The best ETFs for retirement income - MoneySense (2024)

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While exchange-traded funds (ETFs) are appropriate for investors of all ages and life stages, they make particular sense for retirees and those close to retiring. Things like quick and easy broad diversification of asset classes and geographic exposure at a reasonable price are especially relevant when you no longer wish to be exposed to single-stock risks. Mind you, concentration risk still exists even with ETFs because sector or regional ETFs continue to be released, typically with higher fees. Just look at the current furor over AI ETFs (those specifically for artificial intelligence tech companies). So let’s look at retirement ETFs for Canadian investors.

I began researching this topic as part of aMoneyShowpresentation scheduled early in September on MoneySense’s ranking of the best ETFs in Canada. The session will be conducted by myself and MoneySense executive editor Lisa Hannam. Readers may recall I was the lead writer for the annual ETF package—when it was called ETF All-Stars—but after almost a decade, I passed the reins to new writers. This year’s edition was spearheaded by Michael McCullough.

While the MoneySense ETF list (now selected by a panel of seven Canadian ETF experts) is appropriate for all ages and stages of the financial life cycle, a solid subset of the picks can safely be considered by retirees. While the panel didn’t formally designate any of its picks as “retirement-friendly” per se, we do devote a few slides to them in the upcoming presentation, and I bounced some of the ideas below off of some of the expert panellists.

Are asset allocation ETFs all that a retiree needs?

Arguably, all a retiree would need is an all-in-one asset allocation ETF. These ETFs are single-ticket, highly diversified global plays on the stock and bond markets. They cover most national and international markets and the two major asset classes of stocks and bonds.

As Ben Felix, panellist and portfolio manager and head of research with PWL Capital in Ottawa, points out, these ETFs are internally rebalanced, making them much easier to manage, and a single ticket makes it easier to sell them for income as needed. Despite all this, their management expense ratios (MERs) are quite reasonable at 0.2% or so. Many have been MoneySense ETF picks since Vanguard launched them in Canada back in 2018. They were subsequently matched by BMO, iShares, Horizons and others.

Generally speaking, younger Canadians can use the 100% growth asset allocation ETFs, like Vanguard’s VEQT and BlackRock’s XEQT; or slightly more conservative 80% growth/20% fixed-income vehicles like VGRO or BMO’s ZGRO. (All tickers listed here trade on the TSX.)

Near-retirees might go with the traditional 60/40 stocks/bonds mix of classic balanced funds and indeed pension funds, such as Vanguard’s VBAL, iShares’ XBAL and BMO’s ZBAL, to name three popular ETFs.

The MoneySense ETF feature recommends just three asset allocation ETFs for 2023, whittled down from a much larger selection in previous years. They range in risk from an aggressive 100% stocks (XEQT) to the slightly less aggressive 80% stocks/20% bonds mix of XGRO and ZGRO.For retirees wanting an even more conservative mix, Felix says, “VBAL is a solid holding for a retirement portfolio. In some cases, VGRO could also be justified. VRIF is also an interesting product if someone wants to be really hands-off.”

Those fully retired who want even less risk along with a bit of growth could flip to the 40/60 stocks/bonds mix of ETFs like VCNS, XCNS and/or ZCON. A lot of this will depend on your financial objectives and other sources of retirement income. Despite being more than half in fixed income, even these conservative ETFs have significant growth exposure. For example, in XCNS the aggregate weightings include 1.24% in Apple, 1.1% in Microsoft and 0.45% in Nvidia. Compare that with the all-stock XEQT, where Apple makes up 3%, Microsoft 2.67% and Nvidia 1.1%.

Those Canadian investors who are fortunate enough to have a solid inflation-indexed defined benefit (DB) pension could be more aggressive in choosing their asset allocation ETF. And, those without a true DB pension might be more conservative. I’d consider moving up or down in 20% increments, roughly speaking. For example, someone with a DB plan could choose VBAL; those without one, VCNS. However, Felix notes, this depends more on the amount of the pension relative to expenses than on a binary pension-versus-no-pension scenario. These ETFs are available to buy in Canadian dollars and are listed on the TSX. They offer broad global exposure as well as Canadian, all with regular rebalancing. Easy peasy.

Tactical overlays for inflation, low volatility and themes

In practice, most Canadian investors (whether retired or not) may want to do a bit more tinkering with their mix than this. For one, the asset allocation ETFs tend to have minimal exposure to alternative asset classes outside the realm of stocks and bonds. They will own gold stocks and some real estate stocks or real estate investment trusts (REITs), but they have little or no pure exposure to precious metals bullion, commodities or, indeed, cryptocurrencies. (But, maybe for that last asset, that’s a good thing.)

