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:
| Underlying ETF | Allocation |
|---|---|
| Equities | |
| 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% |
| Fixed Income | |
| 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.
Thank you for covering this. The asset allocation doesn’t seem to be determined by market capitalization, and it’s not the variant used in other asset allocation ETFs of market-cap tilted towards home country bias. In the sense of the manager having discretion to shift geographic allocations, is this an actively-managed fund rather than a passive fund? Is tilt towards international developed markets meant to be a tilt towards lower risk? Higher potential growth based on some quantitative model? Higher customary dividends? Will the allocation be shifted by the manager over time? In bonds, the tilt towards ex-north america seems even more extreme. It doesn’t look like the usual investment industry reach for yield, since yield is so low in those bonds.
@Moti: I suspect I will be saying this a lot as more people comment, but here goes: “I will be addressing your questions in future posts.” There’s a lot to cover!
The short answer is, yes, the stock/bond mix and the geographic allocation will evolve over time based on long-term valuations and the expected returns of each asset class. More to come later.
What concerns me is the 4% return is quite high for having 40% of fixed income.
The yield of 4% will most likely include return of capital. Many VRIF holdings yields have return below 4%. Many financial bloggers say that “returning of your own capital” is not a sound investment strategy?
What’s the take on VRIF regarding that aspect?
I am still in saving mode. Are there any one ticket ETFs that you can CONTRIBUTE a fixed monthly amount that is then used to buy more of the ETF? Mutual funds allow this but not ETFs? Tried to do it thru TD Direct but no success.
Why do you not factor in CIBC Monthly Income Fund with its high yield?
@Scott Paul: Unfortunately the main downside of ETFs is that they don’t allow you set up preauthorized monthly contributions like mutual funds do. Here’s a possible workaround:
https://canadiancouchpotato.com/2020/01/28/how-to-set-up-a-hands-off-etf-portfolio/
@Peter: This too falls into the “coming soon” category. Here’s the preview: you’re correct that the interest and dividends will not be enough to generate a 4% distribution. To make up the shortfall, the fund will (as far as possible) periodically sell holdings that have appreciated in value and distribute the capital gains. This is not the same as return of capital. The fund expects to distribute return of capital only rarely, when it is unable to harvest enough in capital gains.
Glad to see you back to blogging! Your posts are always very interesting and insightful.
@Canadian Couch Potato, do you understand why Vanguard is including VBG – Global ex-U.S. Aggregate Bond Index ETF (CAD-hedged)?
It has a yield to maturity of 0.4% with a duration of 8 years. It’s mostly made up of very low yielding European and Japanese government bonds. I don’t understand why you would want to invest in this, it has way more downside risk than upside (because of the duration).
Unless possible Vanguard did some historically return/correlation analysis and that looked the best? But then I would have hoped they would have considered expected return too, not just past performance when yields have been falling. Or maybe they want more assets in this ETF?
You would be much better off in cash in my view (vs. VBG), higher expected return and much lower downside risk.
@Scott Paul. i believe blackrock allows you to PAC their all in one ETFs. you can fill out the paperwork wand they’ll do it. I know Questrade offers it. Best of Luck
@Alex7 Vanguard published a paper exploring the benefits of using global bonds to diversify risk and inflation from different economies: https://personal.vanguard.com/pdf/ISGGLBD.pdf
Justin Bender also analyzed the outcome for a Canadian investor using this particular ETF (VBG) https://www.canadianportfoliomanagerblog.com/expected-returns-of-currency-hedged-global-bond-etfs/
It was published about a year ago so you would need to run new calculations to have a realistic perspective of expected returns.
In summary, we don’t know how economies across the planet are going to evolve and it is proven to have benefits to diversify credit allocation (at least in the past).
@Alex7: To expand on Julian’s comment above, this is a rather complicated concept, but the key idea is that once you add currency hedging to foreign bonds the expected return becomes similar to that of domestic bonds.
