As the generation of Baby Boomers start to retire, they will need to shift their portfolios into a post retirement investment plan.
In years past, this meant changing your asset allocation mix with greater focus on bond investments over stock investments. Recently, both Fidelity and Vanguard introduced retirement investment options that do the work for you through a single mutual fund. In this article we’ll first look at what investments during retirement should accomplish, and then we’ll review Fidelity’s Income Replacement funds and Vanguard’s Managed Payout funds.
Update: Since first publishing this article in 2008, two important developments have occurred. First, Jon Stein founded Betterment, an incredibly easy and inexpensive way to invest. And second, Betterment has developed an automated way to invest while in retirement. They make withdrawals each year for income extremely easy. Here’s a short video about Betterment’s approach:
You can check out Betterment here.
Retirement Income Investing Objectives
Investments during retirement must meet several objectives. First, the investments must generate income to fund expenses during retirement. This is one of the reasons retirees shift investments from growth stocks to dividend paying stocks and bonds. Second, retirement investing requires greater consistency in investment returns. Losing 25% in your portfolio when your 35, while disconcerting, is not financially fatal. Losing 25% of your retirement portfolio when your 70 can have a sever impact on your golden years. Finally, investing during retirement still requires some growth in the portfolio. Given average life expectancies, at age 65 most still have an investing horizon of 20 years or more.
Addressing all of these factors in an investment portfolio is a challenge. So let’s see how Fidelity and Vanguard each address these retirement investment objectives.
Fidelity’s Income Replacement Retirement Investments
Fidelity’s Income Replacement funds invest in a mix of Fidelity equity, fixed income and short-term mutual funds. Each fund is designed to pay out a certain percentage of your balance each year. Depending on how long you want your money to last, you can select a fund that will have paid out 100% of your balance by 2016 through 2042. The longer the period of time you select, the less you’ll receive each month. Over time, the investment mix of each fund will automatically shift to become more conservative as you near the Fund’s horizon date.
Fidelity has an easy to use tool to help you determine which fund is best for you. As reflected in the screen shot below, there are two ways to use Fidelity’s calculator. First, you can enter how much you have to invest and how long you want to invest it, and the calculator will estimate how much money you’ll receive each year. Second, you can enter how much you want to receive each year, and Fidelity will calculate how much you need to invest to generate that annual income.
Using the calculator, I entered $5,000 per year in income for 20 years, and here are the results:
It’s important to understand that Fidelity’s Income Replacement funds are not annuities. There is no guaranteed annual income from these retirement investments. If the market performs better than anticipated, these funds will pay more than expected. If the market under performs expectations, the annual payout will be less.
The minimum investment for the Income Replacement funds is $25,000. The annual expense ratio ranges from 0.54% to 0.67%.
Vanguard’s Managed Payout Retirement Funds
Vangaurd’s Managed Payout Retirement funds take a much different and simpler approach. Vanguard offers three retirement income funds. The Managed Payout Growth Focus fund (VPGFX) maximizes the growth of capital by minimizing annual payouts. Vanguard’s Managed Payout Growth and Distribution fund (VPGDX) balances capital appreciation and income distribution. And the Managed Payout Distribution Focus fund (VPDFX) has a higher payout per dollar invested, and therefore, little or no capital appreciation.
Vanguard’s retirement income calculator will estimate how much monthly income will produce for each of these funds based on the amount invested. As the monthly income distributed goes down, growth of the invested capital increases.
The Vanguard funds require a $25,000 minimum investment, and expenses range from 0.57% to 0.58%.
Although I prefer the simplicity of the Vanguard funds, both Vanguard and Fidility’s retirement income funds offer a simple approach to retirement investing. There are alternatives, of course, which are covered in the mutual fund investing section here at The Dough Roller.