MoneySense’s ETF panellists Yves Rebetez, CFA, partner at Credo Consulting,and Mark Seed, of the My Own Advisor website, aren’t convinced that anyone can rely 100% on asset allocation ETFs. Given volatile markets and unpredictable levels of interest rates and inflation, it can be very risky to go all-in on this type of ETF. That goes double for retirees, when inflation can wreak havoc with long-term nest eggs.

The first half of 2023 didn’t unfold as anticipated, starting with a pivot sooner or later from the U.S. Federal Reserve, with a recovery spurred further by the excitement over ChatGPT, AI and “Nasdaq animal spirits,” Rebetez tells me on a Zoom call. He finds asset allocation ETFs to be “OK, as long as bonds behave.” Bonds, of course, benefited from the long-time bond bubble in the first few years of asset allocation ETFs. That bubble nastily burst in 2022 on both the stock and fixed-income sides, hurt by the successive rises in interest rates. He doesn’t feel we are out of that yet. “Give the bond market more time to digest,” he says, adding that yield curves are still not behaving.

Felix says the fixed-income market looks far more positive in 2023: “Bonds have been declared a dead asset many times in the last decade, and [they] took a beating in 2021 and 2022. This was counterintuitively good news for long-term investors as the now-higher yields far outweigh the capital losses incurred in 2021 and 2022.”

Some MoneySense ETF panellists see a case for adding tactical layers to an asset allocation ETF.

For example, you might use the 40/60 VCNS instead of 60/40 VBAL for 80% of your investments, reserving the other 20% for more tactical mostly specialized equity ETFs. You’d aim for a net 50/50 asset mix after blending the asset allocation ETF and these tactical ETFs, assuming the tactical picks are pure equity plays.

Apart from layering on 10% or 20% of inflation hedges, like gold, commodities or REITs, some of the panellists recommend reducing volatility through “low-vol” equity ETFs, like ZLU (BMO’s low-volatility U.S. equity ETF). By using the more conservative 60% fixed income asset allocation ETFs, that could allow some folding in of equity ETFs that are more defensive in nature.

For taxable/non-registered accounts, you could go with something like ZLB for Canadian equities, or ZLU for U.S. equities. Retirees may feel very comfortable taking a bit more equity risk with such funds, which also provide decent expected annual yields. (More on low-vol ETFs below.)

Another piece of the “retirement ETF puzzle” could be filled with ETFs that provide inflation hedges. Some of you may have seen a couple of Dale Roberts’ blog posts (Roberts is also on the MoneySense ETF panel) on his Cut The Crap Investing website. He writes about what he calls “retirement ETFs” or “defensive ETFs.” He’s especially fond of consumer staples ETFs, as well as health care/pharmaceutical ETFs and utilities ETFs, which are available on both sides of the border. I’ve invested in most of these myself.

Roberts’ site has also championed an ETF I also own: the Purpose Diversified Real Asset Fund (PRA/TSX). In addition to pure equities, it owns gold and silver bullion and commodities futures. Along similar lines is BMO’s Global Infrastructure ETF (ZGI/TSX).

Some Canadian retiree investors may choose pure gold bullion plays like GLD. The panel didn’t formally discuss it, as it’s not technically an ETF. Personally, I find Canadian depository receipts (CDRs), trading in Canadian dollars on the TSX, can also help round out tactical investments. The best example is Berkshire Hathaway (BRK is the CDR ticker), which is low-cost and highly diversified. It takes a deep-value approach to stock-picking.

Of course, its biggest holding is Apple. Similarly, all of the so-called Magnificent Seven U.S. tech giants are also available as CDRs, which some investors may use to play the AI theme. In addition to AAPL (Apple), CDRs include NVDA (Nvidia), MSFT (Microsoft), AMZN (Amazon), TSLA (Tesla), GOOG (Alphabet) and META (Facebook etc.).

Defensive sector ETFs for Canadian retirees

Roberts likes three defensive economic sectors in particular: consumer staples, global utilities and health care. There is plenty of choice here with ETFs traded in U.S. dollars on U.S. exchanges, or defensive ETFs traded in Canadian dollars on the TSX. His three U.S. ETF picks are all from State Street Global Advisors’ SPDR ETFs:XLV Health Care Select SPDR ETF (XLV/NYSE Arca), Consumer Staples Select SPDR ETF (XLP) and Utilities Select SPDR ETF (XLU).

