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Investing Insights: Tax-Managed Funds, Healthcare, and GM

We examine qualified charitable distributions, Caterpillar, and Comcast on this week's episode.

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


Dave Whiston: GM announced a major restructuring on Monday for its North America segment, or GMNA, where they're going to incur up to $3.8 billion in charges to realize about $6 billion in additional free cash flow generation over the next few years. 

What's notable about this is that it's actually involving three assembly plants are going to not receive product after 2019. This is one in Canada and two in the United States, including plants that make vehicles such as the Chevy Cruze compact sedan, Cadillac XTS, the Chevy Volt, the Cadillac CT6, and the Chevy Impala. All in though, these vehicles are only about 9% of GM sales year to date through October. What the company is doing is basically concentrating on where it makes money and what's in demand. 

Light truck models, which are pickups, crossovers, SUVs--those are nearly about 70% of all new vehicle sales every month in the United States, and for GM, that ratio is actually closer to 80%. GM's focusing on where it can really make the most of its money and also invest for the future. They're going to be doubling resources toward EVs and AVs as well. It's going to be painful in the short term, we're looking at about $2 billion in cash restructuring charges, which they're going take on a small credit line to fund, but they think the payback period for this will be under a year. 

Longer term GM, in my opinion, is a very undervalued stock and will remain so, and so what they've been working to do is just get better in the core business, get better in realizing the economies of scale that an automaker GM's size should have. I think this is a positive move in that direction. 

I should stress, though, that we don't really know the fate of these vehicles, in that they did not come out and say these plants will be closed. They just said product will be unallocated after 2019, so we don't know for sure if these vehicles are going away forever, or if some will reappear, perhaps in a different plant. For now, GM I think wants to be flexible and probably wants a little bargaining chip for the upcoming UAW-CBA talks this summer. It just remains to be seen what's going to happen. I would expect these plants are probably going to close, and most of these vehicles do go away. The one exception might be something like the Chevy Volt or perhaps the Cadillac CT6.


Michael Hodel: Comcast is one of our favorite companies in the U.S. telecom industry, and in fact, it's the only firm in the industry that we rate wide moat. The basis for our wide moat rating stems primarily from the strength of the firm's core cable business, where we think its networks provide it with a huge advantage versus its primary rivals, the fixed-line phone companies. We do think wireless service presents a little bit of a threat to Comcast cable business, but we also think Comcast has an opportunity to punch back against wireless by entering the wireless business itself.

NBCUniversal also makes up a big part of Comcast. We don't think NBCU is as well positioned as the core cable business, but we still like what Comcast has done with NBCU over the last several years, building out very well-positioned content franchises and building platforms to monetize those franchises effectively. 

The biggest misstep we see for Comcast here recently was its bid for Sky. We think that Comcast overpaid for Sky a little bit. We like the Sky assets. We think they complement NBCUniversal well, but we do think that Comcast paid too much for that business.

Comcast trades at about a 10% discount to our $42 fair value estimate, which isn't as big of a discount as we've seen over the past couple of months when the bidding for Sky and Fox really heated up. The shares offered a compelling opportunity. We don't think that opportunity is as compelling today, but we still think Comcast shares are attractive here at about $38 a share.


Christine Benz: Hi, I'm Christine Benz for The qualified charitable distribution has been around for a while, but it's particularly compelling under the new tax laws. Joining me to discuss what it is and why RMD-subject investors should take advantage of it is retirement expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: So great to be back here in Chicago, live at Morningstar.

Benz: Great to have you. Let's talk about qualified charitable distributions, the QCD. Let's talk about what it is, first of all, and why in 2018 you think it's a particularly effective strategy.

Slott: In 2018 and going forward, it's one of my favorite provisions because everybody saves taxes. The only problem with it is most people are not taking advantage. You have to change the way you give and that's not easy for people to do, especially for this crowd. By this crowd, I mean the people who qualify for qualified charitable distributions, or QCDs, are only IRA owners or beneficiaries that are 70 1/2 years old or older.

