When Vanguard launched its family of one-ETF portfolios back in 2018, Canadians embraced them enthusiastically. And why not? These so-called “asset allocation ETFs” took a good idea—a balanced mutual fund of stocks and bonds that rebalances automatically—and dramatically improved it using low-cost, globally diversified index ETFs.
This month, Vanguard launched another product that is already generating a lot of buzz: the Vanguard Retirement Income ETF Portfolio (VRIF). While the original family of asset allocation ETFs is popular with folks who are building wealth with regular contributions, VRIF is aimed at investors who are drawing down their portfolio to meet their regular expenses. It’s built from eight underlying ETFs—roughly half stocks and half bonds—and it will make a consistent monthly payout with a target of 4% annually.
Is VRIF a game changer for index investors in retirement? Will it allow you to live off your portfolio’s income without touching the capital? Is its 4% distribution sustainable? Is it a set-it-and-forget-it solution in a RRIF? What about a taxable account? These are some of the many questions that have already cropped up following the launch of this new ETF.
VRIF is a potentially useful new fund, but the comments on some recent blogs and online forums make it clear that many investors have serious misunderstandings about how this fund works and how it should be used. As a result, they’re at risk of making poor decisions. In my next few posts, I’ll do my best to unpack VRIF and clear up some of these myths and mysteries so you can determine whether it’s right for you.
Is VRIF revolutionary?
VRIF has some novel features, but it’s not a fundamentally new idea. In fact, so-called monthly income funds have been a staple in the mutual fund industry for a generation. They’re a specific type of balanced fund (containing a mix of stocks and bonds) that pays a consistent cash distribution each month. They appeal to investors who want a steady stream of cash flow from their portfolio, such as retirees.
All of the big banks and major mutual fund providers offer monthly income funds, and they’re hugely popular, with billions in assets. The enormous RBC Monthly Income Fund (RBF448) is typical: it’s about half stocks and half bonds, and it’s paid out $0.0425 per unit every month for almost six years. Of course, as with any balanced fund, its returns have varied widely: since 2014 it has seen years with both losses and double-digit gains. But through it all, someone holding 10,000 units of this fund (about $145,000 worth at its current price) would have received $425 every month like clockwork. You can see the appeal for someone who needs cash flow to meet regular expenses.
Compare this to the Vanguard Balanced ETF Portfolio (VBAL). This asset allocation ETF makes quarterly distributions, and since its launch almost three years ago these have ranged from about $0.10 per unit to more than $0.18. Lumpy payouts like this don’t matter if you’re building wealth in your RRSP (and probably reinvesting the distributions anyway), but they’re not practical if you rely on your portfolio’s income to pay your condo fees, your cellphone bill, and your Netflix subscription.
That’s where VRIF comes in. Vanguard has announced it will be targeting a 4% distribution annually, with consistent monthly payouts. The fund launched with a unit price of $25, so it will pay out $1 annually, or $0.0833 per unit each month. (The first distribution will be paid on October 8.) If you buy 4,000 units—worth about $100,000 at the current price—you can expect a monthly distribution of $333.33. The distributions will likely be adjusted annually (more on this in a future post), but the tweaks will be small and they will apply to the next 12 monthly payouts, offering much more predictable cash flow than traditional balanced ETFs.
While the structure is more common in the mutual fund world, there are several monthly income ETFs that predate Vanguard’s. The iShares Diversified Monthly Income ETF (XTR) has been making monthly payouts of $0.05 per unit since January 2016; prior to that, it had paid $0.06 per unit since mid-2010. Another example is the iShares Canadian Financial Monthly Income ETF (FIE), which has been churning out $0.04 per unit for more than a decade. The BMO Monthly Income ETF (ZMI) is also approaching its 10th anniversary and has distributed between $0.05 and $0.06 per unit every month for the last seven years or so.
If mutual funds and ETFs have been generating steady monthly income for many years, is VRIF really a “game changer,” as some have called it? That might be going too far, but it is certainly a huge step forward in the evolution of monthly income funds. Let’s explore why.
What makes VRIF different?
Low cost is VRIF’s most obvious benefit: the ETF’s management fee is 0.29%, which should translate to an MER (which includes taxes) of about 0.32%. It’s not unusual for bank-sponsored monthly income mutual funds to come in around 1.50%. Even the ETFs mentioned above have fees about two to three times higher than VRIF’s.
VRIF also promises more thoughtful diversification than traditional monthly income funds. Perhaps not surprisingly, funds in this genre tend to load up on dividend-paying stocks and preferred shares. Many also significantly overweight domestic equities. Put those two things together and you can end up with a portfolio full of Canadian banks. FIE is the most extreme example: it’s specifically designed to hold nothing but stocks and bonds from financial services companies. That’s too narrowly focused to be a complete retirement portfolio. XTR is much less concentrated, but it still has less than 15% of its portfolio in foreign equities.
The BMO Monthly Income ETF (ZMI) has more global diversification than its iShares counterparts, but it’s also a prime example of the focus on yield you often see in monthly income funds: its holdings are primarily dividend stocks, preferred shares, and even a covered call ETF.
Contrast all of this with VRIF, whose underlying holdings look like this:
|FTSE Canada All Cap Index ETF (VCN)||9%|
|U.S. Total Market Index ETF (VUN)||18%|
|FTSE Developed All Cap ex North America Index ETF (VIU)||22%|
|FTSE Emerging Markets All Cap Index ETF (VEE)||1%|
|Canadian Aggregate Bond Index ETF (VAB)||2%|
|Canadian Corporate Bond Index ETF (VCB)||24%|
|U.S. Aggregate Bond Index ETF (CAD-hedged) (VBU)||2%|
|Global ex-U.S. Aggregate Bond Index ETF (CAD-hedged) (VBG)||22%|
A few things jump out here. First, VRIF uses the same building blocks you’ll find in its other asset allocation ETFs: the four equity holdings are total-market index ETFs covering Canadian, U.S., international developed and emerging markets, and the fixed income side includes both Canadian and foreign bond ETFs.
There’s one outlier: all of Vanguard’s other asset allocation ETFs use only “aggregate” bond funds, which track the broad fixed income market and are mostly made up of government issues. VRIF’s largest holding, however, is the Vanguard Canadian Corporate Bond Index ETF (VCB), which you won’t find in any of their other one-ticket portfolios. Corporate bonds typically have higher yields, but they also carry more risk. That said, VCB includes only high-quality, investment-grade issues, so the additional credit risk is probably small.
Although Vanguard has a family of dividend ETFs it could have used to build VRIF, there is no attempt to tilt the portfolio toward high-yield securities. That makes it very different from ZMI, for example, and from most other monthly income funds. VRIF uses a “total return” approach, where a $1 increase in price is treated the same as $1 in interest or dividends. I’ll have much more to say about this idea in a future post.
As for home country bias, VRIF’s equity allocation is actually less skewed to Canada than Vanguard’s other asset allocation ETFs, and it’s dramatically lower than that of most other monthly income mutual funds and ETFs. This is certainly not a portfolio bursting with Canadian banks.
Bottom line, if you’re looking for an ETF that generates consistent cash flow, Vanguard’s new fund seems to offer the best combination of low cost and broad diversification. That’s not a small achievement, especially when you consider the billions of dollars currently invested in monthly income mutual funds.
If you’ve managed to slog your way through this introduction, you should have a clear overview how VRIF compares with the competition. But you probably have questions about how it generates that 4% distribution, how it might change over time, and whether it makes sense to adopt the ETF as part of your own investment plan. I’ll do my best to address these issues in future blog posts. Stay tuned.