Investing Insights: Year-End To-Do's, Dividends, and Oracle

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Damien Conover: Johnson & Johnson stock is down close to 10% today, largely on news of a media report that came out that suggested Johnson & Johnson's talc powder might be related to major health issues, most notably cancer. Within the media report, a lot of ideas were floated that there was this link between asbestos and potentially the talc powder.

Now, there's still going to be a lot of cases that will need to come out litigating this, but our general belief is that J&J will litigate these one by one, and really, over a long period of time wear down the defendants, and the outcome will largely be not a significant impact to the valuation.

With this 10% pullback in the stock, we think the shares are trading pretty close to our fair value, so we were thinking the stock was a little bit overvalued going into the news, and following this news the stock actually looks relatively fairly valued.

We continue to think Johnson and Johnson is well positioned with a wide economic moat, really with a huge diversity of assets that are bringing in a lot of cash flows that will really help fund the firm through any potential legal concerns that it might have with this talc powder issue.

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The clock is ticking on 2018. Joining me to share some last-minute financial planning to-do's is Tim Steffen. He is director of advanced planning for Baird.

Tim, thank you so much for being here.

Tim Steffen: Good to be here.

Benz: Tim, let's talk about some things that people should have on their to-do list if they are thinking about tightening up some financial odds and ends before the end of the year. You say that taking a look at your portfolio, assessing your asset allocation should be something to keep in mind if you are doing some sort of financial review.

Steffen: It's not the kind of thing you wait till the end of the year to do. You can do it at any time obviously. But as you are thinking about these things, and especially, given the volatility we've seen recently, taking a look at your asset allocation, making sure it's still within the ranges for asset classes and the weightings that you wanted, you are not over or underweight or anything like that, rebalancing--this is the right time of the year to kind of think about those things.

Benz: The advantage of doing that potentially at year-end is that you may identify some tax opportunities, especially in your taxable account. Let's talk about tax loss selling, because it strikes me that 2018 is a year when some investors will have some losses among their holdings. Let's talk about how to approach that. You obviously want to focus on your taxable accounts. Do you have any tips to share?

Steffen: As you are accumulating your data here at year end, take a look at what your realized positions, the realized gains have been so far this year. You may have sold some things earlier in the year that you forgot about. Go back and take a look at how you've done this. Your advisor can typically give you a year-end summary of where you are at from a gain/loss standpoint.

Benz: So, compare to your cost basis?

Steffen: Exactly. Yes. Look at what you've sold things for. Make sure your cost basis is accurate. Because if was a position you held a long time ago, your basis on the records may not be appropriate anymore, may not be correct. If it was something you inherited, make sure you adjusted the basis for date of death valuations, up or down. Or any other thing where the basis might have changed, maybe like a stock option exercise or something unusual like that. Get your basis done right. Determine your gains or losses. And if you are in that gain position, then look to see if you have maybe some ways to reduce some of that, offset it with some losses you might have in the portfolio.

Benz: One thing that we expect to see is some mutual funds making these capital gains distributions. They usually come right about this time of year. Potentially if you are someone who is getting one of these distributions, any thoughts on what you should do?

Steffen: Those distributions that come from a mutual fund, they are capital gains. It's no different than if you've sold something yourself. It's a gain that you can offset with losses that you might have. Keep that in mind, as you are getting a word from these funds, as they start trickling out, what the gain distributions are going to be. You may want to offset some of those with some losses, too.

The big thing in all of this is, don't get too hung up on the tax side. Remember, these are investment decisions first. Whatever you are buying or selling, make sure it's a right investment decision, especially if you are selling for a loss.

Benz: Another topic I want to hit on is what's called tax gain harvesting. Let's talk about what that is. It doesn't seem at first blush like something you'd want to do, but actually there may be that tax benefit for certain taxpayers.

Steffen: There maybe reasons to accelerate gains or to realize some gains. The common scenario we see is somebody who has got a loss will say, well, I have a loss maybe I should realize a gain. That's not always the best reason to realize a gain. That loss isn't going anywhere. That's got some value to you. You can save that and use it in a future year if you want. But if you've got something that from an investment standpoint makes sense to sell, you've got that loss that can help minimize or even eliminate the tax cost on it.

The other reason to sell is maybe looking at your tax bracket. You might be in that zero percent capital gain bracket where you can realize a gain at no tax cost. People get surprised at how much income you can actually have before you are out of that 0%. That may be another consideration in terms of realizing gains.

