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Dividend Opportunities, Medicare, and Balanced Funds

We examine electric vehicles and withdrawal strategies for retirees.

Editor's note: We are presenting Morningstar's Investing Insights podcast here. You can subscribe for free on iTunes.

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Allen Good: We think the major integrated oil group offers a bevy of opportunities for dividend-focused investors. Currently yielding anywhere from 4% to 6.5%, the group is largely undervalued based off our assumptions. At those dividend levels, they are trading at historically high levels compared to decades ago, when they traditionally yielded anywhere from 3% to 4%. However, we do not see dividends at risk.

Subsequent to the collapse in oil prices in 2014, all these firms have done significant work in improving their operating and capital cost structure. So, now the dividends are largely safe down to oil prices are $50. Given our long-term assumption around $60 per barrel oil, we think dividends are largely safe as well.

Of the group, Shell (RDS.A) and Total stand out with the greatest opportunity in our opinion. Shell, yielding nearly 6.5%, has grown cash flow steadily over the past eight quarters, and we expect it to continue to do so. In fact, management's current plans call to return $125 billion in dividends and share purchases during the next five years. That's nearly half its current market cap.

Total (TOT), meanwhile, is also improving cash flow. It expects to grow operating cash flow by about $1 billion per year during the next five years, thanks to growing production as well as improved downstream profitability. This growing cash flow should ultimately support dividend growth annually of about 5% to 6%. This makes their current yield of about 5.5% look much more attractive compared to peers.

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Christine Benz: Hi, I'm Christine Benz for Morningstar. Many people are relieved when they're 65 and Medicare-eligible, but finding the right coverage type takes some thought. Joining me to make sense of what she calls "Medicare alphabet soup" is Maria Bruno. She's head of U.S. Wealth Planning Research at Vanguard.

Maria, thank you so much for being here.

Maria Bruno: Thank you, Christine.

Benz: Let's start with what you call kind of a framework for thinking about Medicare selections. You say that it's really important to take a step back and focus on what you need. And you think it's really a balance of--you're looking at affordability, of course, but you're also looking at flexibility and also the likelihood that you'll have coverage when you need it in a pinch.

Bruno: Right.

Benz: So, let's talk about how people can approach that.

Bruno: Yeah, I mean, it can be overwhelming because you hear "Medicare," and it's just not like one Medicare plan. But we created this framework--and my colleague, Steve Weber, came up with this idea and we turned it into a framework for advisors or individuals to get a little bit more comfortable with the decision-making and all the ins and outs of Medicare. We did a very high-level framework. I will preface this by saying that if anybody wants to learn more that they should go to the Medicare.gov website. It's very user-friendly and a lot of good information as well as personalization of that.

But many of us, when we think about insurance coverage, we start looking at plans and what the plan features are, and what the prices are. And that's not necessarily the right way to do it. It's really to take a step back and think about what is important to you when you think about insurance, and then go and find the plan that matches that. So, our framework really thinks about it in three steps. First is: What are your priorities? Second is: Evaluate the plans that match those priorities. And then, thirdly: Go through the enrollment process and understand what that looks like from a timing standpoint.

So, we think about priorities a little bit. One, maybe overall--affordability. I want to minimize over my lifetime the amount of money that I'm going to pay to insurance for my needs. That may mean that on a year-to-year basis, it might be a little bit different. If I incur medical costs, I might have to pay more in any one given year. But my overall affordability, I feel comfortable with. 

The other might be flexibility. Is it important that you can access any type of doctor or a specialist without a preapproval or not having to deal with planned provider networks and things like that? If that's important to you, then that's a factor that you really need to think through before exploring options because you want to make sure you have a match there.

The other might be cost certainty, in terms of, "Hey, I'm on a fixed budget, and I want to make sure what I'm paying for on a monthly basis," or I might want to have this convenience of, "I know I may pay more, but I want to make sure that, you know, I pay for everything, I don't have to worry about coinsurance or any type of deductibles and things like that." So, going through that process can help validate what it is that's important and then you go and find the plan that matches that.