For those Canadian retirees who prefer Canadian-listed ETFs on the TSX, the equivalent ETFs for health care are Harvest’s HHL and BMO’s ZHU; for consumer staples, BMO STPL Global Consumer Staples (STPL/TSX), and iShares XST for Canadian grocers; and for utilities, Harvest Equal Weight Income ETF (HUTL/TSX).

The State Street picks are all 100% U.S. stocks, while the Canadian ETFs tend to be global ones with still-heavy concentrations on U.S. stocks. XST is all Canadian, which could make it a good pick for non-registered accounts, especially for those retirees and near-retirees who want to take advantage of the Canadian dividend tax credit.

Low-volatility ETFs for Canadian retirees

Since U.S. stocks make up roughly half of the world’s stock-market capitalization, low-volatility U.S. ETFs could also make sense for a portion of conservative retiree portfolios.

Best ETFs in Canada panellist Mark Yamada, of PUR Investing, notes that selecting U.S. equities for a portfolio and choosing a low-volatility U.S. equity ETF to do it are “two distinctly different decisions. The common goal is to improve long-term returns, but the paths to achieve this should be considered individually.”

Yamada says Canadian investors, certainly retirees and risk-adverse younger folks, can improve diversification by owning broad-based U.S. indices like the S&P 500, the Nasdaq 100 or the total U.S. market. Note, though, these do include some of the defensive sectors listed above, but also other major sectors that are relatively well represented in Canada (financials, energy, materials) or more in the U.S. (information technology, health care and consumer discretionary).

S&P/TSX Capped Composite versus U.S. indices and U.S. total market

Here, via Yamada, are the sector exposures of the S&P/TSX Capped Composite for Canadian stocks compared with the S&P 500, the Nasdaq-100 and the U.S. total market as at June 30, 2023.

The table shows that U.S. indices have much higher weights in information technology and health care than the Canadian S&P/TSX Composite Index.

“These are important sources of future growth,” says Yamada. U.S. indices also have much lower exposure to financials, a traditional source of stable earnings. “However, lower exposure to energy and materials in the U.S. means less potential volatility from climate instability and supply chain disruption. Diversification means spreading risk to lower volatility and gaining exposure to sectors that may provide more growth.”

Compounding is the true engine for growing financial assets, and volatility impedes compounding. “Higher volatility leads to higher drag,” Yamada says. “The lesson for investors is to lower portfolio volatility. This is the goal for diversification and for some strategies like value investing, too.”

Low-vol ETFs aren’t necessarily structured identically, and ETF sponsors approach this task differently. Three current or former ETFs on the MoneySense “best” list in the low-vol sector include BMO Low Volatility U.S. Equity ETF (ZLU), iShares MSCI Min Vol USA Index ETF (XMU) and Fidelity U.S. Low Volatility Index ETF (FCUL).

As of mid-2023, Yamada found FCUL to have just 5.5% exposure to financials, less than half the 10.2% in XMU and 11.9% in ZLU. And there’s a dramatic difference in exposure to the information technology sector, which is fully 28.3% of the S&P 500.

XMU has roughly market weight in information technology at 30.1% and FCUL has 19.5%, but ZLU has a minuscule 2.5%.

In the other direction, ZLU has 19.4% in utilities, compared to 2.6% for the S&P 500, 3% for XMU and 11.4% for FCUL. Same story with consumer staples: ZLU has 21.5% versus 6.7% for the S&P 500, while XMU has just 5.3% and FCUL is at 13.8%.

What ETFs should Canadian retirees or near-retirees invest in?

So, the lesson for Canadian investors who are retired or will soon be retiring is to check sector weightings. Or, as Yamada says, “Not all low-vol ETFs are the same, so scrutiny is required.”

Finally, there are also annuity-like solutions like Purpose Longevity Fund or Guardian Capital’s GuardPath offering, to which we have devoted past columns (such as Longevity Pension Funds and tontines, respectively).

Obviously, this topic is a vast one, and beyond the scope of this solitary column. See you at the MoneySense MoneyShow session to talk more.

What: Top Canadian ETFs for This Year and Beyond
Who: Jonathan Chevreau and Lisa Hannam
When: Saturday, Sept. 9, 2023, from 12:15 p.m. to 1 p.m. (EST)
Where: Metro Toronto Convention Centre (tap for directions and parking info)
How: Tap the button below to register or call 1-800-970-4355
Cost: FREE!

Read more on ETFs:

• How to use income ETFs for retirement income

• Are ETFs a good investment for an all-weather portfolio?
• How to build an all-ETF portfolio

• Best fixed-income ETFs for Canadian investors