Investing Insights: T. Rowe Upgrades, Dividends, and Taxes

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. T. Rowe Price has had the most upgrades of any fund family this year. I'm here with Russ Kinnel, he is our director of manager research, to look at some of the themes that have led to these upgrades.

Russ, thanks for joining me.

Russ Kinnel: Glad to be here.

Glaser: Let's take a look at T. Rowe. Over the last 12 months, they have had 10 upgrades, only three downgrades. When you look across these upgrades, what stands out to you as the reason that we are more excited about some of these strategies?

Kinnel: We are seeing an older generation of managers retire, and we are becoming more comfortable with the newer generation. I think T. Rowe has done a really good job of filling both its analyst and portfolio manager bench, so that when you see these transitions, generally, they work really nicely at T. Rowe, not just from a style consistency standpoint but from an execution standpoint. As we get to know these managers, we've been upgrading a lot of funds. We visit them every year. I think just really impressive effort across the board at T. Rowe.

Glaser: What are some of the strategies that we've upgraded?

Kinnel: We've upgraded T. Rowe QM Small Growth, which is a quant small growth fund that we've been covering for a while now, but just been gradually more and more impressed with how it's performed, so most recently moved it from Silver to Gold.

Glaser: Another upgrade to Gold was T. Rowe Price Blue Chip Growth. What's the story here?

Kinnel: Larry Puglia has been running the fund since '93. So, obviously, there's no big change there. But just as we've become more comfortable with the analysts supporting the fund, but also the fact that this fund without taking on excessive risks is one of the few large growth funds that's continued to beat the Russell 1000 Growth. Really impressive performance in up markets and down markets. Gradually, it just made a very strong case for Gold.

Glaser: On the negative side though, there have been some downgrades. T. Rowe Price New Income in particular is now Neutral. What gives you less confidence in this strategy?

Kinnel: Manager Dan Shackelford is set to retire in 2019, and there have also been some sector shifts going on at T. Rowe, sector team shifts on the fixed-income group, that give us pause and so we lowered that fund from Bronze to Neutral.

Glaser: Russ, thanks for the update on T. Rowe today.

Kinnel: You're welcome.

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

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Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Medicare open enrollment runs through Dec. 7. Joining me to discuss what goes on during open-enrollment and what you should be looking for is Mark Miller, he's a Morningstar.com contributor.

Mark thank you so much for being here.

Mark Miller: Hi, Christine.

Benz: Mark, let's talk about what open enrollment is. What are the specific items that people are shopping for?

Miller: For people who are enrolled in Medicare this is the time of year when you can make changes in your coverage. You can either change either in or out of traditional fee-for-service Medicare and Medicare Advantage that's kind of choice one.

Benz: OK.

Miller: And then you can also make changes in a standalone prescription drug plan, Medicare Part D. You would be doing that probably only if you are in traditional Medicare because most Medicare Advantage plans not all have the prescription drug coverage baked into it. That's the basic thing people can do this time of the year.

Benz: You always urge retirees who are enrolled in Medicare to reshop their coverage. Let's talk about why you think that's important to do at this time of year.

Miller: The plans can change from year to year. The premiums can change, the out of pockets can change, what's covered can change. The provider networks can change. Just assuming that because it was good for you last year that it will continue to be good for you next year is not always a safe assumption. That's the basic reason.

Benz: And you can save yourself some money potentially.

Miller: You can definitely save yourself some money.

Benz: Let's talk about that, first fork in the road: Medicare Advantage versus traditional Medicare. This is your opportunity to make a switch there, right?

Miller: Yes. Traditional Medicare I always say is sort of the gold standard from the standpoint of flexibility of providers. Almost all healthcare providers take your traditional Medicare card. With Medicare Advantage there may be some money saving opportunities because the plans roll together a bunch of different services. For example I mentioned prescription drug is often rolled in at no extra cost. Lots of them have vision coverage, a number of them provide some level of dental insurance, which by the way maybe a topic for another day. Traditional Medicare does not really cover most dentistry services.

Benz: And huge surprise cost for a lot of retiree households.

Miller: Indeed, it is. The trade-off though with Medicare Advantage is they are typically either HMO or PPO, meaning that you must use in-network providers in order to get the most advantageous services. That can be an issue. I think Medicare Advantage works really well for younger, healthier seniors. The issue that comes up--let's say you are in the middle of the plan year, and something really serious comes up and you want to see the top specialist in your town on whatever this is. That person may or may not be in your plan. It's a typical trade-off of managed care really.

