Exchange-traded funds have grown in popularity in recent years and that trend appears set to continue. The BlackRock ETF Pulse Survey released in January 2017 revealed that 52 percent of investors said they planned to buy ETFs in the next 12 months. Ninety-four percent of U.S. financial advisors surveyed said they expected to invest in ETFs in client portfolios.
ETFs offer a number of advantages for investors who are focused on accumulating assets for retirement. As with any other investment, however, there’s a certain degree of risk. As you move into retirement, your first instinct may be to edge away from volatility but there’s an argument to be made for retaining ETFs in your portfolio.
Lower expenses, for example, are a huge benefit for ETF investors, according to Chris Cook, founder and CEO of Beacon Capital Management in Dayton, Ohio.
“ETFs are extremely cheap compared to most mutual funds,” Cook says. “If you look at a retiree trying to make 4 to 5 percent in their portfolio, even half a percent can make a huge difference.”
[See: 7 ETFs That Allow You to Invest in Space.]
In addition to carrying lower expense ratios, investing in ETFs can also cut down on transaction fees.
“ETFs trade much more efficiently. They’re free of transaction charges on many platforms. If you’re in retirement, you can save quite a bit of money by avoiding those fees,” Cook says.
Daniel Milan, managing partner at Cornerstone Financial Services in Birmingham, Michigan, says remaining invested in ETFs can have a two-fold impact on your retirement portfolio as you begin spending those assets.
“Lower costs, diversification and tax efficiency are strong reasons to keep ETFs in your portfolio,” Milan says. “In retirement, you’re making withdrawals and it’s extremely beneficial to find ways to decrease the impact of those withdrawals on the portfolio’s value.”
Milan says that keeping costs low helps protect the principal balance while the improved tax efficiency ETFs offer can help minimize tax liability. If you’ve moved toward a more conservative asset allocation, the combination of lower costs and lower taxes can also help offset any decrease in expected returns.
Mike Serio, regional chief investment officer for Wells Fargo Private Bank in Denver, cautions against letting the cost tail wag the investment dog, however.
“If [investors] wish to go passive in some asset classes, certainly ETFs can give them efficient ways to access those,” Serio says. “However, there are less efficient asset classes and times when active management will outperform passive, and investors shouldn’t rule out paying an active manager in those instances.”
Tony Drake, owner of Drake & Associates in Milwaukee, points to the diversification factor as a significant consideration for retirees contemplating whether to maintain ETF holdings. “Some ETFs provide great diversification with one purchase,” he says. “This is really important in retirement and for all investors to spread out risk.”
Maintaining the appropriate asset allocation as you transition from your working years to retirement can be challenging. ETFs can simplify decision-making when choosing investments while potentially offering more exposure to broad market indexes and specific sectors.
Another benefit, says Drake, is the fact that ETFs trade like stocks. “We don’t have to wait until the close of business for a price. This allows us to take advantage of increases or decreases in the market quickly,” he says.
Understanding the potential downsides and keeping your overall investment strategy in perspective can help you better understand whether investing in ETFs beyond your retirement date makes sense.
“Protecting capital from large losses should always be the priority,” says Matt Schreiber, president of WBI Investments in Red Bank, New Jersey.
“As long as you have capital, you can generate income. Building a portfolio that supports cash flow needs and generates returns to keep pace with inflation are important considerations,” Schreiber says.
Schreiber reminds investors that not all ETFs are created equal.
“Investors need to know what the ETF owns underlying. Some ETFs can be highly concentrated by having large exposure to several companies,” Schreiber says. “That could potentially expose investors to more loss of capital than expected during a market correction.”
Betsy Billard, a financial advisor with Ameriprise Private Wealth Advisor based in NYC and Glendale, California, says retirees should understand that ETFs don’t always trade at their net asset value.
“ETFs can be much more volatile than stocks or mutual funds in the short term, especially very early in the trading day or at the end of the day,” Billard says. “There have been several instances of small crashes with ETFs in early morning trading due to price disparity between the ETF and the holdings that it tracks.”
Billard says retirees should be mindful of making investments in highly leveraged ETFs or ETFs that have a higher risk profile. Leveraging can result in wild price swings, which could negatively impact your returns.
Sean O’Hara, president of Pacer ETF Distributors in Paoli, Pennsylvania, suggests retirees focus on high free cash flow ETFS.
[See: 9 ETFs to Buy When the Market Tanks.]
“Companies with high free cash flow have healthy balance sheets that allow them to increase dividends over time or invest in future growth and acquisitions,” O’Hara says.
Analysis from Pacer shows that over the past 28 years, high free cash flow stocks have yielded almost double the average annual return of the broad-based index. O’Hara says retirees can also benefit from trend following.
“Trend following ETFs are critical because they remove investor psychology from the equation,” O’Hara says.
He uses the emotional swings following the end of bear and bull markets as an example.
“Panicked investors sell at the bottom because they worry that the market is going to zero,” O’Hara says. “Retirees have shorter time horizons, so capital preservation becomes paramount.”
According to O’Hara, rules-based trend following ETF strategies can help retirees avoid emotion-based decisions.
Cook suggests very broad ETFs for the do-it-yourself retiree investor.
“For the stock side, or growth portion of the portfolio, an ETF that follows the Standard & Poor’s 500 index [would be suitable],” Cook says, while on the bond side, he recommends an ETF that follows the Barclays Aggregate Bond or U.S. government bonds.
“Basically,” Cook says,” you want to be diversified with an opportunity for capital gains, but also some downside protection.”
Drake says it’s important for retirees to keep their risk tolerance in focus when investing in ETFs.
[See: 10 Long-Term Investment Strategies That Work.]
“If you’ve planned appropriately, you should have the dollars saved for retirement. Taking extraordinary amounts of risk at this stage of the game is usually not necessary,” Drake says. “At this point, we should have the hard work done. Now it’s time to preserve and protect what we’ve worked so hard to save.”
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Why You Shouldn’t Abandon ETFs in Retirement originally appeared on usnews.com
