 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 and retirement.

1. Then-chancellor George Osborne pledged to abolish stamp duty for shares purchased in exchange-traded funds in 2013 to try to encourage the growth of UK-domiciled ETFs, but so far the industry has failed to respond with new UK-based launches.[↩]