Pensionize Your Nest Egg With Annuities, Your Super Bonds.

Most Canadians do not have a defined pension with guaranteed income. Speaking of birds and nest eggs, those guaranteed pensions are going the way of the dodo bird. Just 33% of Canadians have a defined benefit workplace pension where the income is guaranteed and usually indexed to inflation.

That’s according to Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income For Life.

Pensionize Your Nest Egg

There’s only one way for me and you to create a generous and guaranteed income stream and that’s by way of the annuity. It’s a topic and product category that gets little attention. And when it gets attention it’s often negative. Annuities are offered by insurance companies. Strike One. Annuities come with ‘high fees’. Strike Two. Let’s not go to Strike Three, we want to keep this blog post alive. In the process we might keep your retirement in good shape as well.

Hear me out. I’ll admit that I have not been a fan of the annuity in the past. I’ll also admit that I knew very little about annuities. That’s always a good way to form an opinion right? Give that thumbs down based on the headlines and 5 minutes of research. So please join me in a more than surprising and interesting discovery of just what the heck is an annuity.

With an annuity you simply purchase your own pension. 

Yup, it’s that simple. As an example, you hand over $100,000 and the insurance company will pay you monthly income, guaranteed for life. Of course that’s a Life Annuity. There are a few types of annuities, but for now we’ll stick to the most common and most popular annuity.

And of course the rates available will fluctuate based on a few factors. Here’s a site that will give you an idea of the rates available in today’s market.

In March of 2019 here’s the rates for a Canadian single male. The payment is in the range of 6% annual for a male at age 65.

Annuity Rates

You can purchase an income stream for life. And of course, the longer you wait to purchase that annuity the greater your payments. You might stagger your annuity purchase(s) over many years and periods of your retirement. That’s typically the advice found in Pensionize Your Nest Egg and offered from advisors who Pensionize a portion of their client’s nest egg.

When you hand over your money, it’s a done deal. 

These are irreversible contracts. When you purchase an annuity you usually exchange control of those funds for guaranteed income for life. When you die, your money goes to the insurance company. To be exact a portion of your monies goes to the survivours – to those who purchased annuities and who might live to 85, 90, 95 or 100. That’s how insurance companies can afford to pay you rates that are well beyond the bond and GIC rates of the day. With an annuity the unlucky (the dead) pay for the lucky (the living).

In the above quote table there is a 10 year guarantee meaning that the payment would continue for 10 years from time of purchase even in the event of an early death. 

Many Canadians are living well into their 90s. 

And from the many tools available at pensionizeyournestegg.com here’s a shocking survivability table for a 65-year-old male.

Survivability Table

For a 65-year-old Canadian male there’s a 25% chance that they’ll live to age 94. Yikes. What side of the annuity grass will you be on? This table demonstrates why a certain level of guaranteed income might be a good idea. You might at least cover your basic living needs for life and projected old age home payments with guaranteed income.

The 3 product allocation buckets. 

The main theme of Pensionize Your Nest Egg is to think product buckets, not traditional asset allocation that would normally include your mix of cash, GICs, stocks and bonds. Instead the theme and 3 buckets is …

  1. Guaranteed Income For Life.
  2. Guaranteed Income Plus Growth Potential.
  3. Asset Growth Potential (your personal portfolio)

Of course Bucket 1 will include government monies, private pensions with an asterisk*, and your personal pension (annuities). Bucket 2 is annuities with some ownership of stock and bond mutual funds that might deliver added growth if the markets and funds cooperate. Bucket 3 is your personal investable dollars – your portfolio.

*your private pension holder could go belly up. See General Motors. 

The book then goes on to demonstrate that if you arrange your assets in the right buckets at the right time you can increase the odds of creating more generous income for life. The book and tools also help create a plan that will allow you to leave a financial legacy if desired. And that is the big question that needs to be answered. Do you want your monies to protect your longevity risk and contribute to your quality of life in retirement, or do your kids and other heirs take precedent?