So, Steve and I--we use this analogy about cars. I've been thinking about getting a new car, right? So, it's like when you go to buy a new car, you kind of know what's important. So, I joke I'm like, "OK, well, I know I want an all-wheel drive car, and I know I want a sedan. So, I'm not going to go look at SUVs." That narrows my field. But then I'm like, "OK, well, I don't necessarily want a car where have to pay for premium gas." Well, that narrows my universe even more. And the reality of it is, I may not be able to find exactly what I'm looking for. No plan is perfect. No car is perfect in terms of a match, but I'm going to get as close to it as I can.

Benz: Right. That's a helpful analogy. So, let's talk about that alphabet soup piece, because it's not just one and done. I don't just pick one Medicare plan. I'm looking at a couple of different things. So, Medicare Part A, that's the hospitalization, and then Part B is what might be paid for physician care, correct?

Bruno: Right.

Benz: But that's not going to cover everything, right, those two together?

Bruno: Correct. So, those two together are what we typically call "Original Medicare." Part A is free. Many of us pay for that through deferrals and through taxes during our working years. Part B we pay for in premiums. The two together is what we call traditional Medicare or Original Medicare. And there's no necessarily out-of-pocket. So, if you incur hospital stays, you may have to pay some monies there. There's not necessarily caps on those out-of-pockets there, and then Part B covers about 80%. So, you want to think about, "OK, do I need to insure for the remainder of that?" And many of us should be thinking about, yes, insuring that. 

Then there's also Part C, which is Medicare Advantage plans. So, these are private companies that contract with Medicare to basically offer Part A and B, but then they also offer things like dental, vision, maybe gym memberships. Then there's Part D, which is basically the prescription drug plans. So, those come together when we think about the Medicare alphabet soup. Those are the four big ones.

Benz: Right. So, regarding the Part D, what about people who have very few drugs that they take and, so, they are sort of looking at the cost of that Part D insurance versus just maybe going without? How should they size up that decision-making?

Bruno: First and foremost, I mentioned the Medicare.gov website. You can actually go in there and put in your prescriptions. So, one: Know what your needs are, again. What are your regular drugs? Put those in. They can do a plan match for you if you're looking for Part D. And then, you can make the decision of, "Do I take a lot of pills? Are they expensive? Are they brand versus generic? Do I want to insure this risk or not?" And then figure out which plan is most convenient. The thing I will say with Part D is, you do want to validate that every year because networks change, the drugs move off of different types of lists. So, if you do--with any of this, really, once you make your decision, you still want to take a look at it on an annual basis. But certainly, with Part D, you want to take a look at that and just make sure that it's economical for you as well. And that will vary by individual.

Benz: And how about thinking about that supplemental insurance policy? The good ones can be a big-ticket item in many retiree households. How should they approach the right policy for them?

Bruno: I think one way to think about it is whether or not to take advantage of a Medicare Advantage plan. They offer the Medicare Part A, B, and probably D as well. These are HMO, PPO type plans. They may be very beneficial from an overall affordability standpoint, but they may not offer as much flexibility because you may be limited to provider networks and things like that. So, that's one decision point.

The other supplemental policy is maybe Medigap policies. So, there's another alphabet soup there. These are plans A through N. These are not Medicare plans. They are Medigap plans. So, it's important distinction there. But basically, they are meant to cover what Medicare doesn't cover. And there it's important to understand, you know, in terms of there's high-deductible supplemental plans--where you may have lower premiums, but when you do incur medical costs, you might have to pay more out of pocket. And then they're more-comprehensive first-dollar coverage type plans, like a Medicare Part F or G--that basically you have to pay higher premiums, but they're more broad in terms of coverage when you do incur those medical expenses. Again, you could go to the Medicare website and help navigate a little bit more. But understanding which of those features are important can help then narrow down that field.

Benz: So, how about enrollment? You mentioned that it's important, at least with the prescription Part D coverage, to kind of re-shop that every year. But how about the first enrollment? I think people get very confused about when they should be signing up for Medicare.

Bruno: Yes. It's not when you turn 65 on your birthday.

Benz: So, don't wait till your birthday?