At the time of Justin’s blog (linked in Julian’s comment) the yield to maturity of VBG was just 0.68%, but its expected return was 2.1% once you factored in the currency hedging. This 2.1% figure was the same as that of VAB at the time.
You need Justin’s brain to do the calculations, but for the rest of us it’s enough to know that the expected return on currency-hedged foreign bonds will be quite different from the yield to maturity.
Hi, this is great coverage of an interesting ETF. I look forward to the future articles and appreciate you putting this out there. I am a total return investor and have no problem selling a few shares for income as I head into retirement. I am intrigued by this product and, now that it’s been introduced, am a bit surprised there isn’t really another ETF quite like it.
-Michael
The VRIF sounds very interesting. Fortunately my wife and I have defined pensions and at this point do not require any additional funds to supplement our lifestyle. Would you consider VEQT or VGRO too risky for our investments in our registered accounts? We are beginning our decumulation process.
Why?? Why would anybody invest in this nonsense fund?? Why to put $100K to get $300 a month?? this is nuts!!
Get maximum of your hard saved money in retirement! I would go for CANOE EIT INCOME FUND (EIT-U:CT) with 13.25% yield and would be getting $1104 a month instead. Fees are higher but you get professional management+ covered call options behind the scenes. Even you’re scared to death, take 50/50 approach, i.e. put half in VRIF and the other half in EIT. You’ll get 8.5% which is more reasonable.
@Andrew: The 13.25% of EIT is mostly made of “return of capital”, so the investors are getting back some of the principal they put in the fund. So only a small fraction of yield is actually interest, dividend or capital gains. If you don’t understand how this works, go on Morningstar and look at the 10+ years performance charts of this fund. It goes steadily down even in the massive bull market of the last decade because this is a fund that depletes itself on purpose to provide a steady payout to retirees. Eventually the cost per unit will be so small I suspect it will have to be closed, but that’s just my guess.
VRIF works on a very different concept, so you can’t really compare the two.
@Charles: First of all I’m not sure about “MOSTLY”, how do you know that? did you check in which months/ years it was MOSTLY return of capital (ROC) or not? Of course, if you’re talking about periods of time like March or April this year, that would be true. That’s why you can simply reinvest distributions back to the fund. The fund has been doing its job for last 23 years with 10 yr compound annual return of 5.8%, if you were reinvesting distributions during plunges returns would be much higher. So how can you say they return you your own money 23 years and your capital is still around? In fact if we took both funds and backtesting them for 10 yrs you will see how EIT easily outperforms VRIF by far (my guess). Secondly, regarding to “depletes itself on purpose to provide a steady payout to retirees” – that’s the whole idea of pension. I think it’s important to take your life in perspective, if you are retiree with paid out home and CPP+OAS ext. payments, why should you rely on 4% from your saved money while life is coming to an END? Third, about “two very different concepts”. The concept here is only one – to get maximum risk-reward yield for your money in the late stage of your life!
After checking out some of the other monthly income fund ETFs, I noticed they all either retained their value or loss value over the last 10-20 years. Do we expect the same from VRIF or is there any growth potential? Seems a drawback would be losing money to inflation without any growth potential.
@Adrian: I’ll be looking at the idea of whether VRIF’s planned distribution is sustainable in a future post. The short answer is, yes, probably. If that’s the case, I’m not sure you would be losing money to inflation. If the fund generates a 4% distribution and the unit price doesn’t change, that would be a 4% total return, which is well ahead of the current inflation rate.
Great stuff as always Dan. For Andrew, check this out on EIT.
https://twitter.com/DanHallett/status/1306761383057461248
It’s a Canadian equity portfolio. Canadian stocks are priced to generate ~7%/yr before fees over the next ten years. Even an optimistic projection would get you no more than 9% per year. EIT needs to generate > 14% per year over time before costs. No manager will add 5% to 7% per year in excess returns over such a long period of time. In theory it could happen. I wouldn’t bet my lifestyle on it (which is what you’re doing if you’re spending that ~13% per year distribution.