Benz: What's the advantage of pre-emptively realizing a gain in that case? Say, you are someone who is in that 0% capital gains tax bracket.

Steffen: So, let's say, you can sell something, it's got to be long-term, you should hold it more than a year, you can sell and realize a gain. If you are in that 0% bracket, you can realize the gain, it's part of your income, part of your AGI, but the tax rate on it might be zero. Then you can turn around and buy right back again if you want. Unlike the wash sales where you sell something at a loss, you have to wait a period before you buy back with gains; that's not the case.

If it's something you really want to own, and you own it for a while, you may be able to sell it, reset your basis essentially at no tax cost. You've got to be careful with that. There's a lot of other things that can be impacted by realizing the gain. Even though the gain may be taxed at 0%, it could have another effect in your return elsewhere. So, you got to be careful there. But it can be something to consider.

Benz: It sounds like with all of these things, get some tax advice unless you are super-duper comfy with tax matters. Let's talk about last-minute retirement plan contributions. You actually have until April 15, right, for IRAs, but the company retirement plan contributions have to go in before year end.

Steffen: 401(k)s, you got to have those maxed out if you are going to do that before the end of December. So, that's a salary deferral thing. You've got to make sure you work with your employer to get that money in before the end of the year. IRAs, yeah, you do have until April 15. If you extend your return, you don't get to extend the time to make a contribution. So, make sure you get it in before that April 15 deadline. That's traditional or Roth IRAs, same thing. If you are 70 1/2 now, you can still contribute to your 401(k), but you can't contribute to an IRA. So, you got to keep that in mind as well. Remember, you turned 70 1/2, you are taking money out of IRAs, you should not put money into it anymore. So, be careful there. But otherwise, yeah, April 15 is the date on IRAs.

Benz: And then, maximum allowable contributions are going up a little bit, right, for both 401(k)s and IRAs?

Steffen: Yeah, they are going up about $500 a piece or so. Youll be able to put some extra money away, but that's not until 2019. So, even if you make your IRA contribution in April of 2019, if it's for 2018, you are still subject to the old contribution levels. That's only if you do it for the calendar year 2019.

Benz: But if I'm setting my 401(k) contributions, I should look to those 2019 figures?

Steffen: Absolutely. Usually, that's done as just a percentage of your income. The employer will keep making that contribution until you hit the max. You may just be contributing for a little bit longer next year because of the higher contribution limits.

Benz: Let's talk about charitable giving, because this is one piece of financial planning due to the changes in the tax code that is pretty different in 2019.

Steffen: It's different, but it isn't different. I mean, the rules about charitable giving specifically haven't really changed all that much. In fact, if anything, they have loosened the rules and made it easier to deduct more of your gifts this year. The problem is, all the other changes they made on the deduction side will make it harder to itemize. With the increase in the standard deduction the limits on other types of deductions that you can claim--the state tax deduction, the home equity interest, the miscellaneous deductions, all of those being capped or eliminated--it will be harder to itemize, and if you don't itemize, your charitable gifts don't provide a tax benefit. So, it is a little trickier this year to determine what's the real tax benefit of your charitable gifts.

Benz: Which is not to say you shouldn't be charitable, but you may not get as much of a tax benefit. But let's talk about people who are subject to required minimum distributions. I know a lot of our viewers are taking their money out of their IRAs. They actually can get a tax benefit.

Steffen: Absolutely. So, if you are over 70 1/2, you can take money directly from your IRA, go right to a charity and it's not reported as taxable income to you. You also don't get to deduct contribution, you don't get to double dip there. But if you are subject to some of these new rules where it's going to be harder for you to get a tax deduction for your charitable gifts, this is a way to still get a tax benefit for that. It's got to go directly from the IRA to the charity. It's only IRAs. You can't do it from a 401(k) or something like that. And you have to be 70 1/2 at the time of the gift, not just the year of the gift but at the time of it. So, if you don't turn 70 1/2 until April, you got to wait till April to do the gift.

Benz: Say I have a little extra time and I want to check off a few other things, what are some good sort of financial planning maintenance things to do at this time?

Steffen: They talk about changing the batteries in your smoke detector when you change your clocks, year end is a good time to think about some of these kinds of things, like reviewing your estate documents, for example. If you've got married or divorced, there was a birth or a death in the family, if you relocated to a new state, your estate plan may need a review. It's a good time to take a look at that.