Now, the big benefit because of the tax law, the tax law eliminated lots of deductions and doubled and raised the standard deduction. More people will not be getting a charitable deduction, but they will be getting a larger standard deduction and more people will be taking that. By using the QCD, if you are subject to RMDs, which IRA owners are after 70 1/2, you can directly transfer from your IRA to charity, give that way--I'm not saying give more, I'm saying give it a different way, change the habit--and take it from the IRA. What you do, that excludes that income from the IRA and the amount you give counts toward your required minimum distribution. It lowers income. In effect, you are getting the standard deduction plus, in effect, a charitable deduction, not a real deduction, but being excluded from income is the same thing as a deduction.

Benz: The name of the game though is that, as you said, I don't want to take a check and then write a check to charity.

Slott: It's about breaking habits.

Benz: Right. So, I want to have my IRA custodian, whether it's Schwab or Fidelity or whatever, deal directly with the charity of my choice. Are all charities set up to handle this?

Slott: No. It's still old school some of them and people still bring checks to them. That's why I say it's got to change. Maybe it will take this one year. When people go to do their taxes, say, next April in 2019 and the accountant says, you know what you should have done, you didn't even get any benefit because you are taking a standard deduction. What should I have done? You should have done the QCD. Well, you can't go back now and do it, but get set up next year and then talk to the charities you are interested in and make sure they have a way. Now, the charities should be coming around …

Benz: I think they are.

Slott: … because what do charities want to do? They want to raise money. They should be more helpful in accepting, and I think, like you said, more of them are, but not enough.

Benz: Let's talk about some of the problems that can crop up. We, I think, touched on one where someone doesn't direct the money straight to charity. That's an issue.

Slott: Right. It has to be direct gift. You can't take a check made out to yourself and give it to the charity. Otherwise, it fails. And when I say a QCD fails, all that means is, you can't exclude it from your RMD. You'd have to add it to your other itemized deductions which you may not get.

Benz: Let's talk about some of the other problems that can crop up. One you say you've encountered is people who have already taken their RMDs, maybe they do them earlier in the year. If they haven't executed the QCD at that time, too late, right?

Slott: Well, you can still do a QCD, but you've already taken your RMD. It can only from future withdrawals from your IRA if you want to take more. The RMD income can't be offset. That's already locked in. You can't undo it. Just to note, if you already took your RMD, you took it, you're going to have to report the income. If you want to use a QCD, because you want to give more, many people do a lot of their giving at the end of the year, you could still use the QCD and it will still be excluded from income, lowering your IRA balance and maybe for a little bit lowering next year's RMD.

Benz: I'm not necessarily limited to my RMD in terms of my QCD amount. Let's talk about that.

Slott: Right. Your RMD can be $10,000. But let's say you want to give $15,000. You can do that. You can give up to $100,000, that's a high limit, per person--not per account--per person, per year if you want to give that much. That's a lot you can exclude from income.

Benz: Let's talk about age, because I think some people might think, a-ha, I'm retired, and I have an IRA, but you need to be 70 1/2.

Slott: You need to be, for this rule, unlike other 70 1/2 rules--which adds to the confusion and problems--you actually have to be 70 1/2. If you are watching this today and you say, oh, good, I'm going to be 70 1/2 next week and you do it today, you don't qualify. You actually have to be 70 1/2.

Benz: Another related point is, sometimes charities give freebies for making a donation or maybe you attend a dinner it's $200. How does that work?

Slott: You can't get anything back. There's a no benefit back rule. Tell them keep your gifts, keep your dinners; I'm giving to you, don't give me anything back. Otherwise, the QCD fails. Another mistake that people make--I mentioned IRA; it only applies to IRAs. I constantly get questions, can I do it from my plan, my 401(k)? No. It's only for IRAs.

Benz: How about younger beneficiaries for an IRA who are subject to RMDs? Is the QCD an option for them?

Slott: It is, but they too have to be age 70 1/2. I get this question a lot from financial advisors who say, well, it says, IRA owners and beneficiaries. But they both have to be 70 1/2. Now, most IRA beneficiaries are not that old. Most IRA beneficiaries are probably in their 40s or 50s or even younger, they don't qualify. It's only beneficiaries who are actually 70 1/2 years old themselves, IRA beneficiaries.

