2 ETFs that are all you need for retirement

The ETFs can be the core of your plan once you retire, but you can also use them while you're accumulating your retirement nest egg as well

In 1994, financial planner William Bengen laid out a compelling case for a very simple retirement withdrawal strategy that is now commonly known as the 4% rule. His work showed how an investment strategy diversified across common stocks and intermediate-term Treasury bonds could help a retiree navigate a 30-year retirement with very little chance of running out of money.

Today, in the age of low-cost exchange-traded funds (ETFs) that focus on indexes, it becomes pretty simple to create such a portfolio with just two funds. For stocks, the Invesco S&P 500 Equal Weight ETF is certainly worth considering. For intermediate Treasury bonds, it's hard to beat the Vanguard Intermediate-Term Treasury Fund Index ETF. Put those two ETFs together in an intelligent way, and they could very well wind up being all you need for retirement.

Ticker Security Last Change Change %
RSP INVESCO EXCHANGE TRADED FD TR S&P 500 EQL WGT ETF 140.34 -0.82 -0.58%
VGIT VANGUARD SCOTTSDALE FDS VANGUARD INTER-TERM GOVT BD 61.76 +0.47 +0.77%

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How the 4% rule works

Bengen's work that came up with the 4% rule focused on retirees who maintained a well-diversified portfolio that was somewhere between a mix of 75% stocks and 25% bonds and a 50-50 mix of the two. He looked back across historical market returns and inflation rates and assumed that a retiree would want to maintain a steady lifestyle throughout retirement, after accounting for inflation.

With those assumptions in place, he checked to see how much a person could withdraw every year and still have a very strong chance of winding up completing a 30-year retirement without running out of money. He calculated that by keeping that diversified and balanced portfolio, a retiree could start by spending 4% of the portfolio's initial account balance and adjust those withdrawals for inflation each year.

Say, for instance, that you expect to need $48,000 a year in retirement ($4,000 per month) to cover your costs and that Social Security should provide you around $1,500 per month. Since Social Security adjusts its payout for inflation each year, you'd need your nest egg to cover the other $2,500 per month -- $30,000 per year. Thanks to the 4% rule, it looks like you could cover that gap with a nest egg of $750,000 across the Invesco S&P 500 Equal Weight and the Vanguard Intermediate-Term Treasury ETFs.

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Why include the Invesco S&P 500 Equal Weight ETF?

The Invesco S&P 500 Equal Weight ETF invests in the same companies that make up most S&P 500 trackers, but it does so a little bit differently. While the typical S&P 500 fund is market-capitalization weighted, the Invesco ETF uses an equal-weighting strategy. In other words, it seeks to own about the same dollar amount in each company in that index.

That gives the Invesco ETF a leg up on diversification, as by market capitalization, the top 10 companies (11 securities due to different share classes) represent nearly 30% of the index. By contrast, in the Invesco ETF, the top 10 holdings represent less than 2.7% of the fund's holdings. That means the Invesco fund is less exposed to challenges that face the largest companies in that index than the typical S&P 500 fund is.

It offers that diversification benefit while still carrying a modest 0.2% expense ratio, which means that the fund's shareholders get virtually all the returns of owning the underlying stocks. Between that modest expense ratio and that diversified portfolio of S&P 500 stocks, the Invesco S&P 500 Equal Weight ETF is worthy of consideration for the stock allocation of your retirement portfolio.

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Why include the Vanguard Intermediate-Term Treasury ETF?

The Vanguard Intermediate-Term Treasury ETF generally invests in U.S. Treasury bonds that mature in three to 10 years.

That time frame is important. As an intermediate-term bond fund, it doesn't own the bonds with the shortest or the longest maturity dates. That three-to-10-year range can provide a sweet spot where the bonds offer higher interest rates than the shortest-term bonds but don't fall in price nearly as far as long-term bonds can when rates rise.

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In addition, as an ETF that owns Treasury bonds, it faces a fairly low default risk. The U.S. government can print dollars while generally borrowing in dollar-denominated bonds. While printing money can drive inflation, that combination -- along with the government's ability to tax -- does provide a very high likelihood that U.S. Treasury debt will be paid.

Although intermediate-term Treasury bonds are not likely to provide a high rate of return over time, they do offer more stability of pricing than stocks do. That's why they play a role in the 4% rule: to make sure you have some higher-certainty money available when you need spending cash. With a nearly invisible 0.05% expense ratio, investors in the Vanguard Intermediate-Term Treasury ETF get the benefits of owning those bonds for very low overhead.

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Two funds for a great future

The beauty of these two ETFs is that not only can they be the core to your plan once you retire, but you can also use them while you're accumulating your retirement nest egg as well. With a longer time horizon while you're still working, you'll likely want to tilt your allocation more heavily toward the stock fund.

As your retirement approaches, you'll want to draw closer to the balanced allocation that's so important when you're spending down your nest egg. Still, you can get away with just these two ETFs and have a great shot at making it to (and through) a financially comfortable retirement.

Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.