5 Years Til Retirement ETFdb Portfolio

Published on September 8, 2009 | Updated February 11, 2014

Portfolio Strategy

Intermediate Time HorizonLow to Intermediate Risk ToleranceIntermediate Current IncomeThe 5 Years Til Retirement ETFdb Portfolio is designed for clients who expect to retire in approximately five years, and expect to live for approximately 30 years following their retirement. This ETFdb Portfolio is inspired by numerous widely-accepted investment strategies that advocate an allocation of roughly 60% equity and 40% fixed income for investors nearing their intended retirement date. We have tilted the equity allocation heavily towards large cap U.S. stocks through IVV, but retain some degree of small cap and international exposure through other funds. In addition, we have included a small allocation to real estate, as we believe this asset class offers potential for enhanced returns as this sector recovers.

This portfolio may be excessively risky for retired investors, but may have an unnecessarily large allocation to fixed income investments for investors facing a long time horizon and/or a relatively high ability to take on risk.

  • Risk Tolerance: Moderate to low. Since clients expect to be generating revenue for another five years, they have a some ability to take risks, but generally should seek less volatile returns.
  • Time Horizon: Intermediate. Although the time until retirement is relatively short, the client’s portfolio will be required to support living expenses and preserve capital as desired.
  • Current Income Needs: Moderate. Since the client anticipates working for another five years until retirement, current income needs from the investment portfolio are minimal at present, but expected to increase significantly over the next decade.

Portfolio Snapshot

Below are the holdings and allocations for the 5 Years Til Retirement ETFdb Portfolio. For each ETF included in this portfolio, we have also provided alternative funds that offer similar exposure.

Ticker ETF Asset Type Allocation Expense Ratio Alternative ETFs
IVV iShares S&P 500 Index Fund Domestic Equities 35.0% 0.07% SPY, VV
IJH iShares S&P MidCap 400 Index Fund Domestic Equities 10.0% 0.15% VO, RWK
IJR iShares S&P SmallCap 600 Index Fund Domestic Equities 5.0% 0.16% VB, PZJ
ADRE PowerShares BLDRS Emerging Markets Index Fund International Equities 5.0% 0.30% EEM, VWO
BND Vanguard Total Bond Market ETF Fixed Income 30.0% 0.10% AGG
SHY iShares 1-3 Year International Treasury Index Fund Fixed Income 8.0% 0.15% TUZ
STPZ Pimco 1-5 Year U.S. TIPS Index Fund Fixed Income 5.0% 0.20% TIP
VNQ Vanguard REIT Index Real Estate 2.0% 0.10% IYR, FRI
Weighted Average Expense Ratio     0.12%  

Historical Return Analysis

Ticker 2009 2010 2011 2012 2013
IVV 26.4% 15.1% 1.9% 16.1% 32.3%
IJH 37.5% 26.7% -2.2% 17.2% 33.5%
IJR 25.8% 26.6% 0.8% 16.3% 41.3%
BND 3.4% 6.2% 7.9% 3.9% -2.1%
SHY 0.4% 2.3% 1.4% 0.3% 0.22%
STPZ n/a 3.5% 4.7% 2.3% 2.1%
ADRE 65.5% 11.0% -18.5% 8.4% -5.1%
VNQ 30.1% 28.4 8.6% 17.6% 2.3%
Portfolio Return n/a 12.6% 2.4% 10.2% 15.6%
Compare to SPY 26.3% 15.0% 1.2% 16.0% 33.2%
Compare to AGG 3.3% 6.4% 7.7% 3.8% -2.0%

The adjacent table provides historical results for each component of this ETFdb Portfolio, as well as backtested results (as available) for the entire portfolio from 2008 to 2012. The table also shows how this ETFdb Portfolio performed relative to a popular stock market benchmark (SPY) and bond benchmark (AGG).

Not surprisingly, this ETFdb Portfolio struggled in 2008 amidst a broad market recession. In 2009 and 2010, this ETFdb Portfolio reclaimed much of the ground lost during 2008. During the recovery in 2009, its evident that ADRE staged an impressive rebound, although the funds strength  tapered off significantly the following year. Notice how VNQ was able to continue full-steam ahead in 2010 as well, rebounding quite strongly considering that the real estate sector still remains fragile.

