Key Points
ETFs can provide low expenses, tax efficiency, and income generation.
Layering different ETFs into your portfolio is a good way to remain diversified.
Like any investment, it's up to you to keep an eye on how your ETF is doing.
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As exchange-traded funds (ETFs) become more popular, you may wonder if it's possible to retire with an ETF-only portfolio. The answer is yes, and many investors already do so. The key is whether the mix of ETFs you hold provides the diversification, income, and risk level your retirement plan requires.
The benefits of building an ETF-only portfolio for retirement are impressive. They include income generation, simplicity, long-term growth potential, low expenses, tax efficiency, and the all-important factor of diversification.
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Why ETF-only retirement portfolios work
ETFs are baskets of securities that you can buy and sell like stocks. They typically track broad indexes or specific asset classes. That means that if you own an ETF tracking the S&P 500 (SNPINDEX: ^GSPC),
Nasdaq Composite (NASDAQINDEX: ^IXIC), Russell 2000, or some other index, your ETF should closely mirror that index's performance.
Taking a closer look at the advantages of the ETF-only approach helps illustrate why they can work so well in retirement.
Built-in diversification
Many ETFs hold hundreds or thousands of different securities in a single fund. While you wouldn't normally research and invest in thousands of different securities, an ETF allows you to own them. By keeping that many different assets in your portfolio, you spread the risk across different sectors and companies.
Low cost
ETFs typically have low (to very low) expense ratios, leaving more money in your account to compound.
Liquidity
ETFs trade all day, which means you can sell them anytime during market hours. If you need cash, ETFs provide access.
Tax efficiency
Because of their structure, ETFs tend to generate fewer capital gains distributions than mutual funds.
Ability to diversify even more
In addition to broad market ETFs, sector ETFs are available. These sector ETFs cover everything, from food to healthcare and technology. As you research different sectors, you can add them to your portfolio, a move that provides you with even greater diversification.
Key considerations
While building a well-diversified ETF-only retirement portfolio can work beautifully, there are several issues to keep in mind. For example:
- You're still in charge: ETFs are not set-it-and-forget-it investments. You need to keep an eye on what's going on with each fund. For example, if you notice that an ETF's gains or losses are significantly different from the gains or losses of the index it's tracking, there's a tracking error that you'll want to investigate. It may be that your fees are too high or that the fund needs rebalancing.
- You must choose your asset allocation: Let's say you want four or five ETFs to round out your portfolio. You must decide your split between stock ETFs, bond/cash ETFs, and broad market and sector ETFs -- based largely on your risk tolerance and income needs.
- There's a sequence-of-returns risk: Buying into a heavy equity ETF allocation shortly before or after you retire can expose you to market losses early in your withdrawal period.
The moral of the story is this: You can absolutely build an ETF portfolio that carries you through retirement. The wise move when making such a big decision may be to meet with a financial advisor who can walk you through your options and help you determine which ETFs are most likely to help enhance your golden years.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