Benz: In terms of the logistics, how does this work? Do I go on to my provider's website? Is there a form? How would I execute this?

Slott: There's a few ways you can do it. And you have to ask your custodian, your Schwab, your TD, Fidelity, financial advisor, whoever does this and say, I want to give this amount to this charity; make sure it goes directly from my IRA to the charity. Now, somebody has to obviously contact the charity. They have to be set up to accept it. 

Or they can give you what's called an IRA checkbook, which I think is a little dangerous. Because an IRA checkbook means every time you write a check from that IRA, that's a distribution. But you can do it that way, but you have to write the check directly to the charity and obviously, you have to notify the custodian that the check was written. I mean, they will see it when the charity cashes the check.

Benz: Maintain a paper trail of this?

Slott: Oh, yeah. Yeah.

Benz: Ed, thank you so much for being here. Interesting maneuver. Thanks for discussing it with us.

Slott: Thank you.

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


Christine Benz: Hi, I'm Christine Benz from Healthcare costs are one of the biggest line items in most retiree budgets. Joining me to discuss some new Vanguard research on the topic is Jean Young, she's a senior research associate with the Vanguard Center for Investor Research.

Jean, thank you so much for being here.

Jean Young: Thank you for having me.

Benz: Jean, let's talk about healthcare expenses in retirement, generally speaking. What are the big out-of-pocket costs that tend to occur in retirement?

Young: I think the biggest cost retirees are going to face is the cost of their insurance premiums. They need to make a choice around supplemental insurance. But that’s probably the number one line item that people have to be prepared for. As we think about it--and this was a collaboration across divisions at Vanguard, we had folks from our advisory services group; we had folks from our investment strategy and our enterprise advice group as we started to think about this--and we actually did something that is unique for us a little bit. We decided to partner with Mercer, because while we are investment experts and planning experts and retirement experts, healthcare experts we could become. But we felt it would be better to partner with healthcare experts. So, our co-authors on this paper are two healthcare actuaries from Mercer.

When we went into this we were very interested in the idea that there are all these big scary numbers out there. We don't think they are helpful. We went away from big scary numbers around saving for retirement. People think in terms of annual costs. Big scary numbers are actually behaviorally distracting and not actionable. Our view is you should think about your regular healthcare as an annual expense and we're all--you and I both-ave health care expenses today. As we think about it, we need to think about how much will that expense grow at retirement, and then of course you do need to think about how much it will grow over time. Because healthcare in the U.S, the costs for healthcare have been rising faster than inflation for a while. The trend is projected to continue. The number one expense people will face, most people will face, all people will face will be their insurance premium.

Benz: And one point your colleague Maria Bruno has made that I think is an important one is that if you are having your healthcare expenses deducted from your paycheck, they feel a little bit invisible to you. So, you might have the sense …

Young: Just like the 401(k) savings.

Benz: Right. So, they are not brand new costs that we all encounter in terms of health insurance and retirement. We just may have been paying them a little more painlessly while we were employed.

Young: Many of us, I know I'm fortunate this way, our healthcare costs while we are working are heavily subsidized. None of us like to see our own premiums go up when we are in open enrollment and we got to make a choice. But most workers, many workers have heavily subsidized premiums. When you think about that cost, you have to think about two things. First of all if you have subsidized premiums you might face a bigger incremental costs. You certainly want to understand that before you get there. The other thing is if you retire before you are Medicare-eligible you have different cost to consider. Now among large employers about 40% still offer some form of retiree medical, but even if you have retiree medical benefit and you have a generous subsidy, you are still facing an increase in that insurance costs most likely.

Benz: Your thought is--and one of the conclusions from the research is--take it year by year rather than being overwhelmed by that single total in-retirement number.

Young: Nobody says you need $600,000 for basic living, food and utilities. We take that year by year.

Benz: And then another point is customize it based on what you have going on. The base case you used is that the median healthcare outlay for a 65-year-old woman would be $5,200, but those costs really ran the gamut from like $3,000 at the low end to over $26,000. If I am thinking through, if I am approaching retirement and thinking through what will my healthcare costs look like, obviously I want to take into account my own health needs and the expenditures that I am having already.

