This story appears in the August 16, 2015 issue of Forbes. Subscribe
Do you need a steady flow of cash from your portfolio? Vanguard has a pretty good deal for you. I have a better one.
The product Vanguard wants you to buy is its Managed Payout fund. This cocktail of stocks, bonds and commodities delivers a nice monthly distribution--a bit more than $3,000 a month on a $1 million stake.
Dividend and interest yields are pretty meager these days, so in order to come up with your monthly check Vanguard has to sell off a few securities. Offsetting these asset sales is the appreciation on the stocks, in which the fund is a net 63% invested.
Over time you may reasonably hope your $1 million will not shrink too much, although it will suffer some tumultuous swings. Managed Payout's share price got killed in 2008. Then it came back to life. If all goes well, Vanguard will be able to boost your paycheck over the years, almost keeping up with the cost of living.
What's not to like? Two things.
The first is the portfolio. Managed Payout has a fifth of your money in "minimum volatility" stocks--sleepy issues like Galenica (a Swiss drug firm) and Clorox. This part of the fund has done well over the past year, but so what? Low-vol investing is a fad.
A tenth is in a "market neutral" fund. The concept here: You buy stocks that go up while shorting stocks that go down, thereby making money in both bull and bear markets. Lovely idea, except that everyone on the planet is trying to buy stocks that go up and sell stocks that go down. A fair expectation for the real return from market-neutral investing is 0%. You don't need this.
Besides the asset mix, I have to quibble with Managed Payout's price tag. Not counting some borrowing costs buried in that market-neutral poker game, the fund has an expense ratio of 0.29%, or $2,900 a year on a $1 million investment. You can do better. Create a home brew out of Vanguard ingredients--its cheap index funds--and you can get your cost down to $780 a year.
The do-it-yourself portfolio starts with a 35% allocation to the Vanguard Total Stock Market fund and 20% to the Vanguard Total International Stock fund.
Now put 25% in Vanguard Total Bond Market. This fund is heavily weighted to shorter-term bonds. Stretch out DIY's maturities by adding a 15% allocation to Vanguard Long-Term Bond. Yes, long-term bonds are risky, but the risk matches the risk built into what you are trying to underwrite, which is a stream of income lasting several decades.
Managed Payout goes global with its bonds. But that means accepting miserable yields in Europe and Japan. My allocation to foreign bonds is 0%.
The Managed Payout fund directs 5% of your money to a Deutsche Bank commodity index. It's not a bad idea to have an inflation hedge, but you don't have to pay a bank to get one. Instead of owning futures, own profit-making, dividend-paying commodity producers. Buy twin $25,000 stakes in Chevron (CVX, 92) and BHP Billiton (BHP, 37). The fact that Chevron's hydrocarbons and almost all of BHP's ores are in oversupply should not deter you; the demand for resources is destined to climb over time.
My portfolio generates $27,000 a year in interest and dividends. (A little over $2,800 would come from Chevron and Billiton, even though these account for only 5% of the portfolio.) So to get your monthly check, you'll have to sell $9,000 of positions annually. Don't be dismayed. That's a considerably slower pace of sales than Managed Payout is currently forced to undertake.
My estimate of the long-term real return on Managed Payout is 3.2% a year, which is a little shy of your draw-down rate. I expect 3.6% from Do-It-Yourself. With the latter you have a better shot at keeping up with the cost of living and leaving behind the original principal for a spouse or another heir.
If your money is at Vanguard, use its mutual funds to build the core of your DIY fund. If it's elsewhere, use the exchange-traded share classes of those Vanguard funds. Tickers for the ETFs are VTI , VXUS , BND and BLV.
You can't beat the money management costs here. Expense ratios are 0.05% for VTI, 0.15% for VXUS, 0.07% for BND and 0.10% for BLV. You pay nothing to hold stocks you picked yourself.