Personally, I would strike Bucket 2 off of the list, entirely. Bucket 2 includes mutual funds that usually come attached to very high fees. Those high fees are likely to eat up most of the stock and bond market gains. I’ll do more research on the topic, but I’m quite confident that I know how this movie ends. I’ve done my research on market-linked guaranteed income products and they are usually quite terrible and confusing. I think you can do better with Bucket 1 working with Bucket 3. If we want to benefit from the growth of the stock markets we need to participate in that growth in the most cost-effective manner possible.

Have a read of Beat the Bank from Larry Bates. High fees can eat up half of your investment gains over longer periods.

Your investments might then take the form of an ETF Portfolio, Canadian Robo Advisor, or One-Ticket Solution.

Treat annuities like super bonds. 

I am with notable retirement scholar Wade Pfau who often calls annuities Super Bonds.

Consider an income annuity as part of your overall fixed-income allocation, says Wade Pfau, a professor of retirement income at the American College. “Income annuities are superior to bonds, but not necessarily superior to stocks,” he says. Mathematically speaking, investors would come out ahead if they replaced their entire fixed-income investment portfolio with income annuities, Pfau says. But this is unrealistic: “It doesn’t account for needing funds for unexpected spending,” he adds.

Here’s the full article, yes, with a US perspective.

It’s not all or nothing with annuities. 

Here’s one of the main themes of the book. Moving on from egg shells here it is in a nut shell. When you pensionize a portion of your nest egg you can then move on to create greater income from your retirement portfolio. It might be a win, win. Greater income security + greater overall retirement income.

From page 84, this is ‘the money’ quote for me.

In fact, we would go so far as to say that once you wrap true longevity insurance around a diversified portfolio (by “pensionizing” a portfolio of your nest egg) you can actually tolerate and afford more risk.

And you might ask about the risks. There is issuer risk. On that you might spread the risk among providers and do your homework.

Author Alexandra Macqueen advised that …

Annuities are insured via Assuris, which covers 100% of the annuity payment up to $2,000 per month, and then 85% on amounts above $2,000.

If a lifeco company fails the assets are transferred to a solvent company.

From table to nest egg?

The goal of the book is to make retirees and financial planners aware of the benefits of annuities and guaranteed income. While not for everyone many retirees would benefit from guaranteed income that currently pays twice or more the going rates for bonds and GICs. 

The book does not intend to offer a financial plan. But now that annuities are on the table they might end up in your nest. 

Thanks for reading. Of course this blog post is not advice and not a recommendation of annuities. The retirement stage can be more than complicated. Many retirees and near retirees will benefit by obtaining advice. You might contact a qualified fee-for-service advisor.

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Send a note to Dale, I’m at cutthecrapinvesting@gmail.com or better yet leave a comment on this post.

41 thoughts

  1. Good column Dale but at what point are annuities simply draining money from your heirs? If you can meet comfortably all your retirement desires through pensions your portfolio and social security what would be the benefit of giving money to an insurance company

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    1. Thanks Brian. Certainly that’s why it’s not for everyone. And there is a trade off on creating income and that financial legacy. There are tools on that site link pensionizeyournestegg.com But most will need to get all in front of a retirement specialist who runs the numbers. There’s all of that emotional ‘stuff’ as well and the value of money for us in each stage of our life. There are too many moving parts for a self directed investor to go this alone. IMHO.

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  2. Hi
    How do you overcome inflation with annuities. I could buy an annuity at age 65 that pays my living expenses. However at age 80 it probably will only be paying 50% of my living expenses. I know there are inflation adjusted annuities but the income is a lot lower.
    Thanks

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    1. This is part of the reason that people should contemplate pensionizing only a PART of their nest egg. Guarantees of any kind, from inflation to longevity, *are expensive.* However, stocks are loosely correlated to inflation, so you would not attempt to overcome inflation with an annuity, but by remaining invested in capital markets.