Young: Your health status. It was interesting, as we went through this work with Mercer, Mercer built the model; we had a lot of input into it. When they turned over the model the first time it's this big new shining toy, what's the first thing you do? You run yourself through it. I am healthy. I just had my annual physical and my biometrics; I am healthy. And when I go through the model I come up healthy. But my parents, particularly my father, has a number of these conditions that when factored in move me from low risk to medium risk. We really spent a lot of time talking about that, because your genetic history, your parental history in particular is a predictor of what your health might be as you age.

Now the good news is as we explored that. The difference between low risk and medium risk, it was $1,000 maybe on the number. It wasn't a big factor. Where the costs get really high is if you are not healthy. If you are high risk. If you have these chronic conditions, if you are overweight, if you are a smoker--that puts you in that high risk pool. It's that old 80-20 rule: 20% of the folks cost 80% of the costs. Your health, and the thing about this is, as you approach retirement, these chronic conditions, for many people they do manifest in your 50s and 60s. You actually know if you are facing a medium or a low risk health spend or if you are facing a higher health spend.

Benz: The elephant in the room here is you've talked about out-of-pocket, ongoing healthcare costs. How about long-term care costs? This is just such an important topic and one unfortunately where there aren't a lot of great answers. But let's talk about how pre-retirees can approach long-term care expenses, how much they should set aside. It's really a vexing issue.

Young: I think one of the contributions we're making here is we're providing people with a frame. We were talking before this interview about your personal situation around long-term care. I have personal situations around long-term care, and this is one of those topics as I am sharing our work across the country, everybody--this is personal. Everybody has a story. Some of the stories are heart-wrenching, but everyone has a story.

I think what we do is we provide a frame. First of all half of folks will have zero paid long-term care expenses. That doesn't mean that they are not getting help from family and friends. But they are not paying for it. Another quarter will spend less than $100,000. We can all handle zero and most of the folks that we know and work with, $100,000 is a number that we can wrap our minds around.

Now the problem is is the tail risk, the 15% of people--more likely to be women--who will spend over a $250,000. But that's 15% of people. It's really hard, we are not good at math. We're not good at putting things in perspective. These events we've all experienced around family members with long-term care are personal. They are emotional, and so we focus on those. But what we don't do well is put that in perspective to the number of folks we know that get to the end of their life never having used long-term care at all. 

In my own life my Grandmother Young, Lucille, she had dementia; her care was provided by my grandfather in the home. At the other extreme my Grandmother Baker, my mother's mother, she lived independently to 96. She fell, we don't know how she fell, because she lived independently. Hospital, hospice--it was very quick. That sounds like a horrible story, but Grandma Baker lived independent.

Now it's a really hard thing to think about. Because as I think about this, am I Grandma Young needing two or three years of long-term care because of Alzheimer's. Or am I Grandma Baker living independent until I pass away in my late 90s. Its very hard to wrap your head around.

Benz: So how do you grapple with it?

Young: I think what we do, the paper came out in June, we've had the model for a while, and in our personal advisory services were starting to pilot this. So, we're testing and learning. We're testing and learning. But a big part of it is to help people understand the risk and talk through the sources of support that might be available and then help you make your personal decision around, how do you want to think about it. Your financial wealth at retirement has to cover a lot of things. One of which it could be long-term care.

Benz: Jean fascinating research. Thank you so much for being here to discuss it with us.

Young: Thank you.

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


Scott Pope: As emerging economies become more urbanized and developed economies replace aging infrastructure, the demand for construction equipment continues to increase. We currently feel wide-moat Caterpillar is optimally positioned to benefit from this infrastructure boom and is significantly undervalued. In recent quarters, Caterpillar has done a remarkable job increasing its profitability. By reducing 25% of its overall manufacturing floor space and trimming headcount by approximately 14%, Caterpillar has emerged a leaner, stronger organization.

Our recent research suggests Caterpillar offers significant upside potential. While the North American construction segment is experiencing significant tailwinds, many of Caterpillar's business segments are well below their midcycle peaks. Currently, its resource industries segment is generating less than half of the revenue it was in 2012. Caterpillar's rail division has also been particularly depressed in recent years suggesting future revenue improvements are likely.