Bruno: No, don't wait for your birthday. So, the way it works in terms of the initial enrollment is--if you want coverage to start at age 65--you basically have a seven-month window for the initial enrollment. Three months before turning 65, your birth month, and then three months after. So, that's really your window to sign up. If you want coverage to start at age 65, you want to do that three months in advance. But that's your window. If you miss that window, then there's an annual enrollment period January through March. The challenge there, though, is that coverage doesn't begin until July. So, the downside is, one, you may not get coverage when you need it. There may be a gap. And then, secondly, if you delay, you may incur some surcharges that will carry on through your life on these premiums. So, do your homework there. But if you're still working and you have employer coverage, then you can certainly wait until you retire. But you want to coordinate the Medicare start with when you actually retire so you don't have a lapse of coverage. So, that's one thing.

And then, once you're enrolled, there's the annual enrollment season, which is Oct. 15 through Dec. 7. This is really your window to make sure that the plan you have meets your needs. So, if you want to make a change in your Medigap policy, for instance, or you want to move to a Medicare Advantage plan or vice versa, that's your window to do that. A word of caution there in that if you do make some changes, you might have to go through an underwriting process. So, your cost may be different or you may actually be denied coverage. So, make sure you understand what the decisions of that impact would be during that window. And then Part D as well: Networks change, coverage changes, formulary drugs change as well. So, it's important to relook at those every year as well.

Benz: Maria, always great to get your perspective. Lots of moving parts here. Thank you so much for being here to unpack them for us.

Bruno: Thank you. Good to be here.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.

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Christine Benz: Hi, I'm Christine Benz for Morningstar. In an era of ultra-low yields, many retirees struggle with how to generate cash flows from their portfolios without taking too much out. Joining me to discuss some strategies for doing that is Colleen Jaconetti. She's a senior investment analyst in Vanguard's Investment Strategy Group.

Colleen, thank you so much for being here.

Colleen Jaconetti: Happy to. Thank you.

Benz: So, I want to talk about some of the strategies that retirees might use to extract cash flows from their portfolios. Let's start with the one that is probably familiar to a lot of our viewers. This is the idea of taking a percentage withdrawal and then taking that dollar amount and just inflation-adjusting that in the years after that. Let's talk about some of the benefits of that strategy.

Jaconetti: Sure. I mean, the main benefit of that is it's a known, stable income stream, right? So, each year you know you're taking out that amount, say, plus inflation, so you can really budget around what your expenses are.

Benz: So, if you start with that 4% withdrawal initially, then give yourself an inflation adjustment--that's the Bill Bengen research that points to that being sustainable over a 25- or 30-year period, assuming that you've got a balanced portfolio. In terms of drawbacks of that strategy, one is that it doesn't adjust at all for market performance.

Jaconetti: Correct. So, the problem is, it ignores market performance. And what can happen there is that if the markets are doing well, you can actually underspend. So, that is actually a drawback, because people might be able to have a more fruitful retirement. But then, also what if the markets are underperforming? And if they're underperforming and you continue to just spend the portfolio, ignoring the fact that your portfolio is going down, you could end up spending well more than 4% each year and then run out of money prematurely.

Benz: So, another strategy that someone might be considering would be to just take a static percentage, hold that steady from year-to-year. And the big advantage of that is that you are tethering your withdrawals to what's going on in your portfolio. If you're taking 5% out, year in and year out, that's going to make you very sensitive to market performance.

Jaconetti: Exactly. So, that sensitivity also brings in fluctuations in spending. So, some retirees maybe have a fixed budget or a higher amount of expenses that are fixed. So, sometimes it's hard for them when they don't know if their income is going to be up 5,000 or down 5,000 or 10,000 in a given year. So, the lack of stability in the spending can cause problems for some retirees.

Benz: Right. So, let's talk about another strategy that you and your colleagues have written about. And this is the idea of using a fixed percentage as a baseline but then giving yourself a little bit of a ceiling and floor on those withdrawals. So, in a bad market environment, you won't take less than X and in a really good environment, you won't take more than Y. Let's talk about the benefits of doing a strategy like that.