      Most annuities sold in Canada today on the private market are not adjusted to inflation (as measured by CPI), but can include a cost-of-living adjustment (think 1%, 2%, 3%) to help overcome the impact of the decaying value of nominal dollars – and yes, this means the payment will be lower than if no COLA is selected!

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      1. Thanks so much Alexandra for stopping in and answering questions. That is greatly appreciated. I have more articles to follow on this including the ‘how to use’ within the full financial plan. I’ll ask for your input on that and also I’ll give it a go on matching levels of annuity with some suggestions on the right ETF or ETF/stock portfolio might work in concert.

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  3. I’d love to pensionize some of my fixed income and cash but have always been a bit suspicious of the annuity. Can you tell me a little about how the monthly payments are taxed?

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      1. The tax treatment of the annuity depends on the source of funds used to buy the annuity. If the funds are from a registered account (RRSP, RRIF), the payments are taxed as “ordinary income” (just like interest income or employment income).

        On the other hand, if the payments are from a non-registered account, they are taxed partly as return of capital (i.e., no tax) and partly as interest; and the purchaser can choose two different forms of taxation for their annuity with non-reg funds: one that spreads tax over the expected lifetime of the purchaser, and one that “front-loads” the tax (like the interest on a mortgage is “front-loaded”).

        The first option, that spreads tax over the expected lifetime, is called a “prescribed” annuity while the second is called a “non-prescribed” annuity. The option to opt for the level taxation of the payments means that the payments can be VERY tax-effective, with potentially little or even NO taxable income coming out of the annuity.

        This option not only reduces the income tax you pay, but also helps preserve other taxable-income-tested beneficiaries, such as OAS and GIS.

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  4. good book review – going to get it

    comment re coverage from Assuris – (I realize you took the info from the book)

    Assuris covers up to $2,000/month 100% and over $2K to 85% see –

    http://www.assuris.ca/Client/Assuris/Assuris_LP4W_LND_WebStation.nsf/page/Examples+of+Payout+Annuity+Protection!OpenDocument

    and that coverage is on the aggregate amount if I hold multiple contracts (staggered annuity contract purchase )
    see -http://www.assuris.ca/Client/Assuris/Assuris_LP4W_LND_WebStation.nsf/page/What+happens+if+I+have+more+than+one+policy!OpenDocument

    says to me never carry more than $2K income with any one insurer

    Dale, I really like your posts btw – good info without BS – duh! hence the name 🙂 -keep up the good work

    Liked by 1 person

    1. Great, thanks for the added clarification. And thanks for the kind comments. I am trying to keep things, or make things as simple as possible. Good things have simplicity and basic common sense at the core. Thanks for stopping by.

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  5. Just curious. If the annuity is intended for a married couple which spouse’s age is used for the rate determination when the age difference is considerable?

    Liked by 1 person

      1. My understanding is that joint is more of a beneficiary set up. So the annuity rate is based on holder, beneficiary gets a survivourship benefit at that rate for a certain period. Hopefully Alexandra can stop by and add more details on that. There are always costs of course to any riders and guarantees and inflation adjustments/benefits.

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      2. With a joint and survivor pension when the two spouses are significantly different in age (think 10+ years), the amounts paid may be lower than if the spouses are close in age. It’s hard to generalize, and there are other features of annuities that can impact the payout amounts (guarantees, cost-of-living adjustments, etc.) Important to consider all of these dials and levers when considering an annuity purchase!

        Liked by 1 person

  6. If Assuris covered 100% of the money invested in an annuity it might be more appealing.

    I’m not a fan of annuities because for me the math doesn’t make sense.

    For each $100K you can get up to $450 per month from an annuity but my high dividend preferred shares ETF (ZPR) pays 4.5% as does my XDIV ETF, my ZDI ETF and my BMO covered call ETF’s pay 6.5% in dividends. Even my US/Global XDG ETF pays 3.3%. And all the ETF’s have growth potential! XDG has returned 6.5% in 12 months.

