Using Defined Income ETFs for Retirement Income

By Keith Whitcomb, RMA

One year my son’s baseball team played in the league championship game. Everything was going great until the star pitcher got tired a few innings too early. In the absence of a viable alternative, the coach was forced to come closer. He was a big kid who could throw hard, but not for very long. After a good run he went wild and the other team kept winning. It showed how in baseball it can be difficult to find a good pitch between the starter and the closest. These middle sleeves …

Likewise, it can be difficult to determine how to invest in these middle stages of a laddered retirement income investment strategy. Year one or year two assets are likely located in high quality cash or near cash. At the other end of the scale, you can get more aggressive and invest in stocks. But what about the three to six years in between?

Traditionally, a portfolio of “safe” bonds would work, or even match, to meet future liabilities. However, given the current low interest rate environment and mounting inflationary pressures, there is little return and significant risk in bonds.

Defined Income ETFs

Strategies that protect against downturns in financial markets by selling off the appreciation potential of assets have been around for years. For retail investors, variable annuity products sold by insurance companies provide this protection in a convenient way. Unfortunately, low liquidity, high fees, minimum key account amounts and complexity have made these solutions a poor fit for many.

Enter the defined-income exchange-traded fund. By shaping the risk / return profile of your assets to match the timing and nature of your budgeted cash flows, this product brings together desirable risk management properties in an ETF package that eliminates many of the loopholes in variable annuities. . It can be a good choice for the rungs of a laddered portfolio strategy that fall between short term stable / liquidity oriented investments and long term appreciation oriented investments. For example, you can use a large buffer for short-term non-discretionary steps and a smaller buffer for longer-term discretionary needs. Here is some additional information:

product detailsInnovative Capital Management first launched this ETF in August 2018 and shares a leading role in this space with First confidence/ CBOE vest. Typical product features include: daily liquidity, twelve month protection period, automatic cap and buffer rollover and reset, a range of upside / downside hedging alternatives and a choice of benchmarks, including SPY, QQQ, EFA and Russel. 2000. New structures are sold at the start of each month, allowing you to spread your purchases throughout the year. This can avoid being exposed to a single annual reset date.

protection – With this product, investment gains are capped at a defined maximum percentage. On the other hand, losses are minimized with a more flexible “buffer”. The buffer provides a layer of protection, but negative feedback outside of a specified coverage range will be yours. Since the cost of protection is paid by selling your asset appreciation opportunity, the more you forgo the potential upside, the more downside protection you get. Here is a table of the cap / buffer conditions for April 2021 that uses the S&P 500 as the benchmark asset.

Price – The expense ratios of these ETFs are around 0.80% (plus any brokerage commissions, trading fees, taxes and extraordinary expenses), which seems high for an ETF. However, compared to insurance products with similar risk mitigation characteristics that are priced at 1.25% for management and subject to other fees (such as contract maintenance fees, withdrawal fees, premium taxes and investment fund operating expenses), the cost seems more reasonable.

Performance characteristics – One of the first things you will notice with this ETF is that it does not follow the benchmark asset during the twelve month income period, but reaches its structured valuation at the end of that period. This is in part due to the pricing behavior of the options used to build the product. The bottom line here is that while you have the ability to buy and sell on a daily basis, it may not be financially beneficial to do so. Additionally, the benchmark assets of these ETFs are generally price appreciation only, which means dividend income is not included. However, the goal here is to improve risk management and participate in the potential for better returns compared to bonds, not to beat low-cost total return equity ETFs. To get an idea of ​​intra-year pricing behavior, see this online site tool.


Let’s face it, if you’re in accumulation mode and have decades before you need to mine your portfolio for cash, capping upside potential may be unnecessary and could end up stunting your account growth. . But for people with a medium-term investment time horizon, like saving for college or a down payment on a house, having the ability to control return on equity can be helpful. The Defined Income ETF is perhaps the most attractive for projected cash flow needs in retirement. The prospect of investing in low yielding bonds that have no downside protection, or risk-managed insurance products with high fees and restrictions, makes this ETF an attractive alternative.

After that? Try one on for size. Consider starting with a small position, perhaps with excess cash in your brokerage or IRA account. Also remember to make this purchase at the beginning of the month. This will prevent any change in the hedge profile that occurs after the ETF enters the market. From there you can get an idea of ​​its performance. Who knows, this ETF might give you “mid-round” relief!

About the Author: Keith Whitcomb, RMA®

Keith Whitcomb, MBA, RMA®, is the Director of Analysis at PERKY and has over 20 years of institutional investment experience. He is licensed in the 6, 63 and 65 series.

Do you have questions about your taxes, your personal finances and your investments? Get answers!

Email Jeffrey Levine, CPA / PFS, Director of Planning at Buckingham Wealth Partners, at: [email protected]

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