What to Buy or Skip: I Bonds, Apple, Amazon.com, or Meta

Ivanna Hampton:

Here’s what’s ahead on this week’s Investing Insights. Earnings from Meta, Amazon, and Apple provided a mix of good and bad news. Find out whose stock we think is cheap or expensive. Plus, I-bonds’ interest rate has dipped. Our team will explain why this popular investment is still worth buying. And what pre-retirees should put on their radar.

This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Meta’s Disappointing in Q3 Earnings

Meta posted an underwhelming third-quarter earnings report along with a disappointing outlook for 2023. But it's the metaverse that has some analysts concerned the company is overpromising and underdelivering. Morningstar Research Services’ senior equity analyst Ali Mogharabi says the firm plans to invest significantly more than he had projected in 2023. However, it comes without much clarity about when any return on this investment could be realized. Meta is also facing pressure from TikTok – the world’s most downloaded app. That has forced Meta to spend big on its Reels short-form video content format. Mogharabi says the Reels investment does appear to be showing some returns with increased engagement and early signs of high monetization potential. Meta's dependence on ad revenue could also take a hit in the event of an economic downturn. That’s something Mogharabi modeled, and it had a negative impact on his estimate of the stock’s intrinsic value. These and other concerns have led him to lower what he thinks Meta's stock is worth to 260-dollars from 346-dollars. Check out the show notes for more on Meta.

Amazon.com Delivered a Sting

Amazon delivered a sting. The online retailer reported disappointing third-quarter results and gave a soft fourