Contenders to Amazon, SECURE Act, and Enbridge
And more on evolution of foreign stock index funds.
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Joe Gemino: Best idea and wide-moat Enbridge has one of the most attractive dividends in the Canadian energy sector. The stock currently has a handsome yield of 6%, which sits above the subsector’s average. We expect Enbridge to increase its dividend by 10% in 2020, but only modest annual increases of 3% thereafter.
In our view, the dividend looks stable, and Enbridge maintains a healthy coverage ratio of 1.5x the cash dividend, which is also above the subsector’s average. The dividend is derived from the company’s contracted pipeline and regulated utilities businesses. Most of the company’s pipelines have long-term contracts in excess of 10 years, which further adds to our conviction of the dividend’s stability.
However, future utilization of the company’s crown jewel asset, the Mainline, is also the major risk to the dividend’s viability. If the pipeline’s future utilization were to be drastically cannibalized by the Keystone XL or Trans Mountain expansion projects, some concern could exist about maintaining the dividend levels. However, we don’t think this scenario is plausible, as we already forecast temporarily minor underutilization of the pipeline while competing projects are built, and we think there are enough low-cost oil sands supply to fill all available pipeline capacity over the long haul.
Enbridge remains one of our top picks in the energy sector, as we think the market is mistaken about the future of the company's cash flows associated with future mainline utilization and the Line 3 replacement project. However, we don't expect the market's concerns will be fully addressed for some time, which can lead to volatile swings in the stock. But we advise investors to stay the course while getting paid a handsome (and growing) dividend. Because in the end, we believe Enbridge's long and winding road will lead to 25% upside.
Christine Benz: Hi, I'm Christine Benz for Morningstar. Younger investors still have a long runway to retirement, but they have to balance that long-term goal against shorter-term objectives like buying homes and paying down debt. Joining me to share some strategies for younger investors just getting their plans off the ground 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. Good to be here.
Benz: We talk a lot about retirees, you and me. But I'd like to talk about the younger set, people who are just kind of getting their plans up and running, maybe have that first job. So, let's kind of start at the top of the pyramid, what is most important for folks at this life stage, and that's really kind of balancing competing priorities. You've got a lot of folks coming out of college with significant amounts of debt. They know they should get started on retirement planning. They know they should have an emergency fund. So, how do they figure out where to deploy their money?
Bruno: I think you nailed that. That's the big one, it's resource allocation in terms of, well, how do I invest my next dollar, if you will, across these different options? So, I think it's fairly straightforward, but it can seem overwhelming. First, you want to think about, what are my high-return type opportunities? And at the forefront of that I would put, if you have a 401(k) with an employer match, for instance, an employer plan, where the company matches, certainly that should be your first source. Because if you give that up, then you're basically leaving money on the table. That's 100% return right there. So, that's the easy one. From there, then you might want to think about what type of debt, or if I'm dealing with some high consumer-type debt that has a high interest rate, that might be the next place that you want to look at in terms of paring that down. So, those would be probably the top two.
Then you want to think about emergency savings. Do I have that rainy-day fund in case of an emergency? And I'd like to spend a little bit of time on that because when you think about what this emergency savings looks like, a conventional rule of thumb has been three to six months' worth of living expenses in a cash account. Well, that may not be the best thing for a young investor given limited resources. One way to think about it might be ... one is spending shock. So, if something were to happen, if the car breaks down or ...
Benz: A big vet bill or something like that.
Bruno: Yes, something like. Yes. Do I have liquid cash to pay those expenses? And maybe there you're talking half-a-month to a month's worth of expenses. And then, the other thing would be a loss-of-income shock. So, what would happen if I lost my job? Do I have enough to live off of? And those are probably more accounts that are marketable, money you have access to, but not necessarily sitting in cash. And one avenue I'd like to explore there is a Roth IRA, for instance. We talk about this a lot as well. The contributions that you would make to a Roth IRA are after tax, so the money has already been taxed, but you can access those contributions income-tax-free and penalty-free. So, you can think about that as something up your sleeve if you need to then access some relatively quick money. Certainly, you want to preserve that for retirement. But it is a multitasking type of thing, I think you've used that word in the past as well in terms of being able to be there in case you need it.
Benz: I'm thinking of that as kind of my income-shock fund. If in a worst-case scenario, I lose my job, and I stay out of my job for a while, that Roth IRA, tapping my contributions tax-free and penalty-free might be a pretty good way to go.
Bruno: What's nice about that, too, is, hey, you're setting the retirement clock already, but that money then there is if you need it, and certainly can save in a nonretirement account as well. What I like about the Roth is that it offers tax-free growth versus a taxable account that grows potentially but at cap-gains tax rates. So, there's a little bit of a difference there. But certainly, nonretirement taxable monies are prudent as well. And then, from there, you really want to think about the other sources; around there, I would say balancing down debt with also saving for retirement as well. Or you might have other goals. So, balance. It's not all or nothing, but it's a little bit of a seesaw in terms of balancing those two types of goals.
Benz: You referenced Roth IRAs, very attractive from the standpoint of flexibility and being able to pull those contributions if in a worst-case scenario you need them. But how about that sort of fork in the road if I'm contributing to my employer plan, and I have the traditional 401(k) make the pretax contributions and I also have the Roth 401(k), where I can make after-tax contributions. How should people approach that decision?
Bruno: Well, that's a good question. For younger investors, if their plan sponsor offers the Roth option, not everyone does, but we're seeing an increasingly higher number of plan sponsors offering that option. Young investors might want to consider that in terms of their deferrals for their contributions. And the reason is, when you're young, you're most likely in a lower tax bracket than you will be later. So, the key then is, when do you pay tax on those monies? You want to do that when you're in a relatively lower tax bracket. And for young investors, the value of the tax deduction that they might get with the contributions in a traditional deferred account are probably far outweighed by the tax-free growth that they would get with the Roth over those number of years of compounding. So, that's very attractive.
We talk about tax diversification for investors and holding different account types. With the 401(k), you may direct your contributions to a Roth, but your company match must go into the traditional deferred account. So, right off the bat, you get tax diversification right there. So, that's a nice feature as well.
Benz: Another vehicle that might come into play would be a health savings account, if you're covered by a high-deductible healthcare plan, which is increasingly common. How should younger folks think about funding those HSAs?
Bruno: Right. So, healthcare is needed for all of us. What's nice about the HSA plan--as you mentioned, you have to have a high-deductible healthcare plan, offers the health savings account. The premiums are typically lower, they might be higher out of pocket; however, there are caps on that amount as well. But that money is unique in that it's got triple tax benefits. So, you made the contributions with pretax dollars, the account grows tax-deferred, and then when you pull that money out for healthcare reasons, it's tax-free. So, it's a very attractive tax vehicle. And you can almost think about it as a retirement savings vehicle if you have the means to do so. That would probably be the rosiest of situations in terms of, hey, I'm going to put money into this account, and I may have other monies that I may use for my healthcare expenses if I were to incur them. The reality of it is, many young investors or those with limited means may not be able to do that. But even putting the monies into the health savings account, you're taking advantage of the tax benefit because the monies are made with pretax dollars and then tax-free distributions.
Benz: So even if my plan is to use my HSA just as a basic kind of spend-as-I-go vehicle, it's still wise to run it through the HSA and pick up those tax benefits?
Bruno: Yes. I mean, it can be. Absolutely, it can be. That's more of a transactional type of account. Now, the thing I will say is, you want to look in terms of what type of investment options do you have within your health savings account and just make sure you understand how--what the plan offers, what the cost of those investments might be, and make your choice there as well.
Benz: Maria, always great to get your perspective. Thank you so much for being here.
Bruno: Thank you. Good to be here.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.
Zain Akbari: Although Amazon has dramatically disrupted the retail landscape, we believe not all sectors are equally vulnerable to the digital juggernaut. In an Observer titled “Up the Creek but With a Paddle: Retailers That Can Succeed Despite the Age of Amazon,” we update our proprietary framework evaluating brick-and-mortar retailers’ standing in an increasingly multichannel world.
Our proprietary framework highlights immediacy of need, customer proximity, difficult-to-digitize business models, pricing dynamics, and the store experience as areas from which conventional retailers can derive enduring protections against the digital onslaught. Although we believe Amazon and the rest of e-commerce have significant room for future growth, we expect customers’ channel decisions will vary based on the situation, product, and their personal circumstances.