Related to that would be beneficiary designations, retirement plans, life insurance policies, trusts that you have. Make sure those designations are still correct. Related to that would be executor or guardianship designations you made, are those still appropriate. Review the whole financial plan and everything. Even take a look at things like your online passwords and that. Maybe this is the time of year to reset those.

Benz: Or use one of those password minders which are …

Steffen: Absolutely. Automatic generators or something like that to update all that information.

Benz: Lots of helpful tips there. Tim, thank you so much for taking the time to be here.

Steffen: You bet, Christine.

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

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Does it matter that it's difficult to beat the market? I'm here today with Alex Bryan, he is the director of passive strategies research for North America, he is also the editor of Morningstar's ETFInvestor newsletter, to find out.

Alex, thanks for joining me.

Alex Bryan: Thank you for having me.

Glaser: Alex, you recently took over as the editor of ETFInvestor, and in your first cover story one of the things you talked about was that you think it's difficult to beat the market. Why is this the case?

Bryan: I think there is a lot of competition from well-informed investors that makes it very difficult to consistently beat the market. While some investors may be better informed than others, it's really difficult to maintain an informational edge in a world where it's illegal for managers to selectively disclose information to some investors, not to others. Anyone who has the proper motivation, resources, and training can access the same information. They are all looking for undervalued opportunities, stocks or bonds that offer higher returns relative to the risk.

So, if they come across one of those stocks or bonds, there's a lot of competition, a lot of money will flood into those undervalued securities to the point where the prices get bid up to where the future returns are commensurate with the risks that those securities offer. So, really, competition is the key here. It's what drives prices to be close to fundamental value.

Glaser: Are you saying here that the market's efficient and that there's no opportunity for outperformance?

Bryan: Not quite. While it's difficult to beat the market, it's not an impossible task. The markets aren't efficient because people aren't perfect. We are all susceptible to fear and greed and that can cause us to do some dumb things with our money. Like selling out of an investment after the market crashes and returns are actually probably going to be higher going forward. Or maybe losing our valuation discipline after we've had eight- or nine-year bull market and things feel safe.

A lot of investors aren't perfectly rational. We are susceptible to these emotions. We might extrapolate past returns too far into the future, underreact to new information or roll dice on risky stocks and in hopes of making it big. There's lots of inefficiencies in the market, but that doesn't necessarily mean it's easy to beat the market, but it's not perfect by any stretch.

Glaser: If you are trying to maybe exploit some of these inefficiencies, you think it's better to do so using a model than to have kind of an active stock-picker, an active bond-picker. Why is that?

Bryan: I think there's multiple ways to be successful, but I tend to prefer models because models are more consistent, and they are less susceptible to cognitive biases than qualitative judgment might be. Qualitative judgment, while there are certainly great stocker-pickers out there who use qualitative judgement to great effect, it really relies on intuition, and intuition is a very hard thing to develop in an unpredictable environment where there is a lot of noise, there is a lot of unpredictability. That means it's difficult to get good-quality feedback. It's hard to know if your judgment actually was skillful and resulted in you making money or if it was just the result of luck, if you just happened to be in the right place at the right time.

I think models are good because they are better at picking out moderately predictive relationships in this noisy data and applying those insights consistently, which allows investors to profit from the relationships that are in fact there. But I do think you can be successful either way. I just tend to prefer models because I think they are more consistent and less susceptible to biases.

Glaser: Then maybe pulling back a little bit, does any of this really matter? I mean, does beating the market, is that in and of itself, something you should be trying to do? Is there anything wrong with just accepting market returns?

Bryan: Beating the market, while it's great if you can do it, it's not a requisite for investment success. Now, that being said, if you can beat the market, a small advantage when it's compounded over a long period of time can add up to a lot of money. It's actually pretty far down the list of things that you should be worried about.

The market over the long term works for investors. The most important drivers of long-term returns are interest rates and the compensation that investors require for holding risky assets. Sometimes, things will turn out better than expected, and risky assets will just shoot the lights out. Other times, risky assets will offer disappointing returns. But I think over the long term, positive and negative surprises tend to wash out and you are left with a competitive risk premium for your efforts for taking on that risk.

