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Investing Insights: Midyear Tasks for Retirees, GE, and J&J

We look at dividend stocks in the utilities sector, drugmakers on the cutting edge, and a large-growth holding on this week's episode.

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As we enter into the second half of 2018, it might be a good time for retirees to do a portfolio checkup. I'm here today with Christine Benz, she is our director of personal finance, to look at six tips of how to make that go smoothly.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: Christine, you've written a companion article to this video touching on these six steps. But if you are a retiree and you want to take a look at your portfolio, what do you think the first thing to is?

Benz: The first thing is to check your spending rate, because that's kind of the baseline number that will tell you how healthy your in-retirement plan is. If you have your spending totals for the year to date through the middle of the year you can just extrapolate out, annualize that number and then you divide that by your current portfolio balance to arrive at your withdrawal rate. If you are a new retiree, you probably want to come in close to that 4% withdrawal guideline that we often talk about. If you are an older retiree, you can probably take a more aggressive withdrawal rate than just that 4%.

Our colleague, David Blanchett, who is the head of retirement research for Morningstar Investment Management, has written about how retirees should revisit their withdrawal rates on an annual basis, and they might be able to use the required minimum distribution tables that the IRS publishes as kind of a guideline to determine, how much can I sensibly take out of this portfolio per year. That's a starting point that you can use. This is another place where if you work with a financial advisor, if you want some guidance on much you can spend per year, this is a place to get some advice.

Glaser: We saw some volatility in the first half of the year, but stocks did end up. Is this is a good time to revisit your asset allocation to make sure you are not too equity heavy?

Benz: I think it is. If you are conducting any sort of portfolio checkup, that's one of the key things to look at, is what your baseline asset allocation looks like. And Morningstar X-Ray is certainly a great tool for getting a very specific read on your current asset allocation. Many of us, retirees included, have gotten more equity heavy with our portfolios as we have seen stocks drift up. Even if we haven't been aggressively adding to equities, we have seen our equity portfolios enlarging. I do think it's a good time to take a look at that asset allocation, potentially scale back on equities if you are heavier there than your targets would call for.

Glaser: Speaking of that volatility, we don't know what the second half will bring, but there's certainly the possibility of even more, potentially a sell-off, given where valuations are. You think that means it's really important to look at how much cash you are holding today.

Benz: It does. You want to look at cash for a couple of reasons. One is simply--and as you know, I'm a proponent of the Bucket strategy where you set aside enough liquidity to cover your next six months' to two years' worth of living expenses--but I think having cash on hand can make sense, not just from the standpoint of making sure that you are not having to sell anything when it's down to meet your living expenses, but also if you are an opportunistic investor who wants to take advantage of bargains should they present themselves, holding a little bit of extra cash seems like a reasonable strategy to me. I often say, six months' to two years' worth of portfolio withdrawals in cash is a good benchmark. I don't think it's unreasonable for retirees to think about tipping their allocations to cash even higher than that, maybe up to three years, because the opportunity cost seems really quite low to me. Where we have seen cash yields coming online that are over 2% today, the trade-off between investing in cash and say, a short-term bond fund seems like a pretty good one right now.

Glaser: You think this is also a decent time to think about Roth IRA conversion?

Benz: Potentially. And this is something I would urge, especially early retirees to check into. Maria Bruno, who focuses on retirement planning for Vanguard, has talked about those post-retirement, pre-required minimum distributions years as being kind of a sweet spot for investigating conversions, the reason being that you have a lot of control over your income at that life stage where you are not earning a salary, but you are not subject to RMDs. Check into whether converting some traditional assets, IRA assets, to Roth makes sense, work with a tax advisor or a financial advisor. One thing people, I think, underrate is the idea of doing partial conversions versus converting a whole IRA balance. That's another idea. You may be able to work with a tax advisor to figure out specifically how much you can covert in a given year in order to avoid pushing yourself into the next highest tax bracket.

Glaser: Speaking of RMDs, they are not something you have to do at the end of year, but you should start thinking about them now.