We believe home improvement and auto-part retailers are among the best protected, as the sectors deliver in-store advice and convenience that benefits DIYers, strong levels of availability, and an efficient purchasing experience for professionals, and capitalize on customers who prioritize speed and service ahead of price. Although not to the same extent, we see off-price apparel retailers and discount and dollar stores as benefiting from protections against competitive pressure.
Of the more protected retailers we identify, we believe narrow-moat Advance offers patient investors an opportunity. While the firm is still in the midst of a multiyear turnaround, we believe management is taking the right steps to boost part availability and streamline its supply chain and distribution infrastructure.
Additionally, although we expect some sectors will be harder for it to crack, we believe shares of wide-moat Amazon are attractive at current trading levels.
Daniel Sotiroff: Foreign stock index funds have evolved in a few good ways over the past two decades. They now cover a much wider range of markets, and fees have declined to a level similar as U.S.-focused index funds.
Low fees are a starting point when selecting a foreign stock index fund, as low fee index-tracking funds typically prove tough to beat over the long-run. Costs aside, there are some other things that separate good from great.
Foreign index funds come in many different cuts. Those that focus on single countries or regions often don’t provide great diversification. They may be dominated by a small subset of stocks, sectors, or currencies, which makes them more susceptible to these specific types of risks.
Broader portfolios that span multiple countries, regions, and currencies can help tamp down investors’ exposure to these perils. These index-trackers typically fall into two groups. The first targets stocks from overseas developed markets, while the second includes those from emerging economies and captures the wider foreign stock market.
Funds that track large-cap developed-market indexes, like the MSCI EAFE Index or FTSE Developed Ex-U.S. Index, are a great place to start. These benchmarks provide a high degree of diversification while capturing a majority of the available foreign market.
Over the past few years, a few fund providers have expanded on these stalwarts, and they now offer index funds with incremental diversification benefits.
Bolting on stocks from emerging markets is one such way to expand a fund’s reach. Companies listed on emerging-market exchanges can be riskier than their developed-market brethren, but they still represent a relatively small subset of the total foreign stock market. Including them in a foreign stock index fund as a market-cap-weighted component helps spread a fund’s assets over a much wider base without adversely impacting a fund’s overall risk.
Tight index-tracking is another key component of great index-tracking funds. Ultimately, index fund providers should deliver index performance less the fund’s expenses. There are some nuances to foreign markets that can throw that simple math off. But most major index fund providers have a handle on any potential issues that can arise.
Steady tracking also requires infrastructure, technology, and a well-managed team that can execute these strategies. These components are more difficult for individuals to evaluate, but they are components that drive our ratings for index-tracking funds.
All of these things considered, there is no shortage of great funds that focus on developed markets. Vanguard Developed Markets Index, iShares Core MSCI EAFE ETF, SPDR Portfolio Developed World ex-US ETF, and Schwab International Equity ETF check all of the boxes mentioned above while featuring some of the lowest fees in Morningstar’s foreign large-blend category.
Low fee total foreign market index funds are fewer in number. Vanguard Total International Stock Index comes in both mutual fund and ETF format, while iShares Core MSCI Total International Stock ETF is only available in the ETF wrapper. These Gold-rated funds track different indexes, but they have very similar portfolios and should provide very similar performance. They cover the entire foreign stock market, including emerging markets and small caps, while charging less than 10 basis points annually.
Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. The SECURE Act passed through the House this week, and it's also expected to be approved by the Senate. It was part of a broader spending bill. Joining me to discuss some of the key aspects of the legislation that are likely to have the biggest impact on retirement is Christine Benz. She's Morningstar's director of personal finance.
Christine, thank you for being here today.
Christine Benz: Susan, it's great to be here.
Dziubinski: This is a pretty important piece of legislation.
Benz: It is.
Dziubinski: So, let's talk about some of the various aspects of it, starting with the changes to required minimum distributions. Now, if you've taken your RMDs in 2019, does this change apply to you and what is the change?