    My VSC and VAB bond ETF’s pay 3% so my monthly blended income is $3K from my ETF’s and I retain control of my money.

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    1. Hi mkoskenoja, annuities may not be for everyone. And as a self directed investor I don’t know what I’ll do, and won’t know what I’ll do until the time comes. But now, I am at least going to put them on the table. And I will look at the numbers.

      The main difference is guaranteed income vs non guaranteed. I admit some of those income products look appealing. I always go back to how the higher income stuff got crushed in the financial crisis. I am not sure if we have some long running Canadian ETFs that we can look at, but in the US the multi holding high income funds got slaughtered on price and on income.

      And for most it’s the risk. Most will not have the risk tolerance level of you and me.

      And again, it’s not an all or nothing venture. The Life Annuities are paying about double GIC and bond rates. My link from article shows 6% est available, age 65. They get more generous with age.

      This is an area where investors should certainly seek some help and get informed on the various strategies that goes well beyond the investment products available.

      Thanks for stopping by, Dale

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      1. Understood Dale but anyone with FI ETF bond funds representing 40% or so of their portfolio should be OK.

        To each their own – I’ll never buy an annuity.

        Marko K.

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    2. Hi mkoskenoja,
      Interesting comment but I’m not clear as to what portfolio mix or size is generating $3K monthly (good for you btw 🙂
      What are the percentages of the listed ETFs in the portfolio and what is the total portfolio value?
      Please could you clarify? Thanks!
      As you mention retaining control of the capital is also one of my concerns – but the guaranteed income is also interesting – I’m leaning to a blending of both ideas – probably enough in the annuity stream combined with CPP and OAS to cover minimum living expenses – rest is gravy.
      Btw to get Assuris to cover 100% of your investment simply hold no more than $2K in annuity income from any single provider – see comment and links in previous comment.

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      1. Hi fbgcai – I have $900K invested in about 50% fixed income Vanguard bond ETF’s and 50% in high dividend equity ETF’s from BMO and iShares.

        However, 20% of the fixed income is in the BMO ZPR preferred shares ETF that is often considered a proxy for bonds but it’s down 10% and was been down 25% a few years ago went the BOC rate went close to 0%. It ain’t no FI/bond fund! It pays 4.5% in dividend income though.

        I have 30% of my equity ETF’s in Canada and 15% in each the US and Global ETF’s.

        I was in index funds but went the dividend route when I decided to retire now at 59. It works for me as I don’t have a pension outside of what I will collect from CPP/OAS. I’m taking my CPP in 8 months when I turn 60 and will invest it.

        My wife has her investments in a 60/40 portfolio made up of iShares XDIV and XDG and BMO ZAG aggregate bond ETF. Those funds have low MER’s and pay excellent dividends.

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      2. Hi mkoskenoja thanks for sharing your investment mix and stage in life. It’s always more than interesting and I agree that a self directed investor with the right mix and temperament can do extremely well in retirement.

        Always to each his or her own. And best of luck. Please keep dropping by to share and challenge. 🙂

        Dale

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  7. “I am not sure if we have some long running Canadian ETFs that we can look at, but in the US the multi holding high income funds got slaughtered on price and on income.”

    Why bother with those ETFs and their shaky distributions when we have our big 5 stable banks offering decent growing dividends. Not guaranteed but c’mon, 3 of the 5 have paid continuous dividends without a cut for over 150 years, the other 2 without a cut since 1942 (77 years). That’s plenty safe in my books.

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    1. Agreed about bank dividends Bernie but my iShares XDIV ETF covers 20 big Canadian dividend payers like BMO, RBC, CIBC, Scotia, BCE and Telus, pays a trailing yield of 5.05% at a cost of only .10%. That’s only $100 on $100K for a lot of diversity.

