If I were retired today and had to put all my money into a single fund, I’d probably pick the Vanguard Wellesley Income Fund Investor Shares (VWINX).
This is one of Vanguard’s longest-running actively managed mutual funds, dating back to 1970, and it has delivered a strong 9.17% annualized return since inception, before taxes.
About one-third is allocated to stocks and two-thirds to bonds. The equity sleeve focuses on companies with above-average dividend yield and growth, screened down to a portfolio of fewer than 100 names with reasonable valuations. The bond side primarily holds investment-grade corporate bonds across short, intermediate, and long durations.
The 3.5% 30-day SEC yield is solid, and a 0.22% expense ratio is reasonable for active management. It’s a conservative, income-oriented portfolio that has worked well over time. Still, it’s not perfect. The $3,000 minimum investment can be a hurdle, and if you want the Admiral Shares with a lower 0.15% expense ratio and slightly higher yield, you need $50,000.
The good news is you can replicate a very similar strategy using ETFs. In fact, based on the data, you can slightly outperform Wellesley while maintaining a similar risk and return profile, largely thanks to lower fees. Here’s how.
35% in VIG
To replace Wellesley’s one-third allocation to stocks, you can allocate 35% to the Vanguard Dividend Appreciation ETF (NYSEARCA: VIG | VIG Price Prediction).
For a 0.04% expense ratio, you get exposure to the S&P U.S. Dividend Growers Index.
To be included, companies must have increased dividends for at least 10 consecutive years. The index also excludes the top quartile of highest-yielding stocks, which helps avoid yield traps with weaker fundamentals. From there, holdings are market-cap weighted with a 4% cap at each quarterly rebalance to limit concentration.
The result is a portfolio of 338 companies with strong quality characteristics. Earnings growth sits around 13.1%, and return on equity is about 29.4%. At 26.2 times earnings, it’s not cheap, but you’re paying for a portfolio of durable, high-quality businesses.
Over the past 10 years, with dividends reinvested, it has delivered a 12.34% annualized return before taxes. The 1.56% 30-day SEC yield is also fairly tax-efficient, since VIG’s methodology excludes real estate investment trusts (REITs).
35% in VTC
To replace Wellesley’s bond allocation, you can allocate 65% to the Vanguard Total Corporate Bond ETF (NASDAQ: VTC).
It’s extremely cost-efficient with a 0.03% expense ratio and currently offers a 4.76% 30-day SEC yield.
Credit quality remains solid. While only a small portion is AAA or AA, over 90% of the portfolio is in A and BBB-rated bonds, which are still firmly investment grade. That said, there is credit risk. In a downturn, it won’t hold up as well as Treasuries, but it should still be more stable than equities.
Interest rate sensitivity is another factor. With a duration of 6.7 years, rising rates can pressure prices, while falling rates can provide a tailwind. This can hurt the ETF in years in 2022, but help it during years like 2020.
Taxes are also important here. Corporate bond income is taxed as ordinary income at both federal and state levels. Vanguard notes that over the past three years, a 4.65% annualized return dropped to 2.77% after taxes on distributions. Thus, VTC is best held in a tax-advantaged account.
Putting the Portfolio Together
Simply allocate 35% to VIG and 65% to VTC, and rebalance the mix each year. You can rebalance more frequently, but in taxable accounts, that may trigger capital gains and reduce returns.
Over an 8.39-year backtest period from November 2017 to the present, according to testfolio.io, this ETF mix delivered a 5.82% annualized return versus 5.34% for VWINX, with identical risk-adjusted returns, both at a 0.40 Sharpe ratio.
The edge for the VIG and VTC mix comes primarily from fees. The blended expense ratio of this portfolio is less than 0.04%, compared to 0.22% for VWINX. Lower costs mean more income and returns stay in your pocket.
If you like what Wellesley does but want more flexibility and lower costs, I think this two-ETF combination is a very practical alternative for a retirement portfolio.
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