Benz: Even though Medicare might be the gold standard, traditional Medicare, you are still going to have to bolt on some additional coverage though, right?

Miller: Right, a lot of people perceive as a downside of traditional, there is more moving parts, whereas Medicare Advantage is kind of all in one coverage. Here you are going to have your basic coverage of Medicare Part A and B. You are probably also adding a prescription drug plan, Part D, and many people also buy a Medigap insurance plan, which, as you are referencing, is supplemental coverage that capture out-of-pocket expenses and really can smooth out variations near health spending in a very meaningful way.

The sticking point that's relevant to open enrollment on Medigap is this: If you want to move out of Medicare Advantage into traditional Medicare and you are already several years down the pike in terms of being on Medicare, you've missed the best opportunity to buy Medigap. The best opportunity to buy Medigap is when you first enroll. Because it is an open enrollment period at that time and the insurers cannot do so-called medical underwriting, meaning charge you more because of the health condition or even turn you away for coverage. You can make this switch several years into the road, or whenever. But know that you may have more challenges with Medigap either you are paying more or even being turned away depending on health status.

Benz: In terms of trends that you see when you look at the Medicare Advantage plans, when you look at open enrollment for 2019, let's talk about that.

Miller: The Medicare Advantage. One thing that people may have heard about is that Medicare Advantage plans are now starting to experiment with the new class of services that relate to things like home care, adult care at home, and the like. There is a whole raft of these services, which actually I detailed in the column on Morningstar.com that kind of goes with this discussion we are having. The key thing to know about that is most plans have not rolled out new services this year because the new rules on this just came out in the spring. You probably see more of that in 2020.

The other interesting change I think is a small one but could be important for some people is that there is kind of do-over period that runs from January to the end of March. If you enroll in a Medicare Advantage plan that you don’t like for some reason, you can make a change during this do-over period. Its also then expanded a bit and that you can now also move it back into traditional Medicare if you like during that period. Those I think are the key new things to know about Medicare Advantage.

Benz: Moving on to the Part D, the prescription drug coverage. This is another option, this would be something for people who are covered by traditional Medicare, it's their time to review their coverage and decide if they want to switch insurance plans. Let's talk about the virtue of doing that and more importantly how to do it, assuming that I am confronted with this choice.

Miller: What you find is there is 10 plans that basically are most of the market. When you look at what's going on with the projected premiums for next year, you see that it's kind of all over the map. The overall weighted average increase in premiums for Part D drug plans next year is only expected to go up 2%. But nobody's average and people are enrolled in specific plans. The important thing to do is to look at your plan. When you look at the top 10 for next year the projection is that five of them will have substantial increases, 5% to 10% even. Three of them will go down a bit, and there are two that will be unchanged. There are also changes to the deductible structures in some of them. Basic point is you got to take a look at your own plan. Don't just read that somebody wrote, costs are only going up 2% next year. that may or may not be your situation. You have really got to take a look.

Everybody gets in the mail what's called the annual notice of change, these arrive back in September, that detail any of these changes to your plan that you are enrolled in. Take a close look at that, and if it looks like there is a substantial increase, that you are not happy about, you go on the Medicare Plan Finder at Medicare.gov. and you can run a search to see what might be better options for you. You'll plug in your Medicare number plus your specific prescriptions and the site does a good job of sifting through and showing what might be good fit plans for you.

Benz: That's good advice. Let's talk about a little bit of good news that came to retirees in terms of the cost of living adjustment that Social Security recipients will get. I'd also like to discuss Medicare premiums in that context, the Part B premiums.

Miller: They are related, because in most cases the Medicare Part B premium is deducted from your Social Security benefit. The good news is that we're going to see the highest cost of living adjustments since 2012 next year for seniors. The cost of living adjustment will be 2.8%. The last time it was anywhere this close was 3.6% in 2012. These are set by a formula under federal law that's tied to the cost of living in the Consumer Price Index.

Benz: The bad news is that there are higher costs coming online.

Miller: Inflation is higher. It's coming through in the form of the COLA. Equally good news is that--we won't know the Part B premium for next year until probably little later this year--but it was projected earlier this year by the Medicare trustees to only be going up $1.50 to $135.50.

Benz: A month?

Miller: Yes, a month. Thank you. That means that in short most seniors will get to keep most of the COLA next year which is great.