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      1. XDIV is ok if you can handle the wildly irregular distributions. I prefer reliability, predictability and sustainability in my dividends. Case in point the 12% reduction in monthly distribution between the Sep and Oct payments. See link: http://ca.dividendinvestor.com/historical.php?no=396925

        The fluctuation is even worse with XDG. Note the 44% decrease in payment below, same months: http://ca.dividendinvestor.com/historical.php?no=396925

        BMO ETFs prefer to smooth out their payments rather than jumping around. I prefer their offerings a bit more but, bottom line, you can’t beat holding large cap blue chip dividend growers over the long term. For added safety it helps to have a diverse mix in your basket of Canadian stocks. Its tougher to pick US and int’l stocks so I lean to ETFs and mutual funds for my content in those markets. I used to own more individual stocks but these days I only hold Realty Income (O) and Unilever (UL). I also added a lot of fixed income income. Overall I’m now 20% Cdn, 27% US, 16% Int’l and 35% fixed income (and equivalents). The invested portion is 91% of the portfolio, I also hold 9% cash in a HISA waiting for a more certain market to redeploy.

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      2. Hi Bernie one is probably best to focus on the investment not any distribution bumpiness? It will not matter in the accumulation stage. And in retirement a retiree will plan their income with a mix of cash, bonds and stocks and pensions and other income. They are likely not spending the dividend income month to month.

        It all comes back to the quality of the group of holdings over the longer term.

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      3. Agreed Dale – between my wife and I we have $200K or so in each XDIV and XDG and we never even noticed the dividend bump that Bernie referenced.

        XDG has 249 stocks in it from the US, Canada and globally with a good dividend yield and a total return to us of 7.38% in the past 13 months. With a MER of only .22% it works for me and balances out some of the higher .72% MER’s I pay on my BMO covered call ETF’s.

        Like most things in life to each their own 🙂 I’m very happy with my ETF’s and the monthly distributions. That and I don’t worry about market fluctuations.

        Marko

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  8. Marko,
    Good to see you’re happy with your ETFs, that’s the most important thing! I admit to a certain degree of anality with my budgeting and investments. I withdraw monthly from my RRIF to supplement my company pension, OAS and CPP. I’m ok with a bit of “bumpiness” in my investment path but draw the line with teeth rattling potholes. I’ve designed my portfolio to provide roughly equal monthly income (~within $100 month over month). Yes, I have quarterly payers too which are part of the equation. I haven’t had the need come up but should I have a withdrawal shortfall I can always sell a bit of my Mawer Global Balanced Fund to “help out”. There’s no commissions on mutual funds buys or sells so I prefer that route if need be. I’m quite happy with my overall mix. The volatility has been dampened considerably with the added fixed income content. My 13 month TR is 6.25%, yield currently is 4.45% and I’m withdrawing ~3.8% via equal monthly payments.
    Bernie

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  9. Hi Dale,

    Read your blurb about annuities and have some comments.

    You say “…the longer you wait to purchase that annuity, the greater the payments “Possibly so,but how do you know how long to wait? I have a lot of clients who ” waited ” and now,due to sickness or death, the extra income is useless. People need to look at their health history and us that as a guideline.

    And “stagger your annuity purchases over many years?” 30 or 40 years? In later years, people have long lost in making more money;people just want guaranteed income.The older the person,the less the interest.

    “When you die, your money goes to the insurance company” is not correct. You need to differentiate between registered and non registered monies. At the last death with registered money, any remaining capital is taxed with the balance distributed. With non registered money, payments can continue to beneficiaries for the balance of any remaining period. Only then would any other type of distribution take place;as you say you need” the right buckets at the right time”.

    Finally,”annuities are insured by Assuris,which covers 85% of the annuity payment up to $2k per month”.This appears to be a typo; it is 100 % up to $2k a month and 85% thereafter. That’ why we use multiple companies when necessary.

