Q. I am close to retirement. I have a fairly large portfolio with a healthy mixture of fixed income products as well as stocks and equity ETFs. When I look at funds such as the BMO Monthly Income ETF (ZMI) or the iShares Diversified Monthly Income ETF (XTR), they seem similar to my own portfolio, although I have more global exposure. Is there a significant risk in simplifying my life by putting all of my investments into products such as these? — Wayne
I’m a big fan of simple portfolios, Wayne, especially for DIY investors. A smaller number of moving parts usually means your portfolio will be cheaper and easier to manage, with fewer opportunities for costly mistakes.
The BMO Monthly Income ETF (ZMI) and iShares Diversified Monthly Income ETF (XTR) are both “funds of funds” built from several other ETFs, so they’re as well diversified as many portfolios that include dozens of individual stocks and bonds. And because both ETFs focus on income-generating assets (bonds and dividend-paying stocks), they are appealing to investors who are drawing down their portfolios in retirement.
But before you invest all of your nest egg in a single ETF, let’s have a look at the asset mix in these products:
The first thing you’ll notice from the table above is that the two ETFs have quite different exposures. XTR has significantly more in bonds, as well as only a small amount of foreign equities; ZIM has much more global diversification. If you dig deeper you’ll also find that XTR holds only plain-vanilla stock and bond funds, while ZIM includes some more exotic investments such as floating-rate notes, emerging market bonds and a couple of ETFs that write call and put options on their underlying stocks to generate more income.
The lesson here is that you really need to understand what’s under the hood of a monthly income fund and make sure the asset mix is appropriate. If you’re an aggressive investor, XTR’s high weighting to bonds may not be a good fit. And if you’re relatively conservative, the complexity of ZMI may leave you scratching your head.
Moreover, if you plan to use a monthly income ETF as your only holding, the iShares version is just too focused on Canada. You’ve anticipated this, Wayne, by noting that your own portfolio has more global exposure. It’s important to diversify your equity holdings by including both U.S. and international stocks: a mix of roughly one-third in each is a good rule of thumb.
Finally, while a one-fund portfolio scores big for convenience, it’s likely to be quite tax-inefficient. This isn’t a big issue if the vast majority of your assets are in RRSPs and TFSAs, but if you’ve got a sizeable non-registered account, both of these ETFs are likely to come with hefty tax bills. This is because they’re filled with high-coupon corporate bonds, real-estate investment trusts, and high-dividend foreign equities, all of which generate a lot of fully taxable income.
For all of these reasons, I would tend to advise against using a monthly income ETF as the only holding in a large portfolio. Wayne, you can certainly simply your portfolio by exchanging your individual bonds and stocks for ETFs. But by building your new streamlined portfolio from five or six carefully selected funds rather than an all-in-one solution you’ll be better able to control your risk level, diversification, and tax-efficiency.
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