Jul 30, 2012 93 comments

Managed Payout Funds: Automatic Grocery Buying Machines for the Early Retiree

So let’s say you suddenly have a million dollars, and you want to put it to good use.

As a Mustachian, your first instinct would naturally be to invest the money somewhere, in such a way that it provides reliable income to you for the rest of your life. Thus, you would be Financially Independent, and all future decisions of what to do with your time could be made independently of whether or not you get paid for those activities.

But how do you invest a chunk of money, such that it provides this reliable income without running out? If you just pull a few garbage bags of cash out of the ATM and hoard it at home, inflation will destroy its purchasing power over the course of your lifetime, and you’ll spend your last few decades in relative poverty.

You can put it in a savings account at your local bank and earn 0.1% Maybe you’ll get as high as 0.8% at a more modern bank like ING Direct.

Forget it. For large sums of money, a savings account is little better than storing it under the mattress these days.

You can use certificates of deposit or government bonds. Some of these pay 2-3% in exchange for locking up your money for a very long time. You might keep up with inflation, but only if you reinvest all the interest payments, leaving you with nothing to spend.

Many early retirees have turned to owning rental real estate, because it provides a much higher annual cashflow (10% or more is possible), even while the core asset (the houses or apartment buildings), tends to automatically appreciate with inflation. But not everyone has the patience or the interest to be a landlord – even with the option of hiring a property manager to handle the day-to-day operation of the properties.

Real Estate Investment Trusts (REITs) encapsulate many of the benefits of rental house ownership, with fewer drawbacks and absolutely no work. The downside is that your money is still concentrated in one potentially volatile asset class (usually commercial buildings), the tax treatment isn’t nearly as good, and the yield is lower than owning your own property.

While the real estate options sound good, most diehard investors (myself included) feel safer not having all of their eggs in one basket. After all, real estate is only a tiny slice of the world’s economy, so it makes sense to own parts of all of it instead. Because of this, I try to maintain a more diverse “Asset Allocation” that includes plenty of good old-fashioned stocks.

“Stocks!”, you may say. “But how do I fund a retirement with stocks, when they’re always jumping up and down? Won’t I lose all my money when I’m forced to sell low?”

In a word: No. Stocks make a great companion to the early retiree, even when your goal is a steady stream of income.

First of all, by owning index funds, you’ll automatically own a large number of companies that pay regular dividends. This generates a stream of payments that can show up automatically in your bank account on a predictable schedule.

The problem is that dividend yields aren’t all that high these days. Despite the fact that US stocks seem reasonably priced these days when judged by historical standards, the dividend yield is much lower than it was in previous decades. You can blame this on a cultural shift in investors: many of us prefer to have companies re-invest more of their earnings, or repurchase their own shares (multiplying the value of the shares still in the hands of shareholders), instead of paying us their earnings in cold sweet cash. This helps lower the tax burden of owning stocks. I’d prefer higher dividends myself, but I’ve heard from many who like the system how it is now.

So your stocks will in theory go up faster than inflation, even after paying you dividends. But how do you extract this extra value from the stocks, without manually logging into your retirement account every month and deciding exactly how many shares to sell?

One answer is the Managed Payout Fund – which brings us to the real point of this article!

As it turns out, my old standby Vanguard has at least three funds that do exactly what we’re talking about here. You throw in some money up front, and they handle asset allocation and payout, automatically managed with a reasonably low expense ratio.

Depending on how much of your ‘Stash you want to spend each year, you can chose any of the following three funds:

VPGFX pays you 2.7% per year:
https://personal.vanguard.com/us/funds/snapshot?FundId=1497&FundIntExt=INT
VPGDX pays 4.7% per year:
https://personal.vanguard.com/us/funds/snapshot?FundId=1498&FundIntExt=INT
VPDFX pays 6.8% per year:
https://personal.vanguard.com/us/funds/snapshot?FundId=1499&FundIntExt=INT

“So what is really inside these funds, providing the great returns?”, you may ask.

First of all, don’t confuse payout with actual return. While the fund values will tend to grow with the world economy, the payout amount may turn out to be larger than the growth, slowly draining away your principal.

In fact, VPGFX is likely to be the fastest-growing (and most volatile) fund based on its asset mix, even while it has the lowest scheduled payout. The idea is that younger people would use VPGFX, and older would buy VPDFX.

With that caution aside, let’s look at the actual contents of the first fund in our list, just to get an idea of what’s inside.

Vanguard Total Stock Market Index Fund Investor Shares 45.8%
Vanguard Total International Stock Index Fund Investor Shares 19.5%
Commodities 10.2%
Vanguard REIT Index Fund Investor Shares 10.1%
Vanguard Market Neutral Fund Investor Shares 9.7%
Vanguard Total Bond Market II Index Fund Investor Shares†† 4.7%
Total — 100.0%

Aha – from their description we can see that it’s a nice mixture of other Vanguard funds, automatically maintained in a roughly fixed ratio. Very diverse, which means much more stable than an all-VFINX (US stocks) portfolio.

Their stock/bond mix changes to become more conservative as you move down the list – suggesting the older you get, the further down you go. You’ll get even more stability, in exchange for lower expected returns (even as the actual payout increases).

Thus, the highest-payout fund would be likely to draw down your principal faster than inflation over time (unless we see great stock/bond returns from this point on, a little unlikely given that bond prices are already high, which is why yields are almost zero). So you wouldn’t want to count on a lifetime of retirement with, say, $300k in VPDFX, unless you had some nice safety margins elsewhere in your life.

But if I had to take a big chunk of money and convert it to a relatively safe, stable source of lifetime income by making a single investment, I’d feel pretty good about just throwing everything into VPGDX, and simply enjoying the 4.7% annual paychecks for decades to come. For those who just want a single easy answer, a managed payout funds like these can truly become an Automatic Grocery Buying Machine that funds your Early Retirement. Even if you prefer the lower expense ratio and greater control of buying your own selection of index funds, following the allocation ratios set out in these funds represents a pretty good starting point at sensible investing.

Bonus Info:
Every time I write about my love for Vanguard funds, Canadians ask me if there’s an equivalent available to investors in Canada. This is an important question, since expense ratios for Canadian mutual funds (called MERs) are often ridiculous, 1-2% annually or more. In a world where you’re only earning 7% total, this means your fund company is siphoning off up to a quarter of your total income! Therefore, you should be looking for the lowest fraction of a percent possible, and laughing at anything over 0.5% or so (most of my own funds charge well under 0.2%).

A few answers:

Vanguard Canada is now offering some low-fee ETFs on the toronto stock exchange. Although they are not managed-payout funds, you can still create a nice porfolio from them, collect dividends, and sell off shares as needed to fund retirement.

TD’s e-series funds are another competitive source for Canadian investors. MERs are among the lowest in the country, and the funds are no-bullshit index funds. This allows you to steer clear of traditional mutual funds, which underperform even while overcharging. It also allows you to invest without a financial advisor or stock broker. All funds can be bought directly from TD or Vanguard without commission.

