High dividend and interest funds are important for retirement investing, especially for retirees. Traditionally, income investors have to utilize income producing dividend mutual funds for income investing purpose. Today, with the explosion of ETF offerings, investors now have many income producing ETFs to choose from. It is thus pertinent to compare investment plans that use ETFs vs. those using mutual funds. In this article, we compare an ETF based income investing plan with a plan using Schwab's income mutual fund select funds.
Schwab's Income Select List was developed and is managed by the Charles Schwab Investment Advisory, Inc. (CSIA) experts and includes mutual funds that have met their rigorous criteria, including both quantitative and qualitative factors. All are no-load and no-transaction fee and are selected based on their ability to generate income in their respective asset classes. The list is designed to help you achieve income and growth. The list is updated quarterly by Schwab. See here for latest update.
We form a plan that uses all of the 37 funds in Schwab's income select list. These funds enable participants to gain exposure to four major assets: U.S. equity, foreign equity, REITs, and fixed income. The following are the funds in the select list:
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE GROWTH | SWLSX | Schwab Large-Cap Growth |
| LARGE BLEND | SWANX | Schwab Core Equity Inv |
| Foreign Large Blend | SICNX | Schwab International Core Equity Inst |
| LARGE VALUE | TWEIX | American Century Equity Income Inv |
| LARGE BLEND | TICRX | TIAA-CREF Social Choice Eq Retail |
| LARGE BLEND | PRBLX | Parnassus Equity Income - Inv |
| LARGE VALUE | PQIAX | Principal Equity Income A |
| MID-CAP BLEND | NMMCX | Northern Multi-Manager Mid Cap |
| Foreign Large Blend | LISOX | Lazard Intl Strategic Equity Open |
| LARGE GROWTH | JENSX | Jensen J |
| REAL ESTATE | CSRSX | Cohen & Steers Realty Shares |
| MID-CAP VALUE | ARDEX | Aston/River Road Dividend All Cap Val N |
| Foreign Large Value | AAIPX | American Beacon Intl Equity Inv |
| Muni National Interm | SWNTX | Schwab Tax-Free Bond |
| Intermediate-Term Bond | SWIIX | Schwab Premier Income Instl |
| Intermediate Government | SWGSX | Schwab GNMA |
| Muni National Interm | TWTIX | American Century Interm-T Tx-Fr Bd Inv |
| Emerging Markets Bond | TGINX | TCW Emerging Markets Income N |
| Muni National Interm | STTBX | RidgeWorth Investment Grade T/E Bond I |
| High Yield Bond | STHTX | RidgeWorth High Income I |
| ULTRASHORT BOND | SIGVX | RidgeWorth US Gov Sec Ultra-Short Bd I |
| Intermediate-Term Bond | SAMFX | RidgeWorth Total Return Bond I |
| Intermediate-Term Bond | PTTDX | PIMCO Total Return D |
| Multisector Bond | PONDX | PIMCO Income D |
| Intermediate-Term Bond | PGBOX | JPMorgan Core Bond A |
| WORLD BOND | PFODX | PIMCO Foreign Bond (USD-Hedged) D |
| Muni National Long | NOTEX | Northern Tax-Exempt |
| Intermediate-Term Bond | MWTRX | Metropolitan West Total Return Bond M |
| High Yield Bond | MWHYX | Metropolitan West High Yield Bond M |
| Intermediate-Term Bond | FTRFX | Federated Total Return Bond Instl Svc |
| Short-Term Bond | FSTIX | Federated Short-Term Income Instl |
| Muni Short | FSHIX | Federated Shrt-Interm Dur Muni Instl |
| SHORT GOVERNMENT | FIGTX | Federated US Govt 2-5 Yr Instl |
| Intermediate Government | CPTNX | American Century Government Bond Inv |
| Short-Term Bond | ACSNX | American Century Short Duration Inv |
| Muni National Long | ACLVX | American Century Long-Term Tax-Free Inv |
| Inflation-Protected Bond | ACITX | American Century Infl-Adj Bond Inv |
In our previous articles, we introduced the Retirement Income ETFs II plan. Similar to the above Schwab's income mutual fund plan, this plan consists of 36 funds. These funds enable participants to gain exposure to five major assets: U.S. equity, foreign equity, emerging market equity, REITs, and fixed income. The following shows the ETFs:
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE BLEND | VIG | Vanguard Dividend Appreciation ETF |
| LARGE VALUE | DVY | iShares Dow Jones Select Dividend Index |
| LARGE VALUE | SDY | SPDR S&P Dividend |
| MID-CAP VALUE | PEY | PowerShares HighYield Dividend Achievers |
| MISCELLANEOUS SECTOR | PFF | iShares S&P U.S. Preferred Stock Index |
| Foreign Large Value | PID | PowerShares Intl Dividend Achievers |
