FMD Capital Management

Choosing The Best Funds In Retirement

Written by David Fabian, August 07th, 2014

Market experts are constantly debating the best style of funds to use in retirement. Some believe that index funds with the lowest fees are the best way to stay correlated with the market, while others are firmly entrenched in the notion that active management is the way to go.

Index investors abhor the notion of paying higher fees for stock picking strategies or uncertain risk dynamics. They don’t want to hand over the portfolio decision making to a team of experts that may place their assets in the wrong areas at the wrong times.

On the flip side, active managers tout the ability to make changes as conditions evolve to reduce volatility or enhance their exposure to thriving areas of the market. This can be a compelling argument for a retired investor that is considerably more risk averse and unwilling to sustain large losses.

In my personal opinion, you can successfully marry both types of funds in your portfolio with the right mix of passive and active strategies. Doing so may give you an edge in terms of capturing sustainable income, diversification, and long-term growth of your accounts.

Passive Strategies

As a proponent of using low-cost ETFs, I tend to sway towards passive strategies as the core building blocks of a retirement portfolio. I love ETFs because they are low-cost, liquid, diversified, tax-efficient, and offer a range of unique index methodologies.

Without a doubt, some of the best ETF strategies for retired investors can be found in dividend paying stock funds.

An equity-income fund such as the Vanguard High Dividend Yield ETF (VYM) provides you with exposure to nearly 400 domestic stocks with above-average dividend yields.   This ETF currently has over $12 billion in total assets with a rock bottom expense ratio of just 0.10%. The current yield on VYM is 3.00% and income is paid quarterly to shareholders.

If you are looking for higher yields, an overseas dividend play such as the iShares International Select Dividend ETF (IDV) is an excellent option. This ETF is made up of 100 stocks of foreign developed companies primarily centered around Europe, with a modest allocation to Australia as well. The current distribution yield on IDV is 4.69% and dividends are paid on a quarterly basis.

Active Strategies

In order for me to substitute a passive index for an active strategy, it must show a unique value proposition in terms of asset structure or portfolio objective. In doing so, I know that I am implementing a distinctive alternative to a traditional benchmark.

One actively-managed fund I have owned for some time now is the PIMCO Income Fund (PONDX). This multi-sector bond fund targets specific areas of the fixed-income market (both foreign and domestic) that the manager feels will outperform over time. In addition, PONDX has the flexibility to shift its holdings in response to the manager’s tactical outlook on credit, duration, or interest rate moves.

Right now the PONDX portfolio has an effective duration of 3.42 years and a yield of 3.74%. This fund charges a modest 0.79% expense ratio and has consistently been in a top performer in its class since its inception in 2007.

Another actively managed mutual fund with a unique balanced approach that retired investors should consider is the Loomis Sayles Strategic Income Fund (NEZYX). This fund is classified in the multi-sector bond category but has a significant allocation to traditional dividend paying stocks, preferred stocks, high yield, convertible bonds, and international holdings.

This distinctive asset mix has allowed NEZYX to outperform many traditional bond strategies with a high level of current income. In addition, the manager has the flexibility to actively size the sleeves of the portfolio according to their fundamental outlook on the stock and bond markets. According to the fund company website, NEZYX has average annualized total returns of 13.62% and 9.48% over the last 5 and 10-year periods.

The Bottom Line

While the debate over active and passive will rage on, you can make that case that every investor has unique goals that make both arguments compelling. The ultimate decision on which funds to use in retirement should be based on your risk tolerance, time horizon, and investment objectives. A healthy mix of both styles can likely lead to excellent long-term results.

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