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Want More?

Holly@Clubthrifty July 30, 2012, 4:27 pm

Thank you for the helpful information!!!

We own some rental properties but are always looking to diversify. I’m going to look into it!

Have a great day!

Reply
Lance July 30, 2012, 4:44 pm

Vanguard is a great company! I had never heard of these before but I’m also not near the point in which I would need them. It seems to be a decent option that I have never considered for later in my life though. I’d do more personal research before investing in any type of fund first though. Maybe this is what I’d invest the $800,000 I had left after my exercise of what I’d do if I won $1,000,000 in today’s post over at my blog.

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- Nurse Frugal July 31, 2012, 1:53 pm
  
  This gets me really fired up. I just signed up for a Vanguard account a few months ago and this is awesome information! I really need to start mapping out this plan for early retirement so I can be just as badass as Mr. and Mrs. Money Mustache!!!
  
  Reply
Charan July 30, 2012, 4:51 pm

Hey MM, I have been looking into these and I really like the idea of these funds.

However, the “return of capital” component the monthly payout is around 52% for VPGFX and up to 71% for VPGDX. At a minimum, 52 cents out of every $1 that is paid back in “yield” is really just my money paid back to me minus fees (although with Vanguard I seldom question their fees).

This is the only major issue holding me back. Any ideas/different perspectives on this issue?

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- Mr. Money Mustache July 30, 2012, 5:00 pm
  
  That’s an interesting set of stats, and I need to look into it more. Can you link to the page where you found it?
  
  Surely the “return of capital” component varies along with the annual performance of the underlying equities, right? Thus, maybe your quoted return on capital figures are for the most recent quarter, or some other period which has happened to see a decrease in stock prices.
  
  Similarly, in a typical good year, I would expect to see all three funds showing a negative return of capital (meaning growth was greater than their payout).
  
  The real key to whether these are good investments is, “are the things inside worth owning?”. From looking at the specs, the answer seems like a clear yes to me.
  
  Reply
  - Greg July 31, 2012, 6:26 pm
    
    For distribution amounts and percentages, just click on the “Distributions” tab on the links you provided.
    
    As Charan noted, in 2012, VGPFX’s (monthly) payout consisted of 52% return of capital, 33% investment income, and 15% capital gain (= 100%). For the previous year, the figures were 24.94%, 75.06%, and 0%, respectively. The figures appear to be the same for each month of the calendar year, presumably based on the previous year’s results.
    
    BTW, for VPGDX, the 2012 figures are 71%, 21%, and 8%, and for VPDFX they are 70%, 15%, and 15%.
    
    Personally, I would stay away from these funds. A Mustachian who is unaware (a contradiction in terms?) of how the payout works might not realize that their ‘Stash could be handed back to them, a little bit at a time. The person might never realize that the fund’s performance has declined (because the payout has not), and fail to make financial adjustments (spend less, work some or more) in order to keep a positive savings level in retirement. Over a period of years, they could conceivably get a nasty surprise in their net worth—a punch in the ‘Stash, if you will.
    
    But, hey, if you know what the risks are, then go for it, but you don’t really gain any performance over holding the combination of funds that are held. Oh, and slightly higher fees, because you’re paying for two levels of management (within a fund of funds).
    
    Reply
    - Charan August 1, 2012, 3:23 pm
      
      Greg, thanks for the updates, I had forgotten where I had seen the return of capital distributions.
      
      Here’s another perspective: compare this to a rental property you might purchase to supplement your income. The rent minus expenses and any depreciation is your true yield (some might use the term “taxable yield”). However, if and when you eventually sell the rental property, you will have a return of capital – what you bought the property for – and a capital gain. You get the return of capital in this case, in one big lump sum at the time of sale.
      
      In contrast, in case of these funds, you are getting a return of capital in small monthly drips of (e.g. VPGDX) 71% x 4.7% x market value/12. So in reality you are getting a managed payout of your capital, with a little bit of gains and dividends thrown in for good measure.
      
      So, as their fund names suggest (sorry captain obvious, that’s me) they are “payout funds” – they are designed with that purpose in mind. Paying out part of your capital is part of the deal. If you are OK with this concept and accept it, you would not necessarily find them unfavorable.
      
      MMM, in my day dreams 10 years in the future, I had most of my invest-able assets in VPGDX and living solely off the passive income provided monthly payouts :-) USD 1 million would generate roughly $3,800 – $3,900 monthly at today’s rate. No headaches/overhead on what to sell, monitor individual investments etc.
      
      Reply
  - Tax Tom October 3, 2017, 9:26 am
    
    Hey everyone,
    
    Tax professional here, and I wanted to clear up some confusion on how those return of capital distributions are calculated. MMM makes a great case for these funds, but I think the commenters are misunderstanding them as ‘stache draining schemes disguised with a high payout.
    
    It is entirely possible for a managed payout fund with a 5% distribution to have its holdings increase in value by, say 10%, and yet the investors will still get a return of capital distribution. How can this be, you ask? If the fund gains 10%, and I siphon off only 5%, shouldn’t my entire 5% distribution be gains, not return of capital? NOT NECESSARILY!!
    
    It’s important to understand that the distribution breakdown between gains, dividends, and return of capital is a tax concept, because investors have to report the gains and dividends on their tax returns. And for tax purposes, gains are only taxable once they are REALIZED (sold). If you buy a stock, then it goes way up in value, and you hold the stock, you have no income. You only have taxable gains when you SELL.
    
    How does this apply to our managed payout fund? Let’s say the fund holds 10 stocks, each valued at $100/share. At the end of the year, 9 of the 10 stocks have increased to $110/share. The fund manager decides that he likes these stocks and doesn’t want to sell them, but he still has to make a 5% payout to his investors (about $55 payout). So what does he do? He sells the one stock that had zero gains. For tax reporting, the fund therefore has no taxable gain to distribute to investors because it did not sell any stocks with gains. The distribution, therefore, must be return of capital.
    
    Don’t believe me, and you’re still worried about taking an unexpected punch to the ‘stache? Look up the stock price of these funds and you’ll see that they do in fact rise over time, contrary to the return of capital tax distribution. As would be expected, they rise more slowly than the S&P 500, since they are making such a large payout. In summary, the VALUE of the portfolio (stock price) doesn’t perfectly correlate to the taxable gains recognized each year. It looks like the Vanguard managers are doing a good job of minimizing investors’ tax bills while also growing share price. BRAVO!
    
    This seems too good to be true, you say! What’s the catch? Well, if fund managers employ this strategy year over year, only selling stocks with no gains, the fund will be left holding only stocks with HUGE gains. If the fund ever has to sell these highly appreciated stocks, they will take a huge tax hit. Similar to if you bought AAPL and then sold 20 years later, you would enjoy 19 tax free years followed by a huge tax bill in year 20.
    
