What Is a Targeted-Distribution Fund?

A targeted-distribution fund is a specialized mutual fund or exchange-traded fund (ETF) that distributes regular payments of income or capital gains to its investors. It is designed as a long-term income stream for retirees.

Targeted-distribution funds have gained in popularity as the baby boom generation has aged into retirement and as employer-sponsored defined benefit pension plans disappear.

They are sometimes known as open-end managed-payout funds.

Key Takeaways

  • A targeted-distribution fund or ETF pays its investors a steady stream of income that may be a mix of dividends, interest, and even return of principal.
  • Some but not all guarantee a specific payment.
  • The typical investor in a targeted-distribution fund is a retiree seeking a relatively safe income source.

Understanding the Targeted-Distribution Fund

Unlike annuities, not all targeted-distribution funds promise a specific payment amount or a minimum payout amount. The payments may vary depending on the current market performance of the fund.

Some funds are designed to protect the principal investment while paying out dividends and interest income, while others deplete the principal investment to make the promised payments as necessary.

A fund may state its principal retention strategy or inflation-adjusted payout formula, but if the portfolio performance does not result in sufficient returns, the fund managers are usually not obligated to make payouts or protect principal investments.

Risks and Potential

That makes these instruments a risky option for an investor who hopes to rely on a specific amount of income from investments.

Other investors find a managed payout plan attractive because of its potential to compensate for inflation over time or to achieve an increased overall payout.

Examples of Targeted Distribution Plans

Vanguard's Target Retirement Income Fund is designed for investors who have already retired. Most of its assets are invested in Vanguard bond funds, with the remainder scattered across a number of stock index funds and even an international stock index.

The Strategy Shares Nasdaq 7HANDL Index ETF claims to be the first targeted distribution ETF. The bulk of its investments are in bond ETFs, with 30% in large-cap stock ETFs.

Targeted-Distribution Plan vs. Pension Plan

The targeted-distribution plan is one of many investment choices invented in recent years to replace the private-sector pension that once provided a degree of security for American retirees.

The American private sector began to abandon defined benefit pensions in the 1970s. The tax-deferred company-sponsored 401(k) retirement fund was introduced in 1978, and employers were quick to switch to this less costly way to offer an employee benefit.

The Disappearing Pension

In 1975, the U.S. Department of Labor showed that 88% of private-sector workers were covered under defined benefit plans. By 2005, only 33% of private-sector employees were covered. By 2019, that figure was down to about 12%, according to the Bureau of Labor Statistics.

The situation is very different for government workers. In 1975, 98% of public-sector employees were covered by a pension, and in 2005 that figure still stood at 92%.

Many current workers have neither. A 2015 study released by the Schwartz Center for Economic Policy Analysis at the New School reported that 68% of working-age people did not participate in an employer-sponsored retirement plan of any kind.

Many analysts have long anticipated a crisis for retirees in the coming years, especially as underfunded defined-benefit pensions struggle to remain solvent.