I think just owning the market will actually probably let you do better than most investors that are getting a bit greedy and trying to beat the market. Because you start out with a huge head start with the lower fees that index funds offer. I think being broadly diversified, keeping your costs low, those are the most important things and staying in the market through thick and thin even when things are scary, that's what I think is more important than trying to beat the market.

Glaser: Alex, thank you.

Bryan: Thanks for having me.

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

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Erin Lash: With the holidays in full swing, it seems that everywhere you turn, sweets abound. But for income investors looking to satisfy their sweet tooth, which is the better option: Mondelez or Hershey?

While Mondelez shares trade at a more than 10% discount to our $52 fair value estimate, we don't believe its top priority for cash will center on boosting the income stream paid to shareholders. In this vein, we forecast Mondelez will increase its shareholder dividend in the high single-digit range on average annually through fiscal 2027, but this implies a payout ratio of only around 40%. Rather, we surmise that despite remaining on the sidelines for the better part of the last few years, the firm's prime use of cash will be to invest behind its brands (in the form of research, development, and marketing) as well as acting as a consolidator in the space, with an eye toward expanding its footprint into untapped markets--such as Indonesia and Germany--or other adjacent snacking categories.

However, we view this spend as prudent as it works to profitably reignite its top line by extending the distribution of its fare and more effectively aligning its new products with evolving consumer trends around the world. And because of its entrenched retail relationships, the resources it invests behind its leading brand mix, and expansive global scale, we believe Mondelez is poised to withstand lingering competitive headwinds longer term. But with a yield of just around 2%, we don't portend that this wide-moat name will be viewed as favorably with income investors as its packaged food peers.

As such, we think the more attractive dividend play in the snacking and confectionery aisle is Hershey. Even though Hershey has opted to pursue a handful of inorganic growth opportunities over the past few years (including poaching Amplify and Pirate Brandsk most recently), we don't posit it will deviate from the capital allocation prudence it has exhibited in the past. Our contention hinges on the sizable ownership stake of the Milton Hershey School Trust, which maintains more than 80% voting power, given the Hershey School depends on the firm's dividends to fund its operations.

In this context, we forecast Hershey will also grow its dividend at a high single-digit clip on average annually over the next decade but that it will maintain a dividend payout ratio of just more than 50%. Further, we believe its dominance in the U.S. confectionery space (where it holds about 45% share of the chocolate category versus just a 1% share for private label) and continued investments to bolster its brand mix and standing with retailers should ensure that it withstands intense competitive and macro pressures. Trading at nearly a 10% discount to our $117 fair value estimate, and boasting a dividend yield of just under 3%, we think income investors could find favor with Hershey's shares.

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many retirees use the Bucket System to organize their portfolios. I'm here today with Christine Benz, she is our director of personal finance, for some year-end portfolio maintenance tips to think about if you do use the Bucket System.

Christine, thanks for joining me.

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

Glaser: I know we've talked about this many times, but can you just give a quick recap of what the Bucket Strategy is, what the Bucket Approach is and how a retiree would use it?

Benz: Absolutely. So, I always have to credit Harold Evensky, the financial planner in Coral Gables, Florida, for really influencing the Bucket Approach as I talk about it. He in his practice simply bolts on a cash bucket, Bucket 1, to his clients' long-term portfolios. So, the idea is that they have got enough cash set aside to cover them for the next couple of years, one or two years, and then they have a long-term portfolio that's appropriately allocated. The beauty of that cash bucket is simply that it lets them have peace of mind with the fluctuations that inevitably accompany the long-term portfolio.

In the Bucket Strategy that I talk about, I think about maybe a three-bucket system where you have very short-term spending needs, followed by intermediate spending needs which I have roughly sketched out as covering you for years three through 10 of your retirement and then your long-term spending money would go into equities. The middle piece would go into bonds. That's kind of the basic framework when we talk about the Bucket Approach that I'm thinking about.

Glaser: Retirees who are spending out of that first bucket, that means that it should be diminishing in size during the year. What's the right way to top that off to make sure you have enough money for 2019?

Benz: It's a great thing to think about, and it's important to think about that before you embark on a Bucket Approach: What is my strategy for replenishing that Bucket 1 as I spend from it. And to my mind, there are really three key ways you could go about doing that.