@Charles and @Andrew
ROC on EIT was 88% in 2018! No wonder it’s NAV is plummeting. It would be nasty in a taxable account, in the year you go to sell, because of what ROC does to the ACB .
2017 48.5% ROC
2016 38.0% ROC
2015 29.8% ROC
etc… It’s all on their website and you can check it out for yourself:
http://www.canoefinancial.com/eit-income-fund/tax-information/
Dan, did you see the fact sheet at all? Canadian equity portfolio???
Canadian Equity 46.3%
US Equity 37.4%
Cash 10.1%
International Equity 6.1%
Andrew, I only dug into EIT 18 months ago when asked about the fund. I did NOT check the fact sheet recently. Unfortunately for you (or anyone holding EIT) it doesn’t help EIT’s distribution sustainability. I would not bet on any 100% stock fund generating > 14% per year (before fees) for the next decade from these levels.
The fact that today the fund holds nearly 40% in U.S. hurts – not helps – the situation. The U.S. market is priced to deliver low single-digit returns for the next decade. So what you’ve helped me clarify is that this fund is destined to dig a deeper hole. Its distribution was not sustainable 18 months ago. it is now even less sustainable.
Nothing would please me more than to be proven wrong on this fund because that means all of the people relying on EIT’s distribution to help pay for monthly living expenses can keep counting on its distribution. But 20+ years of analyzing monthly income funds and assessing their sustainability suggests otherwise. Every time I’m gone out on a limb and predicted that a distribution would have to be cut or risk significant NAV erosion – I’ve been right. But I hope I’m wrong.
Dan, in your opinion is the FIE distribution sustainable?
@Paul: It seems unlikely to be sustainable over the long term. FIE’s total return over the last 10 years (during which markets have been strong) was 6.17%, while the distribution is currently pushing 8%. The high fee doesn’t help (almost 1%).
I should stress that “unsustainable” doesn’t mean investors in the fund are in imminent danger of running out of money if they are spending the entire distribution. It could take more than a decade for this to become a problem. It’s just important for investors in these ETFs to may more attention to the total return than to the yield.
Paul, on the off chance you were asking me; I agree with everything Dan B wrote. I’ll add that valuation is in FIE’s favour – for what it’s worth. While the S&P/TSX Composite sports a composite P/E ratio > 13x and has a P/B ratio of 1.8x; FIE (or its index) trades at less than 10x earnings and 1.2x book value (valuation stats are from the iShares profile page for XIC vs FIE). Those aren’t guarantees of future success or even index outperformance; but those data suggest FIE’s future may be pretty good longer term. And even if it doesn’t fully support its monthly payout, FIE is not in the group of the most egregious of monthly income funds – e.g. RBC Managed Payout Solution – Enhanced Plus.
Great concept. Sounds like HNDL on NASDAQ which pays out 7% while maintaining its original price around $25 per share. Not sure how they do it but got to like the returns.
@Fuzzy: I hope these posts have made it clear that you need to understand “how they do it.” Investopedia did an article on HNDL that includes this:
https://www.investopedia.com/investing/etf-designed-retirees/
Going over this again, why depart from passive market cap weighted allocation for this fund? Is there something different about the drawdown phase of investing? I think this fund offers some very clear improvements on the income funds that you’ve provided backrgound on in your series of posts. The flexible, but still reasonably predictable, distributions seem like a wise compromise. The target payout rate is “non-pornographic”, thank goodness, and I assume that has something to do with Vangugard’s DNA as an organization. It’s confusing to me that this product was presented wiithout explanation as as just another station on the conttinuum of the asset allocation etf’s like VBAL
I am interested in retention of principal as well. How does Vanguard guarantee (if they do) that your capital will not erode? I have been primarily focused on dividend income from several equities, all large companies. With the obvious issue with GIC’s (to protect short term cash flow), we have been looking for some other alternatives to balance our portfolio. Looking forward to more detail in your next article.
@Mary: Do check out the other three articles in this series. There is absolutely zero guarantee in a fund like VRIF, as stocks and bonds can always suffer losses. You can expect consist distributions from VRIF, but not consistent returns.