In 2011 while most funds were following ADRE’s example and posting yet again low returns, this portfolio was able to keep returns in the positive end. This portfolio posted a modest gain in 2012, and our conservative mix of stocks and bonds allowed us to slightly outperform the total U.S. bond market as represented by AGG.

Portfolio Expenses

This ETFdb Portfolio is designed for long-term use consistent with a “buy, hold, and rebalance” strategy. As such, minimization of expenses is necessary to avoid return erosion resulting from compounding costs. To this end, we constructed a portfolio with a weighted-average expense ratio of 12 basis points, which is significantly lower than fees charged by actively-managed mutual funds. The impact of this reduced costs structure over the horizon of this portfolio is significant:

    Growth of $1 Million Over 30 Years @ Annual Return Of:
Portfolio Expense Ratio 5% 10% 15%
5 Years Til Retirement ETFdb Portfolio 0.12% $4,180,374 $16,903,418 $64,228,791
Actively-Managed Mutual Fund Portfolio 1.00% $3,243,398 $13,267,678 $50,950,159

Holdings Overview

Below is a brief overview of each component of this ETFdb Portfolio.

  • IVV: This ETF offers exposure to the S&P 500, one of the most widely-followed benchmarks for U.S. equities, and is weighted towards large cap equities.
  • IJH: This ETF tracks a well-diversified basket of mid-cap stocks, which generally have a market cap between $2 billion and $10 billion.
  • IJR: This fund offers exposure to equities of smaller companies, which generally offer greater risk and return characteristics.
  • ADRE: This ETF offers exposure to large cap emerging market equities, which tend to much more volatile than domestic equities but may offer superior returns.
  • BND: This ETF offers diversified exposure to the U.S. investment grade bond market, including corporate debt and U.S. Treasuries.
  • SHY: This ETF provides additional short-term risk free exposure to protect against rising rates and reduce overall volatility.
  • STPZ: This ETF tracks inflation-protected Treasuries, thereby offering protection against an uptick in inflation that could eat into returns of traditional bond funds.
  • VNQ: This ETF offers exposure to U.S. real estate markets. While this asset investment class is risky, it deserves some allocation in this portfolio.

Portfolio Risk Analysis

This ETFdb Portfolio has a moderate risk allocation, with significant allocations to fixed income securities. Although this portfolio maintains nearly 60% of its holdings in equity investments, the vast majority of these holdings are allocated to large cap domestic stocks, which tend to be the least risky of equity investments.

The emerging markets equity allocations represent the most risky component of this portfolio, as these funds tend to be more volatile than their domestic counterparts. Given the moderate risk tolerance of this fund, however, some exposure to emerging markets and real estate investments is appropriate to increase the fund’s expected return.

Equity Overview

This ETFdb Portfolio contains an allocation of 55% to equities, including domestic and international stocks. The vast majority of this portfolio’s equity holdings are in large and giant cap stocks, which generally have a market capitalization of more than $10 billion.

Large cap equities tend to be more stable than mid cap stocks, but also typically offer less growth potential. Although correlation between equities of different sizes is strong, the inclusion of small and micro cap equities in this portfolio does offer some diversification benefits, and also offers exposure to companies more likely to experience significant growth.

The equity portion of this ETFdb Portfolio is dominated by stocks listed and operating primarily within the United States. U.S. equities tend to be more stable that equities listed in developing economies, making them more appropriate for investors nearing retirement.

IVV [Fact Sheet]

One of the most popular ETFs, IVV offers exposure to the S&P 500 Index, a benchmark investing in large, liquid U.S. securities. We have given a significant allocation to IVV because this ETF generally serves as a reliable barometer of U.S. equity markets. And while the companies held by IVV are listed on U.S. equity markets, they are generally global firms that generate a significant portion of revenues from overseas operations. This provides some degree of international diversification within the domestic equities portion of this ETFdb Portfolio. With an expense ratio of only seven basis points, IVV offers cheap, well-diversified equity exposure.