Benz: Thank you Mark. It's always great to get your perspective.

Miller: Thanks for having me Christine.

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

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As we're well into the fourth quarter, many investors are thinking about year-end tax planning. I'm here today with Tim Steffen, he is the director of advanced planning at Baird, to look at some topics.

Tim, thanks for joining me.

Tim Steffen: Thanks, Jeremy.

Glaser: My first question for you is, looking at your tax return for next year, first year of the new tax laws, should investors really expect to see a big difference in their refund next year?

Steffen: The studies are showing that all things being equal from one year to the next, the vast majority of taxpayers are going to see a reduction in their total tax liability. There will be some who break even. There will be a small percentage who will pay more because of the level of their income and some of the deductions they claim. But most people on a total basis are going to pay less tax.

Where they might be a little surprised is when they get their final bottom line number in their tax term--what's their refund, what's their balance due. That may be different than what they expect. The reason being is that a lot of these tax cuts that were enacted this year were already paid back to taxpayers via lower withholding tables. Remember, earlier in the year, the withholding tables were all changed, and people noticed, my take home income has gone up a little because I'm not withholding as much tax. Well, that was the benefit of your tax cut right there.

When you go to file your return, the refund you've gotten in prior years may not be the same refund you are used to getting. Or you may end up actually owing a little bit more than what you think. Again, not that your liability has gone up, but your payments went down as well. The bottom line is going to be a little different for folks this year than what they might expect.

Glaser: Oftentimes, tax experts recommend accelerating deductions, deferring income as much as possible. Is there anything under the new tax law that changes that? Should you be thinking about that differently toward the end of the year?

Steffen: Last year, that was certainly the case, at the end of 2017. Unfortunately, we didn't have a lot of time to react to that because it all happened so late in the year. For 2018, as we compare 2018 to 2019, at this point anyway, it doesn't look like there's going to be anything substantially different; that could change. We'll see what happens with the midterms and all of this other stuff. Assuming '18 and '19 tax laws are the same, then the old standby, as you said, defer income, accelerate deductions probably makes sense.

The exception to that would be, if your own personal situation changes. So, if your income is expected to jump up next year, for whatever reason, maybe your deductions are more valuables to you next year. You push those out into next year. But for most people whose income is pretty consistent from year to year, accelerate deductions into this year, defer income into next to the extent you have the ability to do that.

Glaser: Let's think about property taxes. There was a scramble at the end of last to prepay as much as possible. Anything this year that should be on your radar when it comes to property taxes?

Steffen: The issue there last year was the new limit on state and local tax deductions. So, that's $10,000 hard and fast ceiling on that. If you are getting to the $10,000 already because of your income tax withholding for your state, there's no rush necessarily to accelerate your property taxes into this year nor is there any reason to maybe accelerate next year's into this year. Not all states have the ability to do that. Where I live in Wisconsin we can, but a lot of other states can't. You may just have to pay them as the bill comes. If you have the ability to time them, then you need to talk with your tax advisor, figure out what makes sense. In most cases, there probably won't be a big advantage to accelerating or deferring. You just pay them each year as they come due.

You do want to take a look though some states offer incentives for the property taxes you pay that year. You want to make sure you get something paid every year as opposed to maybe having a year where there isn't any. You may lose out on a state incentive then in that case.

Glaser: How about medical deductions? Any changes on that front?

Steffen: Again, medical expenses is another area where you might have some flexibility in timing when you pay those expenses. You don't have a lot there, but you might have some. One of the things that is scheduled to change for 2019 is medical expenses will be harder to deduct next year. Right now, you can deduct medical expenses if they exceed 7.5% of your income. Next year, that's scheduled to go to 10%, which means, all things being equal, medical expenses will be harder to deduct next year. There may be an incentive for moving them into this year. Now, that could all change. That may go back to 7.5%. We probably won't know that until late 2019. That's how these things tend to work. If your income is going to be lower next year, 10% of a lower number might make it easier to deduct those expenses next year anyway. In general, you're better this year, but your situation might dictate that that's the opposite.

Glaser: Turning to investments, even with the volatility we've seen, you might still be sitting on quite a few gains. Anything that you can do to try to limit any sort of tax burden there?