    Reply
Travis July 30, 2012, 5:06 pm

Vanguard also makes it pretty easy to just setup an automatic withdrawal on a regular basis. It is easy enough to setup- and change every 6 months or year like the managed payouts- based on your new balance/performance. That way you are in full control of the investments behind it all.

There’s no denying the convenience of straight up managed payout funds- and that’s a nice option if one of those offered matches up nicely with your desired asset allocation. But if these don’t match up for you, it isn’t tough to automate withdrawals against other investments if that’s what you want to do…

Reply
- Mr. Money Mustache July 30, 2012, 7:51 pm
  
  That’s a good point Travis.. the automatic withdrawals are still pretty handy.
  
  The main advantage of the managed payouts above that are the automatic rebalancing across multiple asset classes (and possibly simpler consequences when you fill in your annual tax return).
  
  Part of the reason for this article was just general education about the idea of living off of a stock-based portfolio. Even mainstream financial news writers say things like “few people can afford to retire – stocks have been hammered in recent years!”.
  
  The bigger picture must include dividends, selling some of the principal, asset mix, and concepts behind the 4% rule, which is why I put so many links to other articles in this one. I hope it will send a few curious people on a multiple-browser-tabs frenzy of stock market and investment learning!
  
  Reply
  - Debbie M July 31, 2012, 9:37 am
    
    I’m sure it’s cheaper for us to do this work ourselves, but a) here are three allocation set-ups we can check out for and b) one day, if we’re lucky, we’ll get old, and maybe loopy, and it would be a good idea to slide our money into one of these right before we can no longer trust ourselves.
    
    Reply
    - TOM August 2, 2012, 7:26 am
      
      You make an excellent point b. Increasingly, I’ve been reading reports and anecdotes about as we get older, our capability to make prudent investment decisions gets weaker. It is quite scary.
      
      As long as senior you can resolve to not make any drastic changes without first checking it out with an unbiased friend or family member, these do seem like an excellent option to avoid making a costly mistake in one’s later years.
      
      Reply
      - jlcollinsnh August 11, 2012, 9:10 pm
        
        I agree point “b” is an excellent one, but I’d caution using these payout funds as a solution.
        
        As it has been pointed out these funds maintain their payout percentages by selling part of the capital invested in the fund.
        
        Any investment that is paying out capital needs to be closely monitored as that capital is depleted. Exactly what we’ll not be able to do once we’re loopy and old.
        
        Reply
Al July 30, 2012, 5:23 pm

I would imagine you are going to draw out a complainypants or two with this post. Personally I just want to say thanks as I had never heard of these before, and learning something new is worth the price of admission. But after doing some research I found the return of capital thing to be unfavorable. Might be right or some people, but I think I could do the same thing myself without the ROC.

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G.E. Miller July 30, 2012, 5:42 pm

I like the concept a lot. Expense ratios are a bit higher than Vanguard ETF’s or Admiral Shares, but I suppose you are paying a premium for convenience.

Are there any REIT’s or ETF’s that pay out monthly?

Reply
- iwannaretire July 30, 2012, 6:38 pm
  
  Realty Income (O) is a REIT that pays monthly. It has been around for a long time.
  
  Reply
  - Sean July 30, 2012, 8:14 pm
    
    IGD pays monthly – around 10% yield.
    Managed by ING
    
    Reply
Kate July 30, 2012, 5:43 pm

Is the 4.7% annual payouts based on the money that you actually invested or 4.7% of the profits/dividends on VPGDX fund?

It would seem that you would have a substantial amount invested such as at least 100K to get a decent payout so as to cover the cost of groceries for an entire year.

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- Mr. Money Mustache July 30, 2012, 7:36 pm
  
  I believe it’s roughly 4.7% of the amount you invested (which is initially the same as “assets under management” as Sean speculates).
  
  You’re right that you’d need a substantial amount invested. $100k would be about right for my family’s groceries. $550k would have an annual payout of $25,850, roughly equivalent to our whole expenses.
  
  To be safer, I’d bank on only spending about 4% of my capital each year, as explained in the 4% rule article: http://www.mrmoneymustache.com/2012/05/29/how-much-do-i-need-for-retirement/
  
  Reply
  - GregK July 31, 2012, 8:48 am
    
    If you really wanted exactly a 4% payout, you could get there by putting 35% of your portfolio in VPGFX and 65% in VPGDX. Your total payout would be exactly 4% of your total assets invested.
    
    Alternatively, you could put 85% of your portfolio in VPGDX, or 59% of your assets in VPDFX, either of which would get you 4% of your total assets. You’d leave the remainder of your assets in whatever non-payout investment vehicle you liked.
    
    Reply
    - Uncephalized July 31, 2012, 10:43 am
      
      Beat me to it. I was surprised MMM didn’t point this out, as mathematical as he is.
      
      Reply
Poor Student July 30, 2012, 5:44 pm

These would be great for the person who invests merely as means to an end. I really like researching and picking dividend paying stocks or REITs and looking for less traditional means of investing.

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Heath July 30, 2012, 5:49 pm

YAY! More incredibly direct financial advice, with just enough explanation to make me feel that much more confident and informed (without blowing my mind). You’re slowly teaching us about intelligent investing in The Stock Market, in a completely transparent manner, for FREE!

And that’s why THIS is the kind of post I daydream about :-)

Reply
MacGyverIt July 30, 2012, 5:49 pm

MMM amigo,

I’m about to break up with my financial adviser and planned to put a chunk into VFIAX. Given your previous endorsement of the Admiral Shares 500 Index Fund (http://www.mrmoneymustache.com/2011/05/18/how-to-make-money-in-the-stock-market/), today’s post was a surprise — in a good way, knowledge is power! Expenses look to be higher on VPGDX but boy does it have a higher yield (4.57% vs. VFIAX’s 1.99%).

What’s your take on VFIAX vs. VPGDX for a grocery providing investment?

– Mac

Reply
- Mr. Money Mustache July 30, 2012, 7:24 pm
  
  Hey MacGyverit – Glad you are shopping around, but WARNING!… it looks like you may have confused “payout” with “yield”, as I cautioned against in the article. Thanks for doing that so we can explain it further:
  
  – Yield is the amount that standard funds pay out in dividends per year. Standard funds like VFIAX leave all capital gains invested in the funds, so you must manually (or automatically) sell some of your share units to bring home any capital gains for grocery-buying.
  
  – Payout is a specifically generated payment that these managed funds send you, and they get it by sending you all the dividends, plus selling some shares to make up the difference to meet the yield requirement.
  
  If the underlying assets have been going up enough to cover that difference, you’ll still have more of the fund at the end of each year. If they haven’t, they’ll still sell whatever it takes to make the payment and you’ll end up with less remaining in the ‘stash. The amount by which the value decreases is called “return of capital”, aka “getting some of your own money back”. With too much return of capital, you’ll run out of capital left in the fund.
  
  But you also have a finite lifetime, so there’s some balancing to do.
  
  Reply
  - MacGyverIt July 30, 2012, 7:47 pm
    
    You are the Fonz of Finance — thanks for the teachable moment.
    