Benz: I think so. I am a big fan of sourcing required minimum distributions from portfolio withdrawals. Look at your portfolio, size it up, see where you want to make adjustments and pull from those pieces of your portfolio that you want to trim back on from a portfolio perspective, from a risk reduction perspective. For a lot of investors today, their equity component of their portfolios is a logical place to look for trimming, specifically, the growth component of equities because they have performed so well.

Glaser: Another item that many retirees leave to the end of the year is charitable giving. It could make sense to look at that now though.

Benz: I do think so, because things are changing a bit in terms of charitable contributions for many households. Many people, retirees included, will probably not be itemizing their deductions on their tax returns. They won't get the bang for their charitable contributions in the same way that they did in the past. One strategy, I think, well worth exploring for people who are subject to required minimum distributions is what's called a qualified charitable distribution. The basic idea is that you take a portion of your RMD, up to $100,000, and send it directly to the charity of your choice. You are letting your brokerage firm or your mutual fund company work directly with the charity to execute this transaction. The benefit is that that RMD does not affect your adjusted gross income. You may be able to reduce your taxes by taking advantage of the QCD.

Another idea for all retirees or really anyone is the idea of using of a donor-advised fund. And the basic idea there is that if you aggregate all of your charitable contributions into a single year in which you plan to itemize, then you can get more of a bang for your charitable donations by doing that. That's another strategy to investigate if your charitably inclined.

Glaser: Christine, thank you.

Benz: Jeremy, thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.


Travis Miller: Income investors finally have a chance to get back into the stock market with utilities. The sector has been decimated, especially on a relative basis, since November of last year. Interest rates have gone up to 3%. Dividend yields are holding in in the sector around 3.5%, and we think there are several opportunities right now to find both value and yields with a couple of stocks yielding over 4.5% right now in the large-cap space.

One of those is Dominion Energy that we like. This, we think, has the best growth potential, around 7%, plus a 4.5% dividend right now, and it's our only wide-moat utility. An excellent management team there and great investment growth prospects. 

The biggest value play, we think, right now in the utilities sector is PPL. Again, a large-cap name, trading with a yield at 5.5%. There's some concern in the market about their operations in the United Kingdom. We still think the growth can be over 6% over the next few years. Then also, another large-cap widely held name, Duke Energy. Also, trading above 4.5%. Not as much of a value pick, but the income is very good, and we think it can grow 6%.


Damien Conover: Johnson & Johnson reported second-quarter earnings that were largely in line with both our expectations and consensus, and we continue to view the company with a strong, wide economic moat.

One of the things that's interesting about Johnson & Johnson's quarter is the very strong growth in its drug sales. Johnson & Johnson is at a great point of launching a lot of new drugs, both in immunology and oncology. That is really well positioning the overall company and really helping to offset some of the slower growth that we're seeing in the device and consumer division.

What this means on the bottom line is even stronger growth, because the drug division has higher margins. We're seeing the amplified strong growth of the drug unit being reflected in very strong earnings growth.

As we look ahead, we do expect this growth to moderate somewhat as increasing generic competition slows some of the drug growth, but overall, we think the company's very well positioned, and we continue to view the company as rated with a wide moat and valuation of $130--pretty close to where the stock is trading right now. We view the company as largely fairly valued.


Josh Aguilar: We recently downgraded General Electric's moat to narrow from wide. The way we differentiate between a wide moat and narrow moat comes down to our confidence in excess returns. When we assign a firm a wide moat, we're saying we have very high confidence that a company will achieve normalized excess returns over the next decade, and more likely than not over the next 20 years. By contrast, with narrow-moat-rated firms, we're still saying we think it's more likely than not a company can clear that 10-year hurdle, but we don't have that same high degree of confidence we do with wide-moat-rated firms. What ultimately affects our visibility into the future with GE really are two main factors: secular threats facing GE power and lingering liabilities at GE capital.

With power, which is the firm's largest segment by revenue, renewables like wind power are now a cheaper alternative from an unsubsidized levelized cost of energy standpoint. Median prices for wind power as measured by dollar per megawatt hours are, on average, about 25% cheaper than natural gas through the cycle. Moreover, while natural gas generates around half the carbon dioxide emissions that burning coal does, wind power produces virtually no negative environmental impact--it's a clean source of fuel that doesn't emit particulates into the air. 