We are especially impressed with Caterpillar's overall strategy, which is aligned with its customers' needs. As cheaper brands have entered the market, Caterpillar has maintained its focus on providing the lowest total cost of ownership equipment. This entails manufacturing the highest quality products with performance enhancing features and, in the process, extending its technical leadership. For customers in emerging markets who remain focused on upfront cost, Caterpillar manufactures a range of equipment in China under its SEM brand.

Going forward, Caterpillar is poised to capitalize on a variety of global opportunities. The company boasts an exceptionally strong brand and robust dealer network. Considering its wide moat, recent operating performance improvements, and upside revenue potential, we feel Caterpillar presents an excellent opportunity investment at this juncture.


Susan Dziubinski: It's capital gains distribution season, and many investors may find themselves paying taxes on distributions made by funds in their taxable accounts. Investors can limit the tax burden in their taxable accounts by favoring low-turnover, market-cap-weighted index funds and ETFs, which are generally pretty tax efficient. But for those seeking even more tax protection, tax-managed funds may fit the bill. Here to share three of his favorite tax-managed funds is Adam McCullough. He is an analyst in our manager research group focusing on passive strategies.

Adam, thank you for joining us today.

McCullough: Happy to be here, Susan.

Dziubinski: Now, your first pick receives a Morningstar Analyst Rating of Gold, and it lands in the large-blend category. Tell us about that one.

McCullough: That's right. This is Vanguard Tax-Managed Capital Appreciation Fund. What this fund does is it effectively tracks the Russell 1000 Index, so a large-cap index, but it takes two more steps to avoid taxes. One, it avoid stocks that pay higher than average dividend yields. So, dividends are taxed as they are paid out which gives the investor less control about their tax bill from dividends. This fund has a little bit lower dividend yield than the Russell 1000, about 2% versus 2.3% over the past 10 years, but it is less of a tax footprint to avoid those big dividend payers.

The second thing it does is, the portfolio managers keep track of the tax lots of the stocks in the fund. And so, it will look for stocks that have losses and harvest those to offset realized capital gains. It will look for small losses, harvest those, offset the future realized capital gains with those losses. So, it's two levers that the managers pull. But it's still going to have about 99% overlap with the Russell 1000. There won't be that much of a difference with this and the index fund, but it has been a little bit more tax-efficient over the long haul.

Dziubinski: The next fund you wanted to talk about invests in smaller companies.

McCullough: That's right. DFA Tax-Managed US Targeted Value Portfolio looks for stocks in the U.S. market that are cheaper, smaller, and more profitable than the average stock in the market. What this fund does is, it may avoid selling stocks that don't meet that bill, just to avoid realizing capital gains on those stocks in its portfolio. It won't have as pure of a small-cap value profitability tilt as the non-tax-managed version of this fund, but it will avoid some of the capital gains from selling those stocks as they shift out of the threshold.

This fund has distributed some capital gains over the past decade, but it has had less taxes than the actual non-tax-managed fund. Still, you are paying some taxes, but at the same time, you are targeting these cheaper, smaller stocks, so it's hard to avoid taxes when you are selling stocks that leave that area of the market.

Dziubinski: And your last pick today is also another small company fund. Now, how does that one differ?

McCullough: This is more of an index market cap-weighted based fund. This is Vanguard Tax-Managed Small Cap Fund. This fund looks for essentially the same stocks as the stocks in the S&P 600 Small Cap Index, and like the first Vanguard fund, it takes a few extra steps to avoid taxes. Since small-cap stocks pay less dividends than larger cap stocks, it doesn't use that method to avoid taxes. It just uses tax loss harvesting. What it will do is, if it sees that there are some tax lots that it can realize losses in, it will harvest those losses and then offset future gains in the fund.

This fund is still, like the first Vanguard fund, going to look a lot like the index, probably has a 99% overlap with the S&P 600 Small Cap Index, but it will be a little bit more tax efficient over the long haul.

Dziubinski: Great. Adam, thank you so much for sharing your ideas with us today.

McCullough: Thanks for having me here.

Dziubinski: I'm Susan Dziubinski for Thanks for watching. does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.