    Reply
  - jlcollinsnh August 11, 2012, 9:04 pm
    
    perfect explanation of the difference between yield and payout, Mr MM.
    
    May I elaborate a bit on the capital gains part?
    
    Stock funds, like VFIAX actually provide three avenues that can increase your holdings:
    
    Dividends, capital gains distributions and capital gains in the price of your shares.
    
    Dividends are based on the dividends the stocks held in the fund pay and they are paid out on a regular basis, typically twice a year. You can choose to have them paid to you in cash or reinvested in the fund.
    
    Capital gains distributions are any capital gains the fund earned by selling stocks within the fund. As you might guess from the name these are paid out, or distributed, on a regular basis just like the dividends usually on an annual basis. Like dividends you can choose to have them paid to you in cash or reinvested.
    
    Also like dividends you will owe tax on these assuming the fund is held in a taxable account.
    
    If your fund shares increase in price you will also have a capital gain. However, this is not distributed and no tax is due until you sell your shares. To access this money you must sell shares, something you can do anytime. You can also arrange to have shares sold automatically.
    
    Hope this helps!
    
    Reply
Alice July 30, 2012, 6:05 pm

I’ve been looking for something like this since I’m too lazy to build it myself. I’m already with Vanguard so its a no brainer. Now just to figure out how much and which rate….

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- ivyhedge August 2, 2012, 10:17 am
  
  …watch the fees…I wrote something a touch more detailed above. For some folks already at Vanguard, orienting a sub-block of your current holdings in the general direction of these allocations might be more recommended than just buying another fund. No laziness needed: pick the plan and allocate accordingly.
  
  Reply
Adam July 30, 2012, 7:04 pm

This morning I was comparing my T. Rowe Price Roth IRA fees with my wife’s Vanguard fees (Vanguard was way lower, of course, and now I know I should flip to Vanguard. Actually I’ve known this for awhile, just need to do it). We both have target date retirement funds. While on the Vanguard site, I happened across their info on Managed Payout Funds. Not that I’m close to needing something like that, but good info to tuck away for later use. Then I hop on the MMM site this afternoon and BOOM there it is. Nice to be in synch with MMM.

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Sean July 30, 2012, 7:05 pm

Interesting concept. I presume the 4.7% (for example) is of the assets under management, as opposed to your initial buy-in amount? That pretty much guarantees you’ll never completely run out of money, thus making it preferable in my mind to the traditional 4% rule. The exact dollar figures you get will fluctuate from month to month with portfolio valuation, however.

In short, you’ll need to have some flexibility for handling some income variance over time. Sounds downright Mustachian to me.

The tax implications of the “return of capital” portion are also interesting. Income that’s classified as “return of capital” is generally not taxable. A little silver lining in years when you happen to spend your stash down faster than your gains, if those distributions truly are characterized that way. Worth a bit more research, I’d say.

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- Mr. Money Mustache July 30, 2012, 7:39 pm
  
  Yeah, good points Sean.
  
  You may have noticed that I linked to your guest posting (the dividend aristocrats) in this article. Are you ever going to start updating your blog again? You’ve got some good stuff on there!
  
  Reply
  - Sean August 1, 2012, 9:11 am
    
    I’m in the midst of a perfect life storm right now. I’m getting married in September, and have taken a new job on the West coast that starts soon. So I am, all at once, planning my wedding, planning my honeymoon, arranging a cross country move, selling my current house, and hunting for a new house, and I’m still at my current job ;)
    
    I know. Lame excuse. I’m going to start up again soon. I have a long series all specced out. Thanks for the kick in the pants.
    
    Reply
- Alex G. July 30, 2012, 8:12 pm
  
  My reading is that the monthly payout amount is set annually on January 1 and remains constant throughout the year. So, depending on the fund performance, the monthly percentage may actually fluctuate around the target, while the amount will remain constant.
  Definitely correct me if I’m wrong.
  
  Thanks for the heads up MMM. Only recently found your blog and enjoying.
  
  Reply
Joe July 30, 2012, 10:09 pm

Do you know of any comparable funds with longer histories that we might use to estimate yield?

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- Gerard July 31, 2012, 6:22 am
  
  I don’t know of any. But can’t we calculate this just by punching a 4.7% withdrawal of (original?) investment into firecalc? When I try that, I get a 23% failure rate over 30 years.
  
  Reply
George July 30, 2012, 10:10 pm

Thanks for the article MMM. I have never heard of these managed payout funds. It sounds like Mr. Bernstein’s “The Intelligent Asset Allocator” book being built into a real life fund with little maintenance needed for the average investor (I assume that these also have an automatic annual rebalancing built in). I definitely have heard good things about Vanguard. I love learning about passive income and I love learning about all the funds that bring one closer to retirement. Currently, we get about $500 per month in passive income from investments other than managed payout funds. This comes from only a 70k stash (I know a baby stash from your perspective). Over the past 3 years and now currently, we hold the following funds for passive income:

FHY (Closed-End Mutual Fund, comprises Junk Bonds, some Regular Corp Bonds and retail loans, i.e. auto) yields ~9.25% per year (dividend amount varies depending on when exactly you bought your shares): Pays out monthly

JNK (ETF: A Collection of High yield junk bonds for various companies) yields ~7% per year (as a dividend; varies slightly each month*): Pay outs monthly

PFF (ETF: A collection of Preferred Stocks from Various Banks) yields ~6.24% per year (as a dividend; varies slightly each month): Pays out monthly

REM (ETF of REITs from Various Real Estate Companies) yields ~12.56% per year (as a dividend, varies each quarter; paying once per quarter)

Note that these funds do not have the constant payouts that the funds you mentioned appear to have. These funds have yields that vary based on market conditions and change over time.

I realize that these are more risky that what some people can handle (I am currently 31 years old). Especially when you say the words “junk bond”, it is like a mysterious dangerous force that is not to be trusted. Some people think this only a land for wild high rollin wall street bankers and adrenaline junkies. Anyways, I have held JNK for the last 3 years and have not lost any of my money; in fact, when there is a scare in the sector, you just calmly cover your ears from the talking heads in the press, and just accumulate more shares at a discount. I have found that the JNK ETF diversifies you across many different companies so that if one company defaults on their junk bonds, it does not affect the overall value on the fund very much. I could be wrong someday but so far there have not been any problems, only nice paychecks.

MMM my only problem with Vanguard is that while everyone says that their fees are lower, their funds cannot seem to match the kind of large yields I have come accustomed to.

For example, Vanguard has a junk bond mutual fund:
VWEHX that yields about 6.6% per year; The problem is that has consistently trailed its peers in terms of yield, i.e FHY and JNK. I believe that the reason for this is that while the Vanguard bond contains junk, the other funds have junkier junk that Vanguard’s, thus resulting in the higher yield for the others. Vanguard does not have enough risky bonds built into their portfolio and lacks this option.