Steffen: A few things we talk to folks about. One is, if you've realized some gains already this year, which you may have done, now may be the time to harvest some losses in the portfolio to offset some of those gains. If you want to get back into the position, be careful about the wash sale rule, that 30-day period you've got to wait to buy back in. But there may be some opportunity to net losses against gains. If you've got new money that you are looking to invest, you may want to be careful as we closer the end of the year about buying into mutual funds. As they get toward the end of the year, they tend to pay out their capital gain distributions for the whole course of the year. You might buy into a fund just before it pays out the capital gains for the whole year and then you are stuck paying tax on all that. As you get closer to year end, maybe be careful about new investments in funds and wait until those payouts are made.

Other than that, when it comes to investment income, we really talk to folks about managing the portfolio in a way that doesn't generate income you don't need. For example, if you are not living off your portfolio, you don't need dividends and interest, maybe avoid investments that create dividends and interest, because you don't want to pay tax on income you don't need.

Glaser: Anything else you should have in mind as the year ends?

Steffen: Year-end is a great kind of bellwether. It's the time that reminds you of everything else that you should be doing at this time of the year. We talk about things like review beneficiary designations on your retirement plans or your life insurance. Update your estate plans. If there's been a birth or a death in the family, a marriage or a divorce, maybe you moved to a new state, take a look at the estate documents and update those. Looking into your asset allocation. This is a great time to go back and update all those passwords you've got for online. In the era of cybersecurity, the more often you can refresh those passwords, the safer you will be. A lot of those kinds of things we talk about this time of the year.

Glaser: Tim, thank you.

Steffen: Thanks, Jeremy.

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

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. After yesterday's election, the Democrats are set to take control of the House in January while the Republicans will increase their Senate majority. I'm here with Aron Szapiro. He's our director of policy research. We're going to talk about what could this mean for investors.

Aron, thanks for joining me.

Aron Szapiro: Thanks so much for having me.

Glaser: Now that we have divided government, is it safe to say that we're not going to see any big legislative changes? What do you think some of the priorities of House Democrats will be?

Szapiro: I think people don't need to turn to Morningstar to know there's going to be a big focus on investigations, not just of President Trump from the House Democrats, but also of his Cabinet and kind of the routine oversight that you expect in any situation where there's divided government. I don't think we're going too far out on a limb to say that's going to be a focus.

I think there might also be some interest in doing bipartisan legislation around making some tune-ups to the retirement system, making it easier for people to save for the future, so we'll certainly be looking for that as well.

Glaser: If investigations really do take center stage, is that something investors should be following closely? Is it going to have a big impact or is it really more of a political story?

Szapiro: Investors should be following it very closely in their role as citizens, but as they think about their investments, it would really be a mistake to overreact to any of the daily drips of information we get about the investigations.

Let's think back to when Robert Mueller was appointed special counsel. Markets went down in response to that news, and they quickly rebounded, and the reason is that there's just not that much day-to-day connection between investigations and the business of governing. A lot of the agencies that make policy that directly affect investors, like the Securities and Exchange Commission, are really quite independent and somewhat insulated from these kind of day-to-day machinations. I would say investors should stick to their strategy and not worry too much about the day-to-day information on investigations or the tweets back and forth or whatever else.

There are other sources of information that you can turn to and they all agree it's going to be perhaps pretty ugly politically, but I don't think that should change anybody's investment strategy.

Glaser: Let's talk about some of those policy proposals you mentioned. There could be some bipartisan work around retirement. What are some of those that are on your radar right now?

Szapiro: There's a couple of things that have had broad bipartisan support but haven't quite had the support to get through. One thing is letting small employers band together in order to offer a retirement plan and use their greater assets under management for leverage to get a better deal for their participants. This is an idea with bipartisan support, and I think if it doesn't happen in lame duck, one name you're going to hear a lot of in the next session is going to be Richard Neal. He's taking over as the chair of House Ways and Means, and that's the tax writing committee in the House. Of course most of the way we encourage retirement savings flows through the tax code, so he's very interested in these kind of ideas, so that's one thing.

Another kind of fine-tuning idea would be making it easier for people to access longevity protection inside their 401(k) plans. That's an idea with a lot of bipartisan support that just hasn't quite had a champion. I think we'll see likely some movement on some of these, again kind of fine-tuning ideas.

You know, speaking of Rep.r Neal, he's proposed much bigger overhauls to the retirement system, and I would expect to at least see those get some traction on the House side. Obviously they may not go through the Senate and become law, but I think you'll see some fine-tuning of those ideas. A big one for example would be an auto 401(k) bill that he proposed a couple of months ago that would essentially require many more employers to offer some kind of a 401(k). I think there's some issues there that need to be worked out to make sure that these new 401(k)s which wouldn't have as they are currently structured a match requirement, make sure they wouldn't cannibalize existing plans, but that's an important idea.

