One of the most important concepts in retirement investing is understanding the difference between nominal and real returns. A nominal return is simply the percentage gain your investments generate before accounting for inflation. If your portfolio earns 8% during a year when inflation runs at 3%, your nominal return is 8%. Your real return is what remains after inflation has reduced your purchasing power. In that same example, your real return is closer to 5%.
Put another way, nominal returns are what you see on your brokerage statement. Real returns are what you actually get to spend during your golden years. That distinction matters because not every asset class has historically kept pace with inflation, particularly during periods when inflation runs well above the Federal Reserve’s long-term 2% target.
I think retirees have three asset classes that deserve particular attention. Dividend-paying stocks can provide a growing stream of income, Treasury Inflation-Protected Securities (TIPS) directly adjust with inflation, and real estate investment trusts (REITs) have historically offered both income and long-term inflation protection through real assets. Better yet, all three can be accessed through low-cost Charles Schwab ETFs.
60% in SCHD
The Schwab U.S. Dividend Equity ETF (SCHD) serves as the portfolio’s primary source of equity income. SCHD tracks the Dow Jones U.S. Dividend 100 Index while charging an exceptionally low 0.06% expense ratio.
Rather than simply selecting the highest-yielding companies, the index begins with firms that have paid dividends for at least 10 consecutive years before screening them using free cash flow to total debt, return on equity, dividend yield, and five-year dividend growth. The 100 highest-ranked companies form the final portfolio, with quarterly rebalancing and an annual reconstitution.
The result is a portfolio that currently offers a 3.33% 30-day SEC yield while maintaining impressive quality characteristics. As of the latest data, SCHD sports a 26.54% return on equity alongside a forward price-to-earnings ratio of just 19.07, giving investors exposure to profitable businesses without paying excessive valuations.
30% in SCHP
TIPS, are U.S. Treasury bonds whose principal value adjusts with changes in the Consumer Price Index (CPI). Because coupon payments are calculated as a percentage of that inflation-adjusted principal, both the bond’s value and its income generally rise alongside inflation. TIPS have historically performed best when inflation comes in above what the market expected.
The Schwab U.S. TIPS ETF (SCHP) tracks the Bloomberg U.S. Treasury Inflation-Linked Bond Index and currently holds 49 securities. One figure that stands out today is the fund’s 11.34% 30-day SEC yield. Investors shouldn’t assume that represents a permanent level of income.
Much of that unusually high yield reflects a recent surge in inflation adjustments following higher CPI readings, driven in part by energy price increases stemming from disruptions to shipping through the Strait of Hormuz during the ongoing Israel-Iran-U.S. conflict.
10% in SCHH
The Schwab U.S. REIT ETF (SCHH) provides exposure to another asset class that has historically helped investors combat inflation: real estate. SCHH tracks the Dow Jones Equity All REIT Index. One feature I particularly like is that it excludes mortgage REITs.
Despite their name, mortgage REITs generally don’t own income-producing real estate. Instead, they’re primarily leveraged investors in mortgage-backed securities, giving them a very different risk profile than traditional equity REITs.
Equity REITs own physical properties whose rents and property values have historically tended to rise over long periods alongside inflation. They also provide attractive current income, with SCHH currently offering a 3.21% 30-day SEC yield.
Another benefit is that investors don’t need to worry much about overlap with SCHD. Because SCHD’s methodology excludes REITs, the two ETFs complement each other well rather than duplicating holdings.
One tax consideration is worth noting. REIT distributions are generally taxed as ordinary dividends rather than qualified dividends, making SCHH a better fit inside a tax-advantaged account such as a Roth IRA whenever possible.
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