Hello,
Are VRIF shares expected to go up on value over time?
That’s what I don’t understand…
is it always going to be around 24$?
Thanks :-)
@Geoffrey: Vanguard is targeting a 5% return for VRIF, and if it pays out 4% annually that would mean the expectation is for the share price to gradually increase by about 1% over time. But it needs to be stressed that this is a long-term expectation, which means there is zero guarantee it will actually happen, and even if it it does, that 5% return will be a long-term average (over at least 10 or 20 years). Certainly from year to year the price will fluctuate, so you would need to be prepared for that.
The other articles in the VRIF series might help, in particular:
https://canadiancouchpotato.com/2020/10/05/is-vrifs-distribution-sustainable/
Dan
Looking for supplemental monthly investment income for the next 4 years until pension kicks in then I will move the monies back to VBAL to continue accumulating. I am thinking it keeps my money invested until the month I need it and do not incur 9.95 monthly trading costs. Does this make sense? Also do I have the investment required amount calculation based on the current price.
VRIF Jan-2021
Target Yield 4.00%
Unit Price $26.50
Number of units 38,015
Market Value $1,007,397.50
Annual Distribution $40,295.90
Monthly $3,357.99
Novice here, are the management fees of 0.29% subtracted from the 4% yield making net payout 3.71%?
@CP: The management fee isn’t specifically subtracted from the yield in this way. The 4% figure is based on an annual calculation: it’s 4% of the unit price on December 31. It will stay constant in dollar terms for the full 12 months (for example, $0.09 per unit). Fees are still deducted, of course, but you won’t see these explicitly.
its a fund of funds so is the “ETF’s management fee is 0.29%” true ? aren’t the underlying EFT’s also charging MER ?
@Dividendlover: In all “funds of funds” the cost of the underlying funds is included in the published MER. There is no double-dipping.
Correct me if I am wrong, but it looks to that the expectations for a holder for VRIF or other similar funds, would be to collect a steady distribution (4% if valued at $25/share) with little or no growth in NAV. The usual reason to include equities would be add growth to a portfolio.
It seems to me that an investor could buy a rate-reset preferred, also valued at about $25 that has a 4% or higher yield and that will reset at a rate that will maintain that 4% of the original investment. A with VRIF, some equity risk, but not much is based on a reliable company. For diversification, maybe use several such preferreds. Or perhaps a selection of Can/Us preferred etfs.
I understand the attraction of a one-size-fits-all, set and forget etf, but for someone looking 10-20 years ahead, VRIF looks to me like it will underperform most other alternatives.
If I want an idiot proof 4% return that is low risk, say in an TFSA , to supplement my partner leaving the work force is this a good option? Can I just buy $100k and have a reasonable expectation of getting ~$300 per month for the foreseeable future? Is there a better passive income ETF?
@Ryan JG: If you are specifically looking to generate cash flow, the VRIF should be able to do that more or less indefinitely. But please check out the other other articles I did about VRIF to make sure you understand how it works. It is not a guaranteed 4% return: https://canadiancouchpotato.com/2020/09/28/where-does-vrifs-4-payout-come-from/
There’s so many options out there these days, that it can get rather overwhelming.
I’ve never purchased an ETF, nothing against them though. Only, common/preferred stock
—–
I have about 25% of my porfolio in Preferred stock.
Average yield on all of the Preferred combined = ~ 4.88%.
Yet – they are rate resets (one is a min.rate resets). So it’s always a crystal ball gamble as to what will happen in 5-years time with the GOC 5-year bond yields.
Having said that – presumably when our interest rates increase over the next few years, the GOC 5-year bond yield will also increase, thus providing me with similar income that they are now generating.
I’m well aware that the Capital in preferreds is extremely volatile. Bouncing off $25, or stay low for years.
So, perhaps even 1/4 of the portfolio is a bit much, but it’s income security, so it’s hard to know what options are ‘best’, or if it’s all relative.