What GE's biggest proponents often point to is the firm's massive installed base. GE powers about one third of the world's electricity. In theory, this should give them a sizable switching cost competitive advantage and allow GE to continue having a large amount of aftermarket service revenue. The problem, however, is you now have alternative forms of energy that are potentially cheaper and cleaner in an industry that suffers from overcapacity. We're not suggesting gas or other fossil fuels are going away. The wind won't always blow, and the sun won't always shine. But we do think there is a risk of some of these assets becoming stranded assets as renewables, which GE also has exposure to, become increasingly cheaper in a price competitive industry.

Second, GE capital has a lot of legacy issues they’re dealing with, both in insurance and mortgages, and we essentially believe it has no equity value even as it has about $10.9 billion of tangible book value as of its latest balance sheet. The way we arrive at this calculation is we net out the present value of the number of payments GE is required to pay to GE capital over the next six years as it shores up its long-term care reserves. That nets out about $7.1 billion. The rest is a judgment call based on the extent of GE capital's exposure to WMC's subprime mortgage lending activities prior to the crisis. GE is currently being investigated by the Department of Justice for alleged FIRREA violations, which is a civil statute that came out of the savings and loans crisis of the 1980s. They've booked about a $1.5 billion liability, and we think this a starting point. When we compare WMC to Countrywide, we think the liability should be closer to about $5 billion. When all is said and done, our math leaves us with essentially no equity value on GE capital's balance sheet.


Karen Andersen: Branded drugmakers have come under scrutiny for high prices and annual price increases, and the landscape for negotiating discounts with payers has become more competitive. Even though reduced pricing pressure hits the top line for drug firms, we think some drugmakers are successfully using manufacturing improvements to offset pressure on the bottom line. Overall, across the industry, we see gross margins staying relatively steady at a strong 76% over the next five years, as manufacturing improvements and very strong, 95%-plus gross margins on many differentiated and effective therapies counter increased headwinds from pricing on older products and royalty and profit share payments to partners.

Following our deep dive into drug manufacturing and gross margins at 20 narrow and wide moat drug firms under our coverage, we'd like to highlight a few names that stand out for their combination of manufacturing expertise and undervalued stocks. For example, in big pharma, Glaxo and Sanofi are both committed to more efficient continuous manufacturing practices, which are slowly being adopted across the drug industry. In biotech, Biogen, Biomarin, and Roche are all undervalued and are benefiting from novel manufacturing technologies. Biogen's improving productivity makes their ability to serve a sizable potential Alzheimer's market more feasible. BioMarin is poised to see a large gross margin improvement as new drugs launch and as the firm makes progress with novel gene therapy manufacturing. Roche's large manufacturing capacity expansion should give it the flexibility it needs to manufacture a variety of novel and complex biologics. 

Overall, we see several ways to invest in drug firms that are on the cutting edge of manufacturing innovation.


Robby Greengold: Fidelity Advisor New Insights earns a Morningstar Analyst Rating of Silver, reflecting the talent and experience of its leadership. This equity fund is headed by veteran asset managers Will Danoff and John Roth. Their collaboration here is organized in a 60/40 sleeve structure, with each manager operating independently.

Danoff is responsible for the larger slice, and he's been a reliably growth-oriented investor over the past 10 or 15 years. His manages with the foundational belief that stock prices follow earnings. As he scours the market for companies to buy, he looks for superior business models and places a lot of emphasis on the skill of corporate executive teams. Founder-led firms have been among his favorites in recent years: Facebook,, and are good examples of that; those stocks have been significant holdings in this portfolio. Danoff's sleeve mirrors that of his other charge, Fidelity Contrafund, which is a Silver-rated fund that he's run prodigiously for nearly three decades.

Roth tends to be a bit more value-leaning in his approach. His sleeve draws mostly from Fidelity New Millennium, a Bronze-rated large-blend fund that he's managed successfully since 2006. Compared with Danoff, Roth delves further down the market-cap spectrum, he's more willing to bet on turnaround plays, and typically holds more in financials and less in technology and consumer discretionary stocks.

With a capable management duo at the helm, this fund remains a worthy long-term holding. does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.