| Foreign Large Value | IDV | iShares Dow Jones Intl Select Div Idx |
| REAL ESTATE | IYR | iShares Dow Jones US Real Estate |
| REAL ESTATE | ICF | iShares Cohen & Steers Realty Majors |
| Global Real Estate | RWX | SPDR DJ Wilshire Intl Real Estate |
| High Yield Bond | HYG | iShares iBoxx $ High Yield Corporate Bd |
| Long-Term Bond | LQD | iShares iBoxx $ Invest Grade Corp Bond |
| Long-Term Bond | VCLT | Vanguard Long-Term Corp Bond Idx ETF |
| Intermediate-Term Bond | CIU | iShares Barclays Intermediate Credit Bd |
| Intermediate-Term Bond | CORP | PIMCO Investment Grade Corp Bd Index ETF |
| Short-Term Bond | CSJ | iShares Barclays 1-3 Year Credit Bond |
| Short-Term Bond | VCSH | Vanguard Short-Term Corp Bd Idx ETF |
| Intermediate Government | IEI | iShares Barclays 3-7 Year Treasury Bond |
| LONG GOVERNMENT | IEF | iShares Barclays 7-10 Year Treasury |
| SHORT GOVERNMENT | SHY | iShares Barclays 1-3 Year Treasury Bond |
| LONG GOVERNMENT | TLT | iShares Barclays 20+ Year Treas Bond |
| Inflation-Protected Bond | TIP | iShares Barclays TIPS Bond |
| Intermediate-Term Bond | MBB | iShares Barclays MBS Bond |
| Muni National Long | MUB | iShares S&P National Municipal Bond |
| Muni National Short | SHM | SPDR Lehman Short Term Municipal Bond |
| WORLD BOND | BWX | SPDR Lehman Intl Treasury Bond |
| Emerging Markets Bond | EMB | iShares JPMorgan USD Emerg Markets Bond |
| Emerging Markets Bond | PCY | PowerShares Emerging Mkts Sovereign Debt |
| LARGE VALUE | VYM | Vanguard High Dividend Yield Indx ETF |
| DIVERSIFIED EMERGING MKTS | DEM | WisdomTree Emerging Markets Equity Inc |
| LARGE VALUE | FVD | First Trust Value Line Dividend Index |
| WORLD BOND | WIP | SPDR DB Intl Govt Infl-Protected Bond |
| REAL ESTATE | VNQ | Vanguard REIT Index ETF |
| DIVERSIFIED EMERGING MKTS | VWO | Vanguard Emerging Markets Stock ETF |
| Equity Energy | AMJ | JPMorgan Alerian MLP Index ETN |
| DIVERSIFIED EMERGING MKTS | EEM | iShares MSCI Emerging Markets Index |
As of Jun 28, 2011, the Schwab's plan investment choice is rated as above average based on the MyPlanIQ Plan Rating methodology that measures the effectiveness of a plan's available investment funds. It has the following detailed ratings:
Diversification - Rated as great (85%)
Fund Quality - Rated as above average (82%)
Portfolio Building - Rated as above average (82%)
Overall Rating - above average (83%)
Similarly, the Income ETFs II plan investment choice is rated as above average. It has the following detailed ratings:
Diversification - Rated as great (95%)
Fund Quality - Rated as below average (22%)
Portfolio Building - Rated as above average (75%)
Overall Rating - above average (65%)
From the above, we can see the Income ETFs plan offers better diversification but has lower fund quality compared with the Schwab's plan, indicating that the mutual funds still offer better quality through their actively management styles.
We then construct two asset allocation model portfolios from each plan: one is based on strategic asset allocation and the other based on tactical asset allocation strategy. The following shows the portfolios' performance.
Click to enlarge
Performance table (as of Jun 28, 2011)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Schwab Income Mutual Fund Select List Tactical Asset Allocation Moderate | 20% | 163% | 12% | 114% | 12% | 111% |
| Schwab Income Mutual Fund Select List Strategic Asset Allocation Moderate | 15% | 223% | 6% | 35% | 5% | 34% |
| Retirement Income ETFs II Tactical Asset Allocation Moderate | 14% | 119% | 11% | 88% | 13% | 92% |
| Retirement Income ETFs II Strategic Asset Allocation Moderate | 19% | 166% | 5% | 19% | 6% | 24% |
From the above, one can see both the ETF and Schwab plans offer very similar performance, but the Schwab plan has higher Sharpe ratios. This is due to the more volatile nature of ETFs (due to exchange continuous trading). But on the other hand, ETFs offer flexibility while for Schwab mutual funds one has to obey the 90 day minimum holding periods for those funds (this restriction is observed in the portfolio simulation).
To summarize, income producing ETFs are now able to compete with income producing mutual funds in constructing asset allocation portfolios. This is a significant development for many retirement and income oriented investors.
Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.
Disclosure: I am long IYR, TLT.