Jaconetti: Yeah. I mean, I think one of the big benefits is, actually, it's very intuitive for investors. It's kind of what people do. If the markets are doing well, sometimes they take an extra vacation, or they do something. If the markets are not doing well, sometimes they consider spending a little bit less. So, it's intuitive for investors. But then also adding a ceiling and floor actually when the market is up, you actually reinvest a little bit of the extra. So, if the market is up, say, 10%, and you only increase your spending by 5%, that extra 5% gets reinvested in the portfolio, so that if the market is down in the future, you don't have to take your spending down as much. So, you're, kind of, putting a band around the volatility in your spending so that you can have some sort of stability or known year-to-year spending ranges.

Benz: And your research really points to that sort of strategy as kind of striking a happy balance where you are plugging into what's going on in the market, you're not ignoring it, but you're also giving yourself a little bit of stability in cash flows, which I think, in talking to retirees, it's what retirees really want.

Jaconetti: Definitely. Yes.

Benz: So, another factor in the mix is just trajectory of spending. There's been some research about this topic that retirees tend to spend less as their retirements go on. How should retirees think about that?

Jaconetti: Yeah. So, I mean, I think that it's so varied because everyone is so unique and individual. But in general, a lot of retirees maybe from the time they retire until their mid-70s, say, maybe their discretionary spending is higher. So, they maybe go vacations or golfing or out to eat more, and then sometimes they start to slow down a little bit. So, they may voluntarily decide to spend less. And this is where I just caution people, you may be spending less on discretionary things, but you actually may have some more health-type considerations to come in. So, we definitely see in here that there is a reduction in spending, but we're not always sure: Is it because people want to do less or they're a little bit concerned and kind of holding back on spending in case they should have some sort of health event or live longer, so they want to keep a little bit of their money for longer-term expenses.

Benz: Right, right. Lots of different variables to get our heads around. Colleen, thank you so much for being here to shed some light on them.

Jaconetti: Yeah, thanks for having me. Appreciate it.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.

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Seth Goldstein: Electric vehicles accounted for just 2% of new global auto sales in 2018. However, by 2030, we forecast EVs will be 20% of all cars sold, while the market expects just 15%.

We believe EVs will reach cost and functional parity with internal combustion engine vehicles by 2025. As battery costs decline and manufacturing scale is realized, we forecast electric vehicles will reach cost parity with internal combustion engines.

Battery innovations should increase driving range and shorten recharge times so that driving distance and recharging time will reach parity with internal combustion engines.

With costs and function equal, the amount of charging infrastructure in a region will be the wild card that either spurs or limits EV adoption. We think improvements in cost, range, and charging time will be rolled out globally given the size and scale of major automakers and battery producers. In contrast, chargers need to be saturated and nearby to benefit an EV owner.

We believe that China and Europe will have the necessary charging infrastructure to support mass market adoption, while the U.S. will only have enough infrastructure in place in some parts of the country to drive higher EV adoption.

Across the EV supply chain and ancillary industries, opportunities abound. Our top pick auto OEM picks are BMW, Ford, and General Motors. We also like auto suppliers that are well positioned across the ICE, hybrid, and EV platforms, including BorgWarner and Delphi Technologies. Panasonic is our top battery producer stock.

For lithium, we like low-cost producers already in production, such as Albemarle and SQM. We also like utilities that operate in EV-friendly regions such as Edison International.

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Could investing well be as simple as buying a boring old balanced fund and calling it a day? Joining me to share some perspective on that topic and share a few favorite funds is Russ Kinnel. He's Morningstar's director of manager research.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, let's discuss balanced funds. I think some investors say, "Well, I'm too sophisticated for that." But let's discuss some of the pluses that come along with these all-in-one stock bond funds.

Kinnel: Yeah. I think there are a few. One thing we've talked about in the past is how less-volatile funds tend to work well for investors. And so, of course, if you instead of having just stocks, if you combine it with bonds, say, in a 60-40 mix, the classic mix, it's less volatile, and it's easier on investors. It's just less drama, and that works well for investors. Also, there are some firms that are very good at stock and bond selection. Obviously, you want that, or there's no point buying a balanced fund. And again, there's some benefits of combining the two. So, I do think there are some benefits. Even just simply rebalancing within a fund is a little more efficient than if I'm doing it separately with funds because you can do it on a security basis.