Benz: It doesn't. So, unless you have turned 70.5 by the end of 2019, this won't affect you. But for people turning 70.5 in 2019 and beyond, they'll now have a new higher required beginning date for their required minimum distributions. So, it's moving out to 72. So, this is good from the standpoint of affluent retirees. I'm sure a lot of our viewers fall into that bucket where they don't need their IRAs or their traditional 401(k)s for their ongoing spending. They would rather push them off and enjoy the tax deferral and enjoy deferring the tax bill as far as they possibly can. So, I think that this is a good development for them.
I think it's also a good development in light of the fact that we've got more and more people working longer. And if you're pushing your retirement date out, there's often not much space between the time retirement starts and when you have to start taking RMDs. This gives you a little bit more of what Vanguard's Maria Bruno has called the “retirement sweet spot,” which is kind of a planning opportunity where your income may be at a relatively low ebb. You can do some things like maybe accelerate your withdrawals from those tax-deferred accounts. So, I think that there are some opportunities, especially for wealthier retirees who don't need their IRAs imminently in retirement.
Dziubinski: And there are also implications for what we call the “stretch IRA” in this legislation. So, can you step back a little bit and talk about what the stretch IRA is, and then what's changing.
Benz: Right. So, the stretch IRA is something that beneficiaries could take advantage of if they inherited an IRA or some other account from a loved one. The idea was that they could take their required minimum distributions based on their own life expectancy. So, for a very young inheritor, that would allow the opportunity to stretch over many years potentially. Now, under the SECURE Act, assuming it gets passed into law, what will happen is that the person who inherits an account will have to take the proceeds from that account within 10 years of inheriting it. It's not saying that you have to space it out, take equal distributions over 10 years or anything like that. You just have to take all of the amount out by the end of 10 years. So, this is a change. Again, it's going to have a bigger impact on wealthier folks who are in a better position to not tap those inherited assets, who could let the tax benefits stack up.
Dziubinski: Now, the SECURE Act also allows for additional contributions to Traditional IRAs after age 70.5.
Benz: Right. So, these were previously off-limits. And I think this is a good development in that, as I said, we have more and more people working longer. And so the idea of being able to make ongoing contributions makes a lot of sense. Another thing that makes this I think a good development is that it gives Traditional IRA contributions parity with other account types. Because previously, for example, you could still contribute to Roth IRAs, even if you were older than age 70.5. So, I think that this is overall a good development.
Dziubinski: Now, the SECURE Act has a provision that's going to make it easier for workers who work for smaller companies to get retirement plan coverage. Can you talk a little bit about what that means, what a multiple employer plan is, which is on the table?
Benz: Right. So, these multiple employer plans are plans that smaller employers would be able to create. They might be able to band together with other small employers to field a plan for their employees. So, overall, I think this is a really encouraging development because when you look at our system on a broad basis, one thing you see is that a lot of our population, a lot of working people, are not covered by any type of plan at all. So, this would make plans more pervasive, I think. It's a good thing. I will say though, in an ideal world, I would rather have seen some sort of – I still would rather see some sort of a federalized option, maybe similar to the Thrift Savings Plan, where you have a mega company retirement plan option, where it's vetted, where you can put some pressure on the providers to keep the costs down. I think there's just a little bit of inefficiency associated with having all of these different firms, even if they are banding together, field different plans.
Dziubinski: Another, maybe a little bit more controversial aspect of the SECURE Act is the idea it's going to be easier for company retirement plans to offer annuities.
Benz: That's right. So, companies are given safe harbor if they want to offer annuities. Essentially, that protects them from litigation if something happens with the insurance company offering the annuity. So, this has been seen as a big win for insurers. And I think it most certainly is. I will say there's a lot to be said for the very plain-vanilla immediate-type annuities. We've talked to a lot of retirement researchers over the years who have said that this is one of the best things that retirees can do to improve the viability of their plans. But it's an open question about the types of annuities that would be on offer within the context of plans. Some annuities are very high-cost, very opaque. They're not all good. So, I think that that's where things get a little bit murky. It has the potential to be a win for investors, but it really will come down to what type of annuity is chosen.
Dziubinski: It seems like with some of this, time will tell which are the wins for investors out of this. Christine, thank you so much for your time.
Benz: Thank you, Susan.
Dziubinski: I'm Susan Dziubinski for Morningstar. Thanks for tuning in.