IJH [Fact Sheet]

While the majority of domestic equity exposure in this ETFdb Portfolio is achieved through large cap equities, including small and mid cap funds can provide valuable return enhancement and diversification benefits. IJH invests exclusively in U.S.-listed mid cap companies (generally those with a market capitalization between $2 billion and $10 billion). While some investors prefer a “barbell” strategy that complements large cap stocks with small caps, we believe mid caps can offer a unique return profile, and are therefore worthy of inclusion in most portfolios.

IJR [Fact Sheet]

IJR invests in the smallest publicly-traded U.S. equities, focusing on companies with a market capitalization of less than $2 billion. Small cap equities have historically provided larger returns than bigger companies, but also come with more volatility. IJR it provides deep exposure to the small cap equity market by maintaining approximately 600 individual holdings across a variety of sectors.

ADRE [Fact Sheet]

In addition to domestic and foreign developed equities, we continue to believe in the importance of emerging market exposure for most U.S. investors. While some believe that reductions in cross-border investment restrictions have  eliminated benefits of geographic diversification, we think the discrepancies in market performance during the recent recovery indicate otherwise.

Fixed Income Overview

Despite the diversification across sizes and geographies within the equity component of this ETFdb Portfolio, many of these funds maintain relatively high correlations with each other (as evidenced below). In order to smooth overall volatility and achieve stable returns, we have allocated 43% of this ETFdb Portfolio to three fixed income funds: BND, SHY, and STPZ. These ETFs provide exposure to nearly every corner of the fixed income market while maintaining heavy concentrations in low risk securities.

BND [Fact Sheet]

This ETFdb Portfolio achieves the majority of its fixed income exposure through BND, which seeks to track the universe of investment grade bonds available in the U.S. This ETF generally avoids exposure to high risk debt, such as high yield or “junk” bonds, making it a key component of any portfolio designed for investors with a moderate risk tolerance.

SHY [Fact Sheet]

While BND has significant weightings towards Treasuries, SHY invests exclusively in government bonds with a remaining maturity between one and three years. Because these securities are short-term in nature and issued by the U.S. government, they contain minimal credit risk and minimal interest rate risk, both of which are important characteristics for investors seeking to smooth volatility as they reach their retirement date.

STPZ [Fact Sheet]

In addition to BND and SHY, this ETFdb Portfolio protects against upticks in inflation by holding STPZ, an ETF that invests in inflation-protected Treasuries. The face value of inflation-protected securities increases with CPI, which results in higher coupon payments in high inflation environments. We believe that an allocation to TIPs is a vital component of any client portfolio in the current economic environment, and deserve a significant allocation among fixed income investments in most situations.

Overall, this ETFdb Portfolio’s fixed income holdings are dominated by high quality bonds with a short to intermediate duration, protecting investors from widening yield spreads and increases in interest rates.

Real Estate Overview

While many investors now avoid exposure to real estate (besides direct exposure through their residence), we believe this asset class can still offer valuable diversification benefits, as well as opportunities for enhanced returns in certain environments.

VNQ [Fact Sheet]

We have allocated half of the real estate component of this ETFdb Portfolio to VNQ, a well-diversified, relatively inexpensive domestic real estate fund. This ETF invests in REITs across a number of sectors, including industrial, commercial, residential, and retail properties. VNQ is one of the cheapest options for investors to gain exposure to the U.S. real estate market, with an expense ratio of just 0.15%.

ETF Correlation Matrix

Diversification is a key component of any client portfolio. The above chart shows the correlation between each component of the 5 Years Til Retirement ETFdb Portfolio over the last two years. It is noted that because STPZ is a recently launched fund, the correlation metrics presented for this ETF are indicative of a different ETF that invests exclusively in inflation-protected securities: TIP.

As is expected, there is a fairly strong correlation between the equity components in this ETFdb Portfolio. The fixed income elements of this ETFdb Portfolio add meaningful diversification benefits to the portfolio. Overall, this portfolio maintains a moderate degree of diversification resulting from the significant allocation to fixed income securities.

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The information herein is not represented or warranted to be accurate, correct, complete, or timely. Past performance is no guarantee of future results. All investors should read applicable prospectuses before investing.

From time to time, the authors of this report or other employees of ETF Database may have a long or short position in securities referred to herein. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to the accuracy or completeness or otherwise.