Likewise, you can look at Vanguard’s REIT ETF (VNQ), that yield a pitiful 3.6% (in terms of actual payouts of yield through dividends, not returns from capital gains in the share price rising**). Why would someone want this Vanguard REIT when you can buy REM REIT to get 12%? After all the higher your passive income, the faster one can reach FI. In other words, if it takes $3000 a month in passive income to reach early retirement, one would need a $1 million stash to retire with VNQ but only about alittle less than a $300,000 stash with REM. While we can agree that Vanguard has probably the lowest fees in the business, you know that the lower yield of Vanguard’s REIT in comparison to its industry peers is not due to excessive fees being siphoned off. Thus, one has to ask what the hell is Vanguard doing with all the money it gets from its REITs or alternatively, why the hell can’t Vanguard get as much money for their REITs as other fund company’s are able to do?

Am I missing something here on this one? I know one can make the risk argument, but looking at historical data, VNQ and REM seem to be highly correlated. Thus, it appears that it the market decides to inflict damage, i.e. by raising interest rates, all REITs will meet the same fate anyway (through a loss of principal).

Anyways with the higher yielding funds (like the ones I mentioned above), I think some people may like starting their passive income stream with high yield junk bonds so that they get to the point where they have the option to retire as fast as possible; The catch here is that they then would stay in their jobs with the high passive income to then build the stash up to the point where you could slowly convert your junk bonds into safer assets and adjust to your personal preference level of risk. Thus, under this scenario, once a person reaches a $300k stash, thus they have now more confidence; they are technically in FI already; they have FU money; however they can still work their jobs with this new found confidence in order to then build the stash from say 300k into 600k or higher so that it can become more a conservative FIer, i.e. phasing out the junk bonds into Vanguard managed payout funds instead over time, i.e . VPGDX. The end result is the same, but you get to FI faster and get a taste of FI much sooner under this scenario than you normally would have with the conservative investments alone. Plus, the higher passive income early on can provide a good motivating force to help people who are still learning to grow their mustache. Those are my thoughts, is it a good idea or is my theory a pile of shit that I need to learn a lesson from?

*As an example of the variation in yield, for this year the monthly dividend payout on JNK has been between 22 and 26 cents per share for each month i.e. see http://www.google.com/finance?q=JNK&hl=en

** http://www.google.com/finance?q=VNQ&hl=en

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- John July 31, 2012, 1:43 pm
  
  VNQ and REM are two different REIT-type investments. VNQ invests in the properties themselves. REM invests in Mortgage REIT’s (ex. AGNC) – so they don’t own the property, just the mortgages on the properties. There is a higher return (and risk) in mREIT’s vs. REIT’s. To the best of my knowledge, Vanguard doesn’t have an EFT that invests in mREIT’s (like REM does).
  
  Reply
  - George July 31, 2012, 9:43 pm
    
    Thanks for the insight on the different types of REITs. I didn’t want to knock Vanguard too hard because I know they do have good funds.
    
    Like many people mentioned already, the managed payout funds are ok although the return of capital aspect is a little weird. Most of us are probably looking for a return on capital rather than a return of capital. I am still seriously considering investing some money into VFINX with Vanguard, MMM has always recommended that fund from the start. It is only a $3000 minimum buy in to get involved with VFINX.
    
    Reply
  - ivyhedge August 2, 2012, 10:23 am
    
    Correct: there is no Vanguard mREIT vehicle. And the company is generally slow to bring various types of offerings to market; they don’t chase competitors’ offerings (note that two international bond etf offerings due earlier this year were delayed indefinitely).
    
    In addition to iShares’ REM, Market Vectors offers MORT. But I would advise folks who have little experience with REITS – and little or no experience with mREITS to plan for some comprehensive reading to understand the behaviors of REITS in different interest rate environments (lest folks merely chase yield).
    
    Reply
- Jessica Hampton August 1, 2012, 4:42 am
  
  Great questions! I was waiting for someone to come along and answer, and I’m glad John did. I don’t have anything more to add except to note that Vanguard’s high-yield bond fund VWEHX is now closed to new investors. I wonder if they’re planning on revamping the fund and replacing it with a new one?
  
  Reply
  - George August 1, 2012, 9:08 pm
    
    Good point Jessica, its true their High Yield Fund is now closed to new investors.
    
    Most likely it is because in this prolonged low-interest rate environment investors are so starved for decent yields right now that Vanguard has more investor money available than they do of below-grade bonds to invest in that satisfy their criteria. In other words, the demand is really high right now.
    
    In fact the only reason we are probably even discussing Managed Payout Funds right now is because interest rates have been so low for so long which is a big downside for early retirees or future early retirees trying to get that compounding effect to build their stash.
    
    In contrast in the book Your Money Your Life (YMYL) in chapter 9 towards the end of the book, they mention how one could casually just pick up a U.S. treasury bond earning 8 percent. Ahh those must have been the days! Imagine that, a nice safe 8 percent government bond without even having to deal at all with the crazy stock market.
    
    Reply
  - ivyhedge August 2, 2012, 10:26 am
    
    The fund has closed a number of times over the last decade as it digests retail fund flows into high yield by folks chasing income.
    
    The closing action is generally a good event, as it mitigates high inflows that managers are mandated to deploy; the fund flows aren’t regarded as highly (the word sheep comes to mind ).
    
    Reply
Daniel Kinsman July 30, 2012, 10:30 pm

Awesome. Now can you dig up some info for this Australian citizen on global funds that base on an index but negative screen for ethical and environmental concerns? if you could do that, sort them based on fees and post it to MMM that would be great.

And when you’re done can you also fly over here, do my dishes, and take the dog for a walk?

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- Mr. Money Mustache July 31, 2012, 7:37 am
  
  Sure! As long as you live near a beach and can put my family up for a few months this winter! :-)
  
  Reply
  - Liz I September 4, 2012, 5:15 pm
    
    How did this offer go unanswered?! I thought that Australian Mustachians would be falling over themselves to offer you room and board in exchange for investing tips – maybe homebrew tips, fixing the door that doesn’t shut properly and helping design a courtyard shed too! I live on the other side of Melbourne to the beaches, but I know the MM family would consider that part of the adventure. If you do come to Australia (I have a sinking feeling your comment was tongue-in-cheek) I would love to play host.
    
    As of today (“It’s never too late to ditch your gas guzzler”) I have officially caught up with all posts and comments, but this was a much more pertinent point that fully deserves my first comment. Now I have to find a mustache-y avatar.
    
    Reply
    - Mr. Money Mustache September 4, 2012, 7:05 pm
      
      Congratulations Liz!
      
      My request was certainly not joking around – I love getting a chance to visit real-life Mustachians and have met quite a few this year already. I’ve saved your note for future use.. and Melbourne sounds great.
      
      Reply
      - Coral November 22, 2012, 11:15 am
        
        I know I’m late to the party… But did anyone find some equivalent to vanguard for Australians? I’m an Aussie, now living with my partner in Angola (west Africa), and we can potentially stash some cash in accounts in Australia, Angola or Portugal… But have no idea of where/how to start the process and navigate the complex web of international tax implications…!
        The idea of an online stock portfolio management system like vanguard sounds perfect to me, so if anyone does know of an equivalent it would be very welcome!
        