Benz: Right. Some investors, I think, let inertia take hold in terms of doing that rebalancing. They might not want to sell the thing that's performed well. So, it does seem like that's a feather in the cap of balanced products. Let's talk about some of the negatives. I think one of the ones that you might hear from especially more-sophisticated investors is, I want control over my asset allocation. With a product like this I'm kind of ceding control.

Kinnel: Exactly. Obviously, a lot of people over time want to gradually move more into bonds and make other adjustments and you can't do that within a balanced fund. And so, I guess, one idea would be to not make it a huge holding, but if you have other holdings that still allow you some of that flexibility, you can get around that. But you're right, you're giving up some of that control, which is an important factor.

Benz: OK. And some of the funds, some of the large balanced funds, are domestically focused, right? So, for investors who want to make sure that they have a globally diversified portfolio, I guess it depends on the fund, but they might not be getting it.

Kinnel: Yeah, there are really a wide variety of allocation funds out there. Some are very global; some are a little global. Some will use, say, a manager choosing among 30 different sleeves within the firm, others will just be classic U.S. equity, U.S. bond. So, there really are a wide variety so you can really pick what fits your needs best.

Benz: OK. So, you brought a short list of balanced funds. We call it allocation 50% to 70% equity funds within this category. The three funds that you're going to highlight all have a value bias. So, let's talk about why that is. Is that your bias perhaps, or why is it that some of the funds that you really like do have that value bias built in?

Kinnel: Yeah, it's funny that a lot of the best allocation funds out there have a value tilt. I think one simple reason is that value strategy has more income on the equity side. So, overall, you have greater income for investors. And obviously, that's an appeal of a fund. I think another reason is simply value is kind of a conservative outlook of equity investing, and balance is kind of a conservative package for it. So, I think there's another reason that those have historically gone together. There aren't a lot of great growth balanced funds, oddly enough.

Benz: OK. So, let's delve into the funds that you like. One is Dodge & Cox Balanced. Obviously, I think it epitomizes what you're talking about, about a shop that is good at both fixed income and equity investing.

Kinnel: Yeah, and really, they do it fairly similarly. It's all about issue selection for them. So, they have a lot of good managers and analysts who are very good at selecting good stocks, good individual bonds, which means corporate bonds. So, the bond portion also has mortgages and Treasuries, both an emphasis on corporates. And Dodge is just a very stable long-term-focused firm and they have pretty low costs, which is another important part of a balanced fund is you don't want to pay equity fund fees for a mix of equities and bonds. You want somewhere in between those two, and Dodge gives you a good value there.

Benz: OK. Oakmark Equity and Income is another fund that you like. Let's talk about it.

Kinnel: Yeah. As you know, Oakmark is really about security selection in equities. And that's what really is the dominant story here. Clyde McGregor is a very good stock-picker. There's a bond portion here, but it's really about the equity side. And of course, Oakmark, it's a value strategy, relatively concentrated, but just built a really good track record over the long haul.

Benz: OK. Vanguard Wellington is a favorite among our Morningstar.com viewers. It might be familiar to many of them because it's so large. This one I wanted to talk about Russ because it is expecting a manager change next year. So, let's talk about that. And we've still got it at a Gold rating. Let's talk about why you and the team still think it's a very solid pick.

Kinnel: That's right. The equity side manager Ed Bousa of Wellington is set to retire next year. And so, they're in the middle of a transition. We still have a lot of confidence though because Wellington is a deep firm. These transitions tend to be pretty smooth. There's really a team around any manager that's been contributing all along. So, we have a lot of confidence around that. Also, their fixed-income side is very strong. And then, of course, Vanguard's incredibly low fees. You're paying about 20 basis points for this fund. It is a great deal. So, that helps out regardless of the manager. But it is something I think it's worth watching how the transition goes. We'll be watching to see if there are any changes. But we just have a lot of confidence in Wellington and that's reflected in the rating.

Benz: Russ, always great to get your perspective. Thank you so much for being here.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.