A Conservative ETF Portfolio for Retirees

To help identify the best ETF investments to populate these portfolios, I've leaned heavily on the insights of Morningstar's exchange-traded fund team, led by Scott Burns. That team produces Morningstar's ETFInvestor newsletter, which also includes two model portfolios--the Hands-Free Portfolio, a long-term strategic portfolio, and the Hands-On Portfolio, featuring a more tactical-allocation approach. Note that these portfolios include holdings from multiple providers such as Vanguard and iShares, but it's possible to get fairly close to these portfolios' asset allocations using a single provider.

A Total Return Approach
This conservative portfolio stakes less than 25% of its assets in stocks and holds the rest in a combination of cash, Treasury Inflation-Protected Securities, and other bonds.

Yet even though it's heavy on fixed income, this portfolio employs a total-return approach rather than one that's focused on generating current income. With yields as low as they are now, for both stocks and bonds, I think it's impractical to expect that your portfolio can generate a livable level of income without taking outsized risks.

In assembling the portfolio's core fixed-income positions, I followed the thinking of Morningstar's exchange-traded fund team. Instead of a total bond fund, these portfolios include two intermediate-term bond offerings:  iShares iBoxx $ Investment Grade Corporate Bond  and iShares Barclays MBS Bond . Together, these two funds replicate the securities in a total market bond index fund, except they exclude the government-bond exposure. (Those seeking a more streamlined, hands-off portfolio that's agnostic about the current market environment could also use a total bond market index fund like  Vanguard Total Bond Market .) However, it's worth noting that the portfolios don't eschew government bonds altogether. In addition to the aforementioned TIPS position, they include positions in  Vanguard Short-Term Bond ETF , which stakes about 60% of its assets in bonds issued by the U.S. government and its agencies. Those bonds would give the portfolios ballast in an extreme flight to quality like that in 2008.

Although inflation is currently well under control, preserving purchasing power should be a key goal for any long-term portfolio anchored in fixed-income securities. For that reason, this one holds close to 30% of its assets in ETFs with explicit inflation-fighting tendencies. Its core inflation-fighter is  iShares Barclays TIPS Bond , which provides inexpensive, plain-vanilla exposure to TIPS.

The portfolio also includes a smaller position in  SPDR DB International Government Inflation-Protected Bond , giving it exposure to inflation-protected bonds issued by foreign governments. As with TIPS, the foreign inflation-protected bonds' principal values adjust upward to keep pace with inflation in the country in which they're issued. That can provide a valuable hedge in a period of rising global prices, but it also introduces some currency-related risk, as these bonds are denominated in foreign currencies. For that reason, I've kept it to a small position here. Inflation-conscious investors might also consider a small slice of commodities or even precious metals exposure, but they should bear in mind that these funds can be extraordinarily volatile on a stand-alone basis.

On the U.S. equity side, I've again modeled the holdings on ETFInvestor's Hands-Free Portfolio and have included three distinct funds:  Vanguard Mega Cap 300 Index ,  Vanguard Mid Cap ETF , and  Vanguard Small Cap ETF . Holding the three separate funds gives an investor the flexibility to adjust the portfolio's weightings in each of these holdings as needed--for example, all of these portfolios have a slight emphasis on mega-caps versus the broad market. However, one could obtain similar market exposure via a broad market index portfolio such as  Vanguard Total Stock Market ETF . Alternatively, a more conservative investor might invest the bulk of his or her domestic-equity assets in a fund like  Vanguard Dividend Appreciation ETF , which focuses on relatively stable companies with a history of increasing their dividends.

The Role of Cash
As with the portfolios composed of traditional mutual funds, you'll notice that the portfolios I've included here have very limited cash holdings. Morningstar's Lifetime Allocation Indexes include cash only insofar as it improves the portfolio's overall risk/return characteristics, not for liquidity purposes. The amount of cash you hold will be highly dependent on your personal situation: your spending needs, whether you're receiving income from other sources, and the size of your overall portfolio. The conventional rule of thumb is that retirees should hold two to five years' worth of living expenses in cash. But with cash yields as low as they are right now, I think it makes sense to keep cash at the low end of this range and then invest any additional monies you expect to be tapping in the two- to five-year time frame in a high-quality short-term bond fund such as Vanguard Short-Term Bond.

See More Articles by Christine Benz

		New! 30-Minute Money Solutions
		Need help picking up the pieces in this turbulent market? 30-Minute Money Solutions by Morningstar Director of Personal Finance Christine Benz simplifies the daunting task of getting your financial house in order. Written for novice and experienced investors alike, this book offers manageable, step-by-step solutions for tackling money challenges and building a comprehensive financial plan in simple 30-minute increments. Learn more.
		Reserve Your Copy Today--$16.95 Publishes January 2010