One is that you could be quite income-centric in terms of how you construct your portfolio. You could target current income primarily from the equities and bonds in your portfolio, and rely primarily on those income and dividend distributions to refill Bucket 1 on an ongoing basis. Or you could use a strict total return approach, reinvest all dividend and income distributions back into the portfolio, and then maybe once a year take a step back and do some rebalancing and see, well, this part of my portfolio has appreciated, and that's the one I will pull from to refill Bucket 1. Alternatively, you could use a hybrid of those two strategies. You could use income distributions but not go out of your way to build an income-centric portfolio, and then you could use rebalancing proceeds to meet any other cash flow needs that you might have.

How you refill your Bucket 1 for 2019 really depends on what strategy you are using. I happen to like that last approach, the hybrid approach. The good news is for bucketers that yields have gotten better. If you've been relying on organic yields to help source cash flows for your portfolio, that's gotten a little easier because not only have cash yields come up a little bit, but we've also gotten better yields from bonds even though we've had some short-term price dislocations. Definitely step back. Think about how you are employing the Bucket Strategy and use that to determine where you go for cash for next year.

One thing I would point out, Jeremy, for the strict total return, the rebalancers, it's slim pickings really when you think about market performance so far in 2018 where stocks have been pretty flat where we sit here in mid-December and bonds in some cases have losses. This is one reason why I counsel for having a two-year bucket cushion, that if you are using that strict total return approach and there is no ready source of rebalancing proceeds, well, you've got two years set aside; even if you've spent one, you still have a year's worth left of cash flow for next year.

Glaser: If we are going to rebalance, what kind of account should you be looking at to potentially tap in order to refill that cash bucket?

Benz: This is an important question, and I think it does get back to withdrawal sequencing. This is a topic that I've written on and done video interviews on, the idea of thinking about tax-efficient withdrawal sourcing in retirement and using that to inform which specific accounts you go to to supply your living expenses.

If you are someone who is just embarking on retirement, oftentimes you'd want to think about tapping your taxable assets first because they have less long-term tax benefits associated with them. But from a practical standpoint, when I think of many mid-retirement career bucketers, most of their withdrawals are necessarily coming from required minimum distributions that are coming out of those traditional tax-deferred accounts. For many people who are post 70 1/2 who are subject to required minimum distributions, they are probably withdrawing most of the proceeds that they need to refill the cash bucket from their RMDs alone.

Glaser: Finally, what else needs to be on your radar as the year comes to a close?

Benz: I think you do want to also in addition to refilling Bucket 1, you want to think about any rebalancing that you need to do among the buckets. In 2018, as I mentioned, it hasn't been a meteoric year for either stocks or bonds. And in fact, foreign stocks are down a little bit. Maybe you want to do a little bit of intra-equity rebalancing, adding perhaps to foreign stocks because they have underperformed U.S.

In a year like 2017, certainly, there would be many more rebalancing opportunities because we saw very strong equity market performance. Investors had the opportunity to strip back from equities and add to fixed income. It depends on the complexion of your portfolio. But generally speaking, you'd want to have rebalancing on your radar in addition to refilling that Bucket 1.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

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

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John Barrett: Three-star, wide-moat Oracle is a software company that pioneered the relational database in the late 1970s. Their business focuses on providing database and enterprise resource planning, or ERP, solutions to big businesses. There are three key reasons we like Oracle's wide moat.

The first reason is the high switching cost in Oracle's core relational database business, which makes up roughly 35% of Oracle's revenue. The relational databases store a company's mission-critical data. It is important to note that we believe the switching costs are exponentially higher for a global company than a small business, as converting numerous servers in remote locations all over the globe is significantly more complicated than changing out one server at one location.

The second reason is we believe the rise of nonrelational databases like NoSQL and Hadoop are overhyped. These new databases are being used to process large amounts of unstructured data and are providing new ways for companies to use analytics. We think these solutions are unlikely to completely replace relational databases and that relational databases will continue to play a key role in many corporations' IT solutions for a long time.

The third reason is the high switching costs of Oracle's ERP business. Through internal development as well as a number of acquisitions, Oracle has built out an ERP solution that includes applications like client relationship management, human capital management, financial tools, and supply chain management. These applications are typically used by every department of a company on a daily basis, so there is a risk of very serious business disruption when thinking about switching ERP providers.

Even with these characteristics earning Oracle a wide moat, we currently view the stock as fairly valued and recommend investors wait for a larger margin of safety before investing.