        Also, there is definately a lounge room floor to crash on here in Luanda for the MMMs, should you be around this corner of the world (though I warn you, this city can be quite expensive due to the current oil bubble playing out here, i’m slowly leaning the cheaper options, and how to better negotiate prices of veges on the street!)
        
        Reply
        
        Peech May 1, 2013, 5:34 am
        
        Vanguard Australia may suit your needs. I haven’t compared the two, though, so I’m not sure if the conditions differ. Go in with both eyes open. :)
Truelove July 31, 2012, 5:36 am

The fund is “a nice mixture of other Vanguard funds”.

Since the fund you are investing in merely invests in other funds would you not be paying double fees on your investment.

For example: Vanguard REIT Index Fund Investor Shares charges a MER of 0.24% – The VPGFX fund you invested in would see the return from the REIT less the 0.24% and than hit you up with their MER of 0.34% effectively making you pay a MER of 0.58% for that portion of your investment. Similar fund MERs would apply to the other funds invested in.

Would it not make more sense to simply allocate your investments in the various Vanguard funds similar to the VGFX fund allocation and save paying the extra MER for having Vanguard do it for you?

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A knack for money July 31, 2012, 6:01 am

Regarding your bonus info: if Vanguard is not active in your country, you can buy Vanguard ETFs through the New York Stock Exchange (NYSE). This should be possible with almost every broker worldwide.
Of course, for non-americans you have to factor in the possible currency fluctuations between the dollar and your local currency.

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RichUncle EL July 31, 2012, 7:53 am

I was reading some of the fine print and all of the funds have a minimum 25K investment amount and it also stated that these types of funds might not be a good option for individuals who have not reached 59 1/2 years of age. I guess Ill stick with a diversified dividend stock mix until I hit 60 years of age.

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Will July 31, 2012, 7:58 am

Morningstar JUST did an article about these funds yesterday. You can read about them here: http://news.morningstar.com/articlenet/article.aspx?id=561913&t1=1343743054

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Mr. Everyday Dollar July 31, 2012, 8:27 am

Some people, like myself, are still working towards early retirement. I would say that while the funds you outlined are great for early retirees looking for a steady paycheck from their principal, most 9-5ers should have a slightly higher risk to reward strategy.

I am invested in individual stocks, mostly growth, some dividend (http://mreverydaydollar.com/how-to-become-financially-independent-step-3/) and am handily beating the S&P500. This supercharging of my returns will allow me to retire earlier.

When I near my early retirement age of 42 I will be transitioning from this (mostly) growth portfolio to a more balanced mix between REITs, MLPs (Master Limited Partnerships), and dividend producers to “get a paycheck” without touching principal.

The other option for 9-5ers, and you’d be well to do this as well, is to purchase dividend stocks with growing dividends and reinvest the distributions selectively while adding new capital. Eventually you will reach the dividend crossover point where your dividends cover your expenses.

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- Mr. Money Mustache July 31, 2012, 9:21 am
  
  Great point, Mr. Everyday.
  
  Even while I like the idea of these funds, AND I’m long past retirement, they are still not appropriate for me right now. Why? Because we already have the MMM family’s spending needs covered through other things (rental house, now-rare part-time work, etc.). So 100% of my stock holdings are still in reinvestment mode, and I’m not pulling out any of the dividends, capital gains, or principal.
  
  On the other hand, if I sell the big rental house this year, and want to replace it with an even more passive source of income, these funds would be a nice match.
  
  Reply
  - Uncephalized July 31, 2012, 10:49 am
    
    You are going to be very wealthy when you die, MMM.
    
    Not to be morbid or anything. But I’d love to see a post on what you might do with your estate, which will probably be quite substantial. I’m sure you’ve got some ideas for how to put that hard-won wealth to use once you no longer need it…
    
    Reply
    - Mr. Money Mustache July 31, 2012, 2:42 pm
      
      Don’t worry, I’ll find a way give it away (aka invest it in society itself) more quickly as I get older. I’m learning right now about how to do it wisely, and plan to write about it too. There will be no substantial estate!
      
      Reply
      - Uncephalized July 31, 2012, 3:01 pm
        
        Sounds good, I’ll be excited to read about it!
        
        Hopefully any such concerns are far, far in my future. :D
        
        Reply
      - Sean August 6, 2012, 9:09 pm
        
        Have you looked into charitable remainder trusts? They can be a good option to hang onto some security during your lifetime while benefiting charities in a major way.
        
        Reply
James July 31, 2012, 8:51 am

Thanks for the info, I hadn’t heard of this fund at Vanguard. I’m still in accumulation phase, but that is the exact sort of fund I’ll be interested in at some point.

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Joe @ Retire By 40 July 31, 2012, 8:54 am

I’ll check these out. 4.7% is not bad at all.
I can put a portion of my taxable account into these funds and forget about it. In my tax deferred account, I’ll keep managing it. I’ll have to read up on them a little more.

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- Seth Anderson May 30, 2014, 1:52 pm
  
  Remember that 4.7% is not all yield. A portion of that is return of principal.
  
  Reply
Debbie M July 31, 2012, 10:15 am

I’d never heard of “market neutral” investments; wikipedia says these are hedge funds. It’s interesting that all these portfolios have 10 – 20% of the money in hedge funds and another 10% in commodities (two areas I am not specifically invested in).

Vanguard does have a market neutral fund (VMNFX); expenses are 0.25%; return has been a little negative. I wonder how you pick things for this sort of fund. It looks pretty diverse right now with, from most to least: information technology, financials, industrials, consumer discretionary, health care, consumer staples, energy, materials, utilities, and telecom.

For commodities, I’m guessing they use something like their materials admiral index fund (VMIAX) with 0.19% expenses and a low five-year return. It has mostly chemical companies, but also metals, gases, glass, and paper.

Both of those seem to overlap with their big stock fund (like REITs do).

Anyone else have either of these in their portfolios? (I am modern enough to already have international stocks and REITs.)

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- ivyhedge August 2, 2012, 10:32 am
  
  Market neutral vehicles are generally long/short strategies. This one is simple, and costly: better options exist, but I’m not going to get into a tear down of this asset class and highjack MMM’s otherwise useful posting.
  
  There is no direct (futures) commodities exposure: funds that offer materials are just equities, and they’ll generally not be contramovers as are the hard assets (at least, when correlations don’t head to 1 when retail investors throw up their hands).
  
  Consider VNQI to test your MPT “modernity”.
  
  Reply
skyrefuge July 31, 2012, 10:56 am

I’m not sure if I’ll ever invest in these funds, but I was really happy to learn that they exist when I came across them a few months ago. Why? Because sometimes it feels to me like the whole amateur Internet-o-sphere is single-mindedly obsessed with dividend stocks, and believes that’s the only possible way to safely generate passive retirement income; actually selling shares (principal) for income will obviously cause INSTANT DOOM and only a fool would do it. (this despite the fact that a company paying you a dividend is really the same thing as forcing you to sell some shares).