One thing that might not quite be on many investors' radars, but it occurred to me as the night was unfolding is, Democratic governors have been trying to expand access to retirement plans for people who don't have coverage at work with these auto IRA programs. Obviously we saw a bunch of Democrats pick up governorships last night, so I suspect we'll see some of those proposals emerging in new states as well.

Glaser: Looking at the Senate, does that larger Republican majority there open up any opportunities for legislation that maybe had been stymied there before or would you expect the status quo?

Szapiro: I don't think it makes a huge difference. It makes a big difference politically, of course, in going into the next election cycle, but in terms of legislation, the magic number in the Senate is really 40, where you kind of lose the ability to filibuster, and in a divided government situation, that's not even that important.

I actually think the most important thing we should look for in the Senate is who's going to take over Orrin Hatch's role as chairman of Senate Finance. There's sort of rumors there. I'll leave this to other websites, but once we know, we'll do some analysis on what his or her track record is and what kind of proposals we might see and how they would affect ordinary investors. That's a big change that's going to happen there, and that's sort of an important committee from the perspective if you're an ordinary person saving for retirement or other goals.

Glaser: Other than Senate Finance, what else are you going to be looking for in the next couple of months to get a sense of what we could see early next year?

Szapiro: It'll be really interesting in January where this first wave of bills from the committee chairmen come out, and we'll get a lot more clarity then. I think that the f range of possibilities is from again finetuning to fairly big proposals that may not make it through this session, but set the stage in the future.

I guess the other thing, everybody always has to mention infrastructure, everybody always says well, there could be a deal on infrastructure. We've been hearing that for some time, so I'm a little skeptical, but if there were a big infrastructure bill that was able to find purchase in the House and get through the Senate, that would first of all signal a much more bipartisan style of governing than I think is generally the common wisdom, and would probably provide a fairly meaningful short-term stimulus and long-term help for the economy. It's something to keep an eye on, but I don't think it's a hugely likely probability.

Glaser: Aron, thank you for your analysis this morning.

Szapiro: Thanks so much.

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

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Erin Lash: While sales and consumption growth in the cereal aisle has languished over the past few years, we think investors would be well-served to indulge on the shares of the leading manufacturers in the space, namely wide-moat General Mills and Kellogg, both of which we view as undervalued.

For one, we think the market's confidence in General Mills' ability to restore top-line growth has faltered, considering continued softness in volume across the industry as well as skepticism around the acquisition of natural pet food company Blue Buffalo earlier this year. While the deal carries some inherent risk as General Mills enters a category in which it has limited experience, we remain confident in the firm's ability to efficiently integrate Blue Buffalo and extract cost synergies from combining these operations, as we expect it will lean on the experience gained when it added Annie's and others to its mix--leveraging its supply chain and distribution capabilities while largely leaving the acquired firm's operating model intact.

Further, we don't surmise its hunger for deals will compromise its ability to return cash to shareholders. We model a dividend payout ratio averaging 65% over our 10-year explicit forecast (which is in line with its five-year historical average), and implies mid-single-digit dividend growth. Given its discounted price, trading about 25% below our $58 fair value estimate, and with a 4%-plus dividend yield, we think the stock provides a sufficient margin of safety for long-term investors.

Further, we suggest investors with an appetite for income should give Kellogg a look, as it boasts a dividend yield of more than 3%. Kellogg's position as a leader in the U.S. cereal aisle (holding more than one third share of the domestic ready-to-eat cereal space), combined with its efforts to bolster its position in the on-trend snacking category (which now accounts for more than half of its total sales base, up from just one quarter at the start of the century) makes it a valued partner for retailers.

From our vantage point, Kellogg's decision to pivot away from direct-store distribution (which had accounted for about a quarter of its U.S. business) and transition completely to a warehouse model has been a prudent means to free up resources to invest further behind its brands in terms of innovation, marketing, and new packaging, and ultimately support its entrenched relationships with retailers, which we believe is a pillar of its intangible asset-based wide moat.

As such, with shares trading around a nearly a 15% discount to our valuation, combined with our expectations for mid-single-digit annual growth in its dividend over our explicit forecast horizon, we think investors would also be wise to keep this wide-moat name on their radar screens.