    Best,

    Ivon T Hughes
    LifeAnnuities.com

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    1. Thanks Ivon, re when and why and how much, that’s why I wrote … “The retirement stage can be more than complicated. Many retirees and near retirees will benefit by obtaining advice. You might contact a qualified fee-for-service advisor.”

      I’ll check on the insurance mention with Alexandra.

      Thanks for stopping by.

      Dale

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    2. @Ivon I’m guessing you skimmed all the comments (or didn’t read them) the Assuris coverage was discussed way back on March 7 but thank you for verifying

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  10. Historically I have agreed with you, and planned annuity purchases for myself …… until the Cdn Preffered Share market collapsed in 2015 and now again …. without valid reason. Now the choice between
    (a) an annuity paying under 6% (say for a male 65) where your payment is flat even if inflation takes off, and you lose 100% access to principal on purchase, and
    (b) a portfolio of preferred shares from the same companies that issue the annuities, paying over 5.5%, with increasing payments if interests rates (inflation) take off, and you keep access to all the principal. And you have the same longevity insurance as with the annuity.

    Hands down, the Cdn Preferreds win. I own a bundle and will hold till I die.

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    1. I agree with you about preferred shares Chris. I have $90K of the BMO ZPR laddered pref shares ETF. They are down 10% so I see them as being on sale. I am planning to buy more next week.

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    2. Chris,

      “…and you keep access to all the principal.”

      Not necessarily “all that principle” because the stock price may go down leaving you with less principle like HPR has done with mkoskenoja. There are pros and cons with all securities. I prefer common stock over preferreds because there is inflation protection built in through dividend growth.

      Liked by 1 person

      1. To each his or her own, for sure, but I’m with Bernie on this one. I’d go for that dividend growth. Especially in Canada some juicy dividends with dividend growth could trump the pref yield in quick order. With my current Canadian mix the yield on cost would go to about 8%or more in 5 years, with about 9% annual dividend growth. Manage the core stock risk with some ‘traditional’ bonds. Perhaps a mix of universe bond index and some hyrbrid xhb for a wee boost.

        Dale

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      2. But the logic you and Dale are using goes ….. You seem to agree that Preferreds are now better than annuities … but common are better than preferreds ….. therefore common shares are better than annuities.

        All keeping in mind that we are talking about the safe, continuing, income flows to fund the base necessities of life in retirement.

        Regarding your other comments…..
        I really don’t see inflation without an increase in T5 interest rates … which will increase the yields of RRprefs. And sometime in the future, retail investors will eventually figure out that the price of RRprefs should NOT go down when interest rates go down …. that unless there is a change in risk, their price should move back to Par at every reset , exactly like a T5 bond. I am not holding my breath (just look at the longevity of the false narratives regarding RRSPs that have survived generations),

        Liked by 1 person

  11. bmo monthly income uses a very small component of US prefs. If I was looking for a big of an income booster, but I’m not, I’d look to a modest amount of the covered call products. I’ll stick with the core of dividend growth stocks with bonds. I probably should have REITs, but don’t. 🙂

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    1. Hey John, many ETFs will have a lumpy distribution as the dividends arrive in lumpy fashion. Some ETFs will smooth out the distributions, some will not. For example, Vanguard High Dividend Yield Index ETF VDY has a very lumpy distribution. The important consideration would be the annual distributions. With VDY the first full year of distributions paid was .75 per share. In 2018 they paid 1.33. I’ve held that one in my wife’s account almost from inception. I researched the fund as I worked on the marketing materials for the Vanguard ETF launch.

      Also keep in mind that companies can come and go, especially with an index that is smart beta. Meaning that some higher yielders might bet the boot, reducing the yield. In fact the index methodology is looking to do ‘just that’ at times. They may lessen the yield but increase the overall quality or ‘safety’ of the basket of holdings. They are looking for the dividend sweet spot. juicy but not too risky. They run financial filters as you likely know, seeking greater financial health.

      I will look into XDIV to see if they are attempting any kind of dividend smoothing.

      Like

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