So it’s nice to see that the smart and respectable people at Vanguard are like “nah man, of course it’s fine to sell shares to generate income…we’re so confident that it can be done sustainably that we’ve gone to the trouble of creating this whole set of funds to prove it to you”.

Their existence is also another implicit endorsement of 4% (or whatever) Safe Withdrawal Rate theory.

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- rjack July 31, 2012, 12:17 pm
  
  “Because sometimes it feels to me like the whole amateur Internet-o-sphere is single-mindedly obsessed with dividend stocks, and believes that’s the only possible way to safely generate passive retirement income…”
  
  And if enough people focus exclusively on dividend stocks it will drive down yields to the point where dividend stocks are a poor investment.
  
  Reply
Tom h July 31, 2012, 5:37 pm

Beyond the yields and dividends surely there’s a moral dimension to what your money gets invested in?

Ethical investing anyone?

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- FreeUrChains August 1, 2012, 11:04 am
  
  Would you like to go to the casino in Las Vegas? (just bought 1000 shares of Las Vegas Sands)
  
  Can one buy shares of a Porn Company? Or do we just let Billionaires of the Porn industry with Internet and DVD Tycoons go rampant and make as much as they please at the expense of the sex worker and their under payments.
  
  Seems like America is ignoring these issues, and/or protects all grey area immoral ethic business practices because it’s capitalistic in nature. (even if it is harming morally the worker-consumer-taxed-mindlessly-inactive&entertained slaves.)
  
  Reply
- ivyhedge August 2, 2012, 10:35 am
  
  If you wish to narrow your universe such that returns are de-facto biased, and handicapped: sure.
  
  My response to clients is that unless you have an absolute mandate to avoid “something in particular” (some foundations and endowments), invest as you would (or how someone is assisting you to do) and use the capital gains and/or distributions to invest in charities or causes you enjoy.
  
  Might sound harsh or binary, but necessarily restricting your sample set has shown over decades to have generally done little else than serve as a superficial psychological shield and mitigate returns with layers of costly “monitoring”.
  
  Reply
David Horne July 31, 2012, 7:17 pm

Yeah, those sound like an interesting option to keep in mind. Unfortunately, they’re not for me yet. I’m still on the building up the ‘stash side of the hill, so having a percent taken out without any consideration of performance isn’t the best idea. But eventually that balance should swing the other way.

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Alek Hartzog July 31, 2012, 10:55 pm

Slightly off-topic…what are your thoughts on the vanguard ETFs? I know for me their commission is $9 instead of $45 per transaction, making it easier to invest in index funds in smaller chunks.

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- Mark August 1, 2012, 12:09 pm
  
  If you have a Vanguard brokerage account, then the commission is $0 – which is less than $9!
  
  Reply
  - ivyhedge August 2, 2012, 10:36 am
    
    Mark August is correct: $0 commissions. And if you’re paying $9 or $45 anywhere, you’re paying far too much.
    
    Also note: many Van etfs cost the equivalent of Admiral Shares. In a few cases, they are slightly cheaper.
    
    Reply
Peter August 1, 2012, 6:32 am

Is there anything like the Vanguard index funds in central Europe? I’m located in Austria, does anyone here know about such funds in the European Union?

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- A knack for money August 2, 2012, 12:13 am
  
  As I said in a previous comment, you should take a look at the Vanguard ETFs which are sold just like stock on the NYSE.
  
  Reply
jennypenny August 1, 2012, 8:14 am

As you list in your post, it’s easy to figure out the components of the funds and their allocations. I think it makes more sense to follow the fund and own the individual pieces at Vanguard instead of the fund itself. You’ll pay less than .34% in fees, especially when you have enough capital to invest in Admiral shares for the specific funds.

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- Mark August 1, 2012, 3:50 pm
  
  These funds are simply a convenient way of implementing a withdrawl strategy. There is no reason to own them unless you want someone to help you maintain an asset allocation by systematically selling the right amount of each one.
  
  Sure you could do it yourself, but some (many?) people will be willing to let someone do it for them. I know many older people who will appreciate this tye of fund.
  
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FreeUrChains August 1, 2012, 10:52 am

There is one major downside to owning index funds. You lose the power of Growth.

The Hedge Fund Managers control all the risk and profit from the exponential rewards. (why do you think the best make over 2 Billion per year? Not from 4% returns). Their bonuses come from the expense ratio fees, while their paychecks come from the Funds Additional Growth. The Hedge Fund Managers and Boards control and collect all stock buys and sells, then distrubute lower amounts of fixed returns to the restricted fund payout for it’s investors; and keep all the rest. Almost like a Pirate Captain, taking 50% of the loot, giving 20% each to his/her’s two lieutenants, then dividing the remaining 10% amongst the crew; where as, you, the investors, are treated as the crew.

401ks, IRA, Index Funds, ETFs, all are managed this same way. They borrow the investors money, give then a 4% or less return, while they may make returns of 20-200%/ year depending on the Hedge Fund Managers Skill set and discounts they can leverage out of other funds, companies, or politicians.

An Example of Exponential Stock Growth: (That happens with all successful business operations.)

Exxon Mobile. $1000 worth of shares bought 2/3/87. 25 years later, accumulation worth of $3,000,000, after 3x 2:1 splits, 5%-120% annual dividend growth payouts, and 800% price share increase over 25 years.

Man creates miracles from Dust.

You are giving up the risk and Exponential Reward, for a diversified fixed rate of Return.

It’s better to own the individual stocks/investments yourself with your own managed portfolio, then it is to be an investor to someone elses at a return of only 4%.

This is also the hidden value of Property Ownership, possibilities of exponential value growth thru the decades whether for minerals, soil, or space, as the population increases exponentially,

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- Mark August 1, 2012, 3:48 pm
  
  You may be slightly confused. These Vanguard index funds simply mirror the market. The stock funds and ETFs do pretty much exactly the same as your XOM example except that the money is divided among hundreds of stocks. Some do as well or better than XOM and some do worse.
  
  Reply
- RobDiesel August 2, 2012, 1:12 am
  
  Of course, if you’re not looking for amazing returns AND you’re not looking to actually MANAGE a bunch of stocks, then investing in a VTSAX with whatever monthly or annual contributions could do the trick.
  
  Basically, an automatic $200 a month into VTSAX and more if you can, will enable you to pull a nice retirement when the day comes.
  I don’t see why this wouldn’t work even if you suddenly came across a million dollars.
  Invest that too, right?
  
  Reply
asdf August 1, 2012, 1:03 pm

These funds sound good, but they are regularly panned by the savvy investors over at bogleheads.org:

https://www.google.com/search?sitesearch=bogleheads.org&q=managed+payout

Your article should mention and address the issues that these guys raise.

