Using Mutual Funds To Generate Retirement Income
In retirement, it's more crucial than ever to preserve capital. Because retirees are no longer working, they can't live off income from a job. That means drawing down from retirement accounts to cover living expenses.
It also means decreasing exposure to stocks, which are riskier than bonds. Even within the broader asset class of equities, it's crucial to manage risk. For example, small caps tend to have higher volatility than large caps, so a retiree's portfolio must be designed carefully to generate some growth, while mitigating risk so as not to jeopardize principal.
TIAA-CREF Lifecycle Retirement
The TIAA-CREF Lifecycle Retirement Income Fund Institutional (MUTF: TLRIX) has a one-year return of 7.06 percent.
This is a "fund of funds,” in which managers typically allocate around 40 percent into stocks and 60 percent into bonds.
The top holding is the TIAA-CREF Bond Fund Institutional Class (MUTF: TIBDX), accounting for 26.63 percent of the fund. That weighting indicates the conservative nature of the overall fund.
Vanguard Target Retirement
Another fund widely used by retirees is the Vanguard Target Retirement Income Fund Investor Shares (MUTF: VTINX). This has a one-year return of 6.47 percent.
This fund's allocations automatically shift as the owner ages. At retirement, the allocation is a 50-50 stock/bond split. Stock exposure is ratcheted down to 30 percent in the seven years following retirement.
This, too, consists of other funds. The top holding is the Vanguard Total Bond Market II Index Fund Investor Shares (MUTF: VTBIX), constituting 39.36 percent of fund holdings. The second-most heavily weighted investment is the Vanguard Total Stock Market Index Fund Investor Shares (MUTF: VTSMX) at 21.05 percent.
By overweighting fixed income, fund managers understand that returns won't match those of equities. However, bonds smooth out the effect of stock market gyrations, and give retirees a way to draw income during an equity market correction. It's still necessary to maintain equity exposure, to allow for some growth. But weighting more heavily toward stocks helps manage downside risk in retirement.
© 2016 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.