An ETF for Every Age: Investors 50 to 67 Should Dial Down Risk (but Stay Diversified)
The popularity of exchange-traded funds has exploded recently. As part of Money's series on an ETF for every age, the following discusses appropriate strategies and a fund that is suitable for investors ages 50 to 67.
Even though I'm still eight years away, I'm looking forward to my 50th birthday. Not the prostate exams, but routine naps sound nice. So does the ability to sit back and appreciate the decades of compounding growth my portfolio will have experienced by that point.
Because by age 50, if you've been fortunate enough to have extra income to invest over three decades, your money really starts to work for you. Assuming a 10% annual return — which is the S&P 500's average since 1957 — once your principal reaches $100,000, growth begins to rapidly accelerate.
That's the power of compounding, which you can think of like a snowball effect. The larger the principal, the more you earn on it, and the faster growth accelerates. When those earnings are combined with dividend reinvestment and dollar-cost averaging — wherein you commit to making equal contributions on a recurring basis — each monetary mile marker begins approaching at a faster clip.
For people in this age group, that growth is aided by increased annual contribution limits for Roth IRAs. Whereas the annual cap is $7,000 for those 49 and younger, once you hit 50, it increases to $8,000, or $666.66 per month. That additional monthly contribution on top of your $100,000 with an annual 10% return would mean that by age 55, you will have doubled your money, and by age 67, it'd be more than $884,000.
Importantly, for investors ages 50 to 67, a focus on wealth preservation should now tip the scales in favor of safety. That can be accomplished with ETFs that still provide broad market exposure but also give you an appropriate balance between risk and reward.
A shift to safety-focused funds
Preserving your wealth while continuing to grow your principal can be achieved with a number of lower-risk, passively managed index funds, such as the S&P 500 ETF Trust (SPY), the SPDR Portfolio S&P 500 ETF (SPLG) or the Vanguard S&P 500 ETF (VOO). An argument can be made in favor of any of those three, as they are all benchmarked against the S&P 500, feature similar holdings with nearly identical weightings and charge low expense ratios.
However, while those funds all hold more than 500 stocks — which itself offsets some risk compared to narrower, growth-focused ETFs — the issue these funds present to aging investors is their weightings. Because the market has become highly concentrated with the explosive growth of the Magnificent Seven, weighted index ETFs reflect that concentration, too.
VOO, for instance, has 504 holdings, but the companies that make up the Magnificent Seven account for 31.63% of the fund's allocations. For SPLG, it's 31.47%, and for SPY, it's 31.51%.
The solution: An equal-weighted index ETF that allocates identical amounts of money to each company it holds. Equal-weighted funds reduce the impact of any single company's poor performance dragging down the entire ETF. At the same time, they give investors proportionate access to smaller companies (like those at the bottom of the S&P 500), which could provide higher growth potential.
The Invesco S&P 500 Equal Weight ETF (RSP) fits the bill. Its expense ratio of 0.20% is more than offset by its 1.58% dividend, and over the past year, it gained 15.60%. While that lagged the S&P 500's 22.54% gain over the same time, the fund provided shareholders with peace of mind while yielding an average of 66 cents per share each quarter.
Over the past 40 years, large-cap stocks — specifically those represented by the S&P 500 — have had the best returns of any asset class, outgaining real estate, bonds and gold. But if you've spent decades preparing for retirement, now isn't the time to risk your nest egg. Before leaving the workforce, if you still want exposure to the broad market to help ensure financial viability throughout your golden years, equal-weighted ETFs can provide both tempered growth and safety.
More from Money:
An ETF for Every Age: 18 to 35
An ETF for Every Age: 36 to 49