Million Dollar Journey

Building Wealth through Saving and Investing

Welcome to Million Dollar Journey! If you're new here, you can learn about me, read our user guide, and even follow my net worth updates. A great place to start reading is with the popular articles located in the right side bar. If you would like to join thousands of others and keep up with the free daily updates, you can subscribe to the RSS feed via reader or E-mail.

On your way out, make sure to check out the exclusive Million Dollar Journey Freebies and Deals.

Retirement Income ETF Portfolio

A relative recently approached me for investing advice.  This relative, we’ll call him Uncle Alex, is approaching retirement and is wondering how to create an income portfolio.  Uncle Alex was a small business owner for most of his working life and managed to accumulate a fair bit of capital to fund his retirement years.

Some professionals recommend a 50/50 equity/bond split during retirement so that the portfolio will last 30 years with a high certainty of success assuming  a 4% annual withdrawal (adjusted for inflation).  In my opinion though, it depends on the risk tolerance of the investor.  There’s no point putting Uncle Alex in 50% equities if he can’t sleep at night due to the volatility of the market.  For example, if he was 50% equities during the downturn of 2008, there was a point where his entire portfolio could have fallen as much as 25%.

Besides the asset allocation, there’s the task of choosing appropriate investments that produce income.  Unfortunately, right now with interest rates at record lows, short term fixed income yields are unattractive.  However, in addition to the cash that fixed income produces, there is the benefit of reduced portfolio volatility.

To keep things simple, lets assume that we go 45% stocks and 45% bonds and 10% cash.  Assume that Uncle Alex has enough capital to live off the distributions of the portfolio without having to touch the capital.  However, we’ll leave some cash in place should he need a lump sum in the future.

Having said that, here are the investment vehicles that I would consider using for an ETF income portfolio:

Equities

Strong Dividend Equities: CDZ (MER: 0.60%) or XDV (MER: 0.50%) and VIG (MER: 0.28%) – These ETF’s have different focuses, but produce a strong dividend income stream.  CDZ mimics the dividend achievers list which focuses on Canadian companies that have a history of increasing their dividends over time.  XDV focuses on Canadian blue chips with the highest yield.  Although CDZ has a slightly higher MER, it has a higher distribution as it holds income trusts.  As well, it distributes monthly instead of quarterly.  VIG is similar to CDZ except that it focuses on the US dividend achievers index.

Real Estate: XRE (MER: 0.55%) – Although Riocan (REI.UN) is a large weighting on this real estate investment trust ETF, I like the diversity that it provides across Canada.  If the risk tolerance was a bit higher, I would simply buy the top 3 REITs which covers 50% of the index, offer a higher yield, and save the annual MER.

Preferred Shares: CPD (MER: 0.45%) – This is Claymore’s preferred share ETF which covers the Canadian preferred share index.  With preferred shares, you get lower volatility than equities and a higher yield.  However like bonds, preferred shares are sensitive to interest rate fluctuations.  Look for this ETF to become cheaper if interest rates rise aggressively.

Fixed Income

Short Term Bonds: XSB (MER: 0.25%) or CLF (MER: 0.15%) – The shorter the duration of the bond, the lower the correlation with the overall market which is why short term bonds have a place in every portfolio (IMO).  XSB is an iShares product that has a fairly low MER and holds both government and corporate short term bonds.  CLF on the other hand has an even lower MER but holds only government short term bonds.  My preference leans towards CLF as it has a lower MER but similar yield as XSB.

Corporate Bonds: XCB (MER: 0.40% ) or CBO (MER: 0.25%) – Investment grade corporate bonds are considered slightly higher risk than government bonds, but offer higher yields.  The iShares XCB has a slightly higher MER, but also a higher yield with a duration of 5.27 years.  The Claymore laddered corporate bond ETF CBO has a lower MER and a shorter duration of 2.64 years.

Real Return Bonds: XRB (MER: 0.35%) – Real return bonds provide a hedge against inflation as they provide an interest rate over and above the inflation rate.  Although the yield might be a bit lower, XRB provides protection during an volatile interest rate period.

Cash

GIC Ladder – For this portion of the portfolio, a 5 year GIC ladder would be constructed.  When the bottom rung matures every year, it will be reinvested in the highest 5 year rate available.

Ideal Income ETF Portfolio (assume 45/45/10)

  • CDZ – 15% (current yield: 4.26%)
  • VIG – 5% (current yield: 1.83%)
  • XRE – 10% (if buy top 3 REITs, current yield: 5.57% or 3.66% with XRE )
  • CPD – 15% (current yield: 5.10%)
  • CLF – 15% (current yield: 4.18%)
  • CBO -15% (current yield: 4.67%)
  • XRB -15% (current yield: 2.38%)
  • GIC Ladder – 10% (assume current yield: 2.40%)

Total Yield (as of April 2010): 4.01%

A couple considerations is that Canadian dividends face a gross up of 45% which is counted as income when testing seniors benefits.  For example, a senior can make up to around $67k before facing clawbacks of 15% for every dollar above the threshold.  However, in this particular case, Uncle Alex will be splitting the income proceeds with his spouse, which means the total distributions won’t reach the OAS claw back threshold.

As well, to reduce overall taxation, the securities would need proper portfolio allocation.

Back to you, what would you include in an income portfolio?







17 Comments, Comment or Ping

  1. 1. penny

    Great stock tips! I’m not a big fan of the ETF’s but if you can trade them well they’re ok. They seem to be working for you, I try and keep it to high dividend stocks but that doesn’t always work out so well either.

