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You worked hard raising your family. You were fiscally responsible keeping debt under control. You invested regularly in your 401K even years where it was difficult to do so. Now the time has come for your portfolio to work for you. As you enter a new stage of investing, the distribution stage, justifiably you have concerns. What approach to investing will best serve your needs, will last through your entire retirement and provide support for generations to come?

Exchange Traded Funds are a common way to invest preferred by many in part because management fees are often considerably lower than those associated with mutual funds. People also like that they provide broad exposure to the market or segments of the market. Most track indexes such as the S&P 500. For more than 20 years that was how I invested in my 401K with the Federal government as part of the Thrift Savings Program or TSP, as its commonly known. It's a solid retirement program with very low fees. It served me well.

In 2008 things changed when I retired and moved from the accumulation phase of investing to the distribution stage. Suddenly it was about income, not just capital gain.

I had moved into all cash in the months before my retirement and stayed there until it became apparent that earning less than 3% while "safe" wouldn't cut it long term.

In 2011 I rolled my 401K into a self-directed account in large part because of my concerns about the index funds provided in the TSP. Frankly I didn't like the high exposure to banks and technology. I felt I could not longer invest in the S&P 500 Index and sleep well at night, even though this same Index had served me well for more than 20 years, earning an average return during that period of 9.75%.

In 2011 I discovered Dividend Growth Investing and began to discuss my personal investment experience using this approach with my personal portfolio here on Seeking Alpha. Over and over in the articles I write I am asked the question "Can't I just follow the model of Dividend Growth Investing through an ETF"? Let's see how such an ETF might play out during the accumulation stage where safe and growing monthly income is job one.

A common theme of many writers here at Seeking Alpha of late is their belief that Dividend Growth Investors lack a true understanding of the risk they are taking by not embracing the "tried and true" approach of a professionally managed portfolio designed to follow Modern Portfolio theory, the basis for most ETFs including many that profess a Dividend Growth approach. David Van Knapp has written a series of articles about Dividend ETFs and why in his opinion they have failed to fully embrace the Dividend Growth approach practiced my many in the distribution stage, chiefly 4% income from equities with five or more years of sustained dividend growth at a rate exceeding inflation.

Let's look under the hood of one of the largest dividend ETFs- The Vanguard High Dividend Yield ETF - VYM. VYM seeks to track the performance of the FTSE - High Dividend Yield Index. According to Vanguard's Web Site VYM currently yields 3.05% and has reasonable fees of .10%. Contributor Bob Johnson has a current article in which he discusses what he sees as the positives associated with this ETF. This ETF provides exposure to 388 dividend-paying stocks yet it is weighted so that just under 35% of your investment lies in the following 10 stocks:

Top Holdings

Company

Symbol

% Assets

Exxon Mobil Corporation

XOM

6.06

General Electric Company

GE

3.61

Chevron Corporation

CVX

3.47

Johnson & Johnson

JNJ

3.36

Microsoft Corporation

MSFT

3.25

Procter & Gamble Company

PG

3.18

Pfizer, Inc.

PFE

3.11

AT&T Inc.

T

3.02

Wells Fargo & Company

WFC

2.94

JP Morgan Chase & Co.

JPM

2.71

Traditionally retirees depending on capital gains to support the 4% withdraw approach have used the S&P 500 Index as their performance benchmark. So how did VYM match up with the market since 2008? Its 5-year average was 9% vs. 7.82% for the S&P 500. It did however trail the market in three of the past five years. O.K with market beating performance, low fees and professional management no wonder so many have their money invested here.

The larger question remains. How does it measure up as an investment choice for retirees during the distribution stage?

Many dividend growth investors favor equal weight positions to limit reduction to income should a stock cut or eliminate its dividend. Many hold 50 or more equal weight positions to further safeguard lost income due to a dividend cut or elimination. The largest position in VYM is Exxon Mobile - XOM, which yields 2.5% at over 6%. If XOM were held in a 50-stock Dividend Growth Distribution Portfolio it would only represent an investment of 2%. Should an event occur that resulted in an elimination of the dividend it would have a much lesser impact on an investor's monthly income from dividend distributions.

Of the top-10 holdings for VYM, four would be rejected by many retired dividend growth investors who require equities with five or more years of sustained dividend growth at a rate exceeding inflation. General Electric - GE, Pfizer - PFE, Wells Fargo - WFC and J.P. Morgan all lack that record of dividend consistency having cut their dividends following 2008. Others would be concerned about such heavy exposure to big banks in general after what happened in 2008.

Inconsistency in quarterly yield and dividend distribution is another area of concern for many in the distribution stage. Many in this stage favor constructing a portfolio that yields a minimum of 4% and dividends with expected dividend growth greater than inflation. Those favoring this approach are seeking to obtain necessary retirement income without the need to apply the traditional 4% plus inflation withdraw rule.

By not selling stock for income each month, each quarter or each year they are increasing their chances of outlasting their portfolio. With an ETF like VYM and inconsistent distributions under 4% plus inflation, investors in the distribution stage will be more likely to need to sell low to obtain necessary income including times of pullbacks and bear markets.

Many have expressed that retirees new to Dividend Growth investing will lack the necessary staying power the next time the market retreats 25%, particularly those facing such a pullback for the first time as Self Directed Investors. Let's look for a moment at performance for the market and VYM during the last severe market retreat in 2008. The S&P 500 Index declined in 2008 by 37% while VYM declined by 32.1%. What is even more disturbing is that the number of dividend cuts from the S&P 500 meant significant reductions in monthly dividend income.

High concentration of banks, technology and drugs and low concentration of consumer staples and utilities resulted in greater losses in monthly income than was the case with Dividend Growth Distribution Portfolios favoring consumer staples, utilities and in general things people need to live. Losses again were less severe when positions were equal weight. Of the top-10 weighted stocks in VYM, Microsoft - MFST lost 44.1% of its value and General Electric - GE a staggering 52.95%. To its credit Microsoft continued its regular dividend payments to its stockholders.

In Part Two of this series I'll be comparing the performance of VYM for each year from 2008 forward when compared to both the market and typical Dividend Growth portfolios.

I'll also be considering what might happen to a first-year distribution phase investor with an investment mix of 60% VYM and 40% Treasuries in terms of both income and capital should be have a repeat of what the market sustained in 2008. For now it is time to hear from those of you either in the distribution stage or getting close to the date when your portfolio works for you. What do you believe is the best combination for a "Sleep Well at Night" Portfolio to best serve your needs during this important final stage of investing?

Disclosure: I am long T, CVX, JNJ, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Do Retirees Need A Dividend ETF Or A Portfolio Of Individual Stocks?