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Leon @ Hardworking Penguin August 2, 2012, 10:26 am

I still think real estate is a superior option compared to the stock market given today’s housing prices (buying a house in 2006 may not be a good idea given the returns, then again, buying Facebook at $38 is not a great idea either, but say at $10? Gotta think again).

With today’s interest rates you can still cash flow and each month you get the benefits of rental income, depreciation, amortization through paying down the loan, and the opportunity for future gains in equity (in many areas houses are worth less than the cost to build – a trend that can’t possibly last forever!). Not to mention inflation will help you as your payments will be fixed while your house value and rental income will go up.

Right now my single family rentals average 8-12% cash on cash returns after expenses – a return that will get to 15-20% easy if you can obtain a bank loan.

While I don’t recommend going 100% into real estate (you still need some liquid assets after all) I would go at least 80%.

And yes, managing rentals do require some skills, but it is well worth it.

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Philip August 2, 2012, 8:06 pm

What is the difference between a Managed Payout Fund and an Annuity? What I’m basically seeing here is a version of an annuity where one deposits a sum of money then pays someone to give it back to them, except here there is the possibility of running out depending on the whims of the market.

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- Relevant Investments August 3, 2012, 7:21 am
  
  You assume all of the risk in a Managed Payout Fund. If your investments tank you lose, if they perform better than expected you win, When you die the remaining balance becomes part of your estate.
  
  There are several different types of Annuities but they are all insurance products where the insurance company absorbs some or all of the risk by guaranteeing a fixed or variable payout, or a minimum return on investment.
  
  But of course there is a cost factor and the insurance companies first priority is to make money. Annuities with the highest payouts may keep the entire remaining balance for themselves upon your passing. Others will lower their payout for clauses covering both spouses or guaranteeing a certain payout.
  
  Bottom Line – Annuities are complex insurance instruments that are not suited for everyone. If it sounds too good to be true there is something you are missing. Don’t forget, Insurance companies always win.
  
  Equity Indexed Annuities are the latest “too good to be true” products. Go to:
  
  http://relevantinvestments.com/equity-indexed-annuities-buyer-beware/
  
  for more info.
  
  Reply
- Mark August 3, 2012, 9:29 am
  
  Surely one differnce is that you can sell the entire fund (or part of it) any time you want and get all or part of your money back. With an annuity, you don’t usually have that flexibility.
  
  Reply
- asdf August 3, 2012, 10:55 am
  
  These funds are absolutely, completely different than annuities.
  
  Annuities are products sold by insurance companies. In exchange for a lump sum of money, the insurance company is contractually obligated to provide the purchaser some amount of money for the rest of their life. In short, people purchase annuities to protect against longevity risk (the risk that you will outlive your savings). When you die, you cannot bequeath the income stream to your heirs, or the money that you already gave to the insurance company.
  
  These funds are investments. You own the shares, and can bequeath them when you die or sell them at any time you like. But the investment company (in this case Vanguard) is not entering to a contract with you to provide predetermined payments for the rest of your life.
  
  Reply
joe August 8, 2012, 9:10 pm

How are these “managed payout funds” significantly different than what I am already invested in?
Here is my portfolio:

In my 401k/457b:

10% Stable Value Fund
30% Total Bond Index Fund
25% Large-Cap Index Fund
9% Mid-Cap Index Fund
8% Small-Cap Index Fund
18% Total International Index Fund (ex-U.S.)

In my ROTH IRA:

50% Reit Index Fund (VGSIX)
50% TIPS (VIPSX)

* Next year I will add another asset class or two to my ROTH IRA to round off my investments. I am considering a micro-cap fund and/or a global bond fund, along with, perhaps, a precious metals fund (as long as the expenses are low).

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Jerry August 10, 2012, 12:29 pm

Dr Bernstein would not recommend these payout funds with the high % of assets being in stocks for most folks unless they were in their 20’s & early 30’s and willing to risk high volatility. For those who know not of Dr Bernstein and his work I recommend reading his most recent book “The Investor’s Manifesto”. In the same vein please pick up the “Bogleheads Guide To Investing”.

Before buying any of these payout funds, check out what the Bogleheads have to say about payout funds on their website. I’m not attempting to dissuade anyone from making investments in the Vanguard payout funds. Just get an opinion from those who don’t like the payout funds to help you form your own opinion.

I had not heard of these funds before but I appreciate finding out about them now. As for me, after learning about them and reading unfavorable remarks elsewhere, I’m going to keep most of my money in the Boglehead’s recommendation of the 3 core funds but I am going to take some of my money and put into a payout fund. We shall see how playing both ends against the middle works.

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Andre August 11, 2012, 3:32 am

Is accounting for US federal income taxes on a managed payout mutual fund cumbersome? Each month the fund is selling shares and sending you the monthly payout. Those shares have a cost basis. The fund manager must keep track of the cost basis. At year end, the fund will send you the 1099 showing dividends and realized capital gains. So, I guess, everything one needs to file their tax return is provided on the 1099, right?

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Paula June 29, 2013, 8:51 pm

In your Bonus Info paragraph you note that on a 7% return, management fees of 2% can rob you of a quarter of your earnings.

Recently on Frontline’s Retirement Gamble, Bill Bogle said that 2% fees can rob you of two thirds of your total earnings. Two thirds! The narrator later corroborated what Mr. Bogle said with an online compounding calculator. What an eye-opener.

The next day after seeing that documentary (I love PBS- they fall under the Frugal-not-Cheap scenario for sure) I checked into my retirement account, was relieved to see that it had at least one, ONE Vanguard index fund, so I exchanged everything I had into it and set all my future contributions to go to it. I have an IRA that I manage as well, so it’s not like I’m throwing all my eggs into the same basket.

I’m enjoying your blog. I like it way better than EEE.

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KDubz June 21, 2016, 12:35 pm

As an update to anyone new to MMM and trying to catch up on all the older articles, the 3 Vanguard funds have merged into one as of 2014. VPGDX currently has an annual distribution rate of 4%

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FMaz January 23, 2017, 8:34 pm

I’m surprised no Canadian spoke about the Mawer mutual funds, which are all no load. Sure the MER will make MMM skeptical at first, but their returns thus far are making up for it.

(.. Now one could say past performance is no indication of future performance… True, then might as well choose funds completely at random.)

Mawer equity funds tend to be quite volatile, so I guess it boils down to how much volatility you can handle… But I’ve been really happy with them so far.

Personnally I’d rather pay 1.6% MER but get an average net return of 12% compared to paying only 0.06% but getting an average net return of 7%.

Sure if 2 funds would perform the same, I’d be stupid not to go with the lowest MER; but don’t just judge a fund based on its MER.

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Andy March 4, 2021, 3:55 pm

Hey MMM,
Not sure if you check comments on old articles like this, but I was reading this one today and went to look at the managed payout funds at Vanguard. It looks like in 2020 they renamed these funds and, as far as I can tell, did away with the payout aspect which was the whole point of this post. May be worth revisiting and maybe doing an update?

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