  2. Very well written FT. I’m an iShares fan myself, but I think it’s good you’ve highlighted Claymore’s products as well. I also like the fact you made the portfolio bump just over the 4% mark! I’ve had a busy year, trying to “get out” of high-MER funds and into more of an indexed portfolio. This article speaks to me and I’m sure it will resonate with your faithful followers! Cheers.

  3. This is a great idea. The diversification seems to work OK.

    Is everyone shying away from Income Trusts still? Won’t the return be better than most bonds?

  4. Thanks for the information. I’m still trying to learn how to invest in stock portfolios and maybe even start my own retirement funds so these kinds of posts really help me understand.

  5. 5. Henry

    FT: MER for CPD is .45%.

    Maybe VIG isn’t that ideal, since its yield is only 1.83%. Even broad market indices like S&P500 and TSX Composite index has a similar yield.

    Since capital preservation is the goal, have you considered SMA 200 as an exit point indicator for equities exposure?

  6. 6. nitromicro

    Good article. I’ve been moving my long term holdings to Pref Shares of various highly rated firms and away from ETFs. The positives is they have no MER and provide a quite secure return at slightly over 6% in dividends. Bank of Montreal’s BMO.PR.L pays $1.45 in dividends annually (paid quarterly) and sells for $24.01. That’s a return of 6.04%. It’s true that the share price may fall IF interest rates rise, but that only matters IF you plan to sell the share and not just use the dividend income. At 44, I will be holding for a long time. The other benefit of Pref Shares is the dividends a more secure than a common share dividends. ie: common shares will be cut before pref share dividends are touched.

  7. 7. WealthManager

    As an alternative to VIG, what about Claymore’s CVY and HGI which are the underlying ETF’s within Claymore Canada’s hedged CYH? I don’t see hardly any coverage/opinion of these yet they’re definitely in my “on deck” list as I dig a little deeper. The choice to go with CYH directly may be a good option for some as well (pending too many factors to get into in this post!)

  8. Good article. I love using income ETFs in my portfolio as well. Thanks 4 sharing.

  9. Thanks for the heads up about the MER of CPD Henry! About VIG, although I like the strategy behind the ETF, the yield is a bit on the low side. I’m going to keep looking.

    WealthManager – I’ll look into CVY and HGI, I haven’t gone over those yet.

  10. 10. DAvid

    Dividends, dividends, dividends! In western Canada you can have some $70,000 + annually in large corporation dividend income, tax free. Like some others have mentioned, I’d look at a variety of common or preferred stocks, due to the low MER, and the continued dividend.

    DAvid

  11. DAvid, good to hear from you again! What you state isn’t entirely true, after $50k dividend income, you’d face Alternative Minimum Tax. It’s not much, but still enough to call it a tax.

  12. 12. cannon_fodder

    FT,

    Glad you pointed out the dreaded AMT… go to taxtips.ca and use their free online calculators for each province. They are one of the few calculators that figures out the AMT.

    I’d assume that the yield on VIG if held in a TFSA or non-registered account would be subject to withholding tax from the US?

    Can someone smarter than me weigh in on preferreds… I thought for certain preferreds there is an option for the company to take them back at some point in the future. That would be a slap in the face if you count on them for an annuity type income stream. Which brings up another point – has anyone shown that a long term view of preferreds keeps pace with inflation?

  13. 13. B.Hawes

    Hello ; I m semi-retired ,am wondering what your thoughts are on Bank of Montreal s Nasdaq 100 Equity Hedged to CAD Index ETF ,.thank you.

  14. Very good article, FT.

    How will the allocation change if this income portfolio is constructed in a TFSA? Basically, we don’t have to worry about any clawbacks, AMT or any other Tax at all?

    CVY in non-RRSP portfolio would result in the NRT (Non-resident tax), and thus the dividends received shall only by 65% of the total dividends.

    How will the portfolio change if this is part of an RRSP plan?

  15. Hey Amit,

    If you are interested in tax optimizing your portfolio, I’ve written an article on portfolio allocation that may be of interest.

  16. 16. TinyPotato

    Great list.

    Just a note, iShares recently changed XDV to a monthly distribution.

  17. Thanks for the heads up TinyPotato.

    Trackbacks

Reply to “Retirement Income ETF Portfolio”

Subscribe without commenting



Get the Latest

      

Money Tips Newsletter

Premium Sponsors



Recent Comments

  • SC: Hey Ed, I have started the SM and have run into something I didn’t see coming. For my HELOC from Scotia...
  • FrugalTrader: Wouldn’t assets transferred to a spouse via rollover be exempt from probate?
  • James: The most simple and overlooked tax strategy for business owners is the dual will. By having a secondary will...
  • James: Great Article. I am a Financial Planner for a large FI. Patricia..there is no free lunch. I used to work for...
  • JT: Thanks, Ed. That is what I suspected. JT
  • Ed Rempel: Hi JT, You have to be careful taking out the growth. In your example, you sell $20,000 and 5/6 of that is...
  • Ed Rempel: Hi K, A couple things: 1. Leveraged investing is a high risk strategy. If your risk tolerance is only at...
  • Loonie Lover: Just on the subject of dotting the “i”s and crossing the “t”s, don’t...
  • LifeInsuranceCanada.com: Brief summary: Spouse gets everything when I die :). Seriously, my planning goes like this....
  • Jeff Guarino: The explanation is all wrong. My commuted valued continues to go lower as I get older. I can retire at...
 css.php