ETFs As an Investment for Retirement

November 14, 2012

ETFs As an Investment for Retirement

etfs investmentThere is a great difference between an income earner in his 30s, and another income earner in his late 50s and 60s. Those nearing retirement have lesser number of years to work, and so a narrower window of opportunity when it comes to getting money from a steady income source in order to invest. As such, it is essential that investors in this category get their investments right from the get-go as there is little margin for error, especially when it comes to ETFs.

Exchange traded funds (ETFs) now make up about 10% of all money invested in the financial markets. They can represent a balanced mix between a steadier type of investment and reasonable returns based on the trader’s risk appetite.

ETFs are created to enable traders make money by being positioned in several profitable assets packed into one basket. Due to the fact that the investor who is close to retirement does not have the luxury of time to recover from risky and bad bets in the market, it is essential that a less risky style of ETF investing is employed ab initio. A person with up to 30 years of work still to come (in stable professions) has a lot of time to recover from a bad investment, but a near-retiree with less than 5 years left on the job does not have that kind of time. For this class of people, a strategy that will aim to for capital preservation followed by conservative compounding over the remaining years of working life is a better approach. Trying to hit one huge home run is a bad gamble and nerve really ends well, and this forces the investor to take more risk and this could just be the beginning of a life of poverty after retirement. Surely, this is not what near-retirees envisage for their lives after working hard for many years.

If you are a near-retiree, or you have just gone into retirement and you are looking for a way to structure your ETF investment so they are profitable without putting you under so much risk-induced stress, you can try a class of ETFs built specifically for retirement investing. These are the so-called target date ETFs. These ETFs employ a unique asset allocation strategy that makes the ETF basket more conservative as the years go by.

Target ETFs work best when started a good number of years before retirement. An investment start date of about 15 years pre-retirement is perfect for the use of target date ETFs. The ETF basket starts off with a greater concentration of the basket being in more speculative instruments such as stocks and maybe commodities and forex. The more conservative instruments make up the least percentage of the basket. So we could have something like this:

–       Stocks- 40%

–       Currencies/commodity derivatives- 50%

–        Bonds- 10%

Under the investor-manager agreement guiding target date ETFs, the asset allocation ratios are adjusted by the account managers on a yearly basis in such a way that the less conservative components of the ETF basket are gradually reduced while the more conservative components of the ETF basket begin to take a more prominent place in the ETF. This continues throughout the duration of the ETF investment so that by the time the investor is due for retirement, the ETF basket may be composed of almost entirely very conservative instruments. So our basket will now look like this:

–       Stocks – 15%

–       Commodities and other derivative instruments – 5%

–       Bonds –80%

The asset re-allocations are performed by the asset manager at a date that is agreed by the manager and investor when the agreements are being signed so that the rebalancing of assets in the ETF basket can be done automatically without the investor even having to know about it, knowing that his bases are covered.

With such a wide range of instruments that can be used to make up an ETF basket, any asset manager worth his salt should have no problems performing the correct rebalancing and reallocation of assets to match the target dates. The example given above is hypothetical and usually, the number of years that the investor has before retirement will determine the frequency of the asset reallocation as well as the composition of the ETF basket.

Target date ETFs are the safest form of ETF investing for retirement. There are other forms of ETF investing for retirement. We also have ETFs that make up part of a 401K retirement plan. Whatever one that is used to prepare for retirement, the investor must make sure that the asset manager can boast of a good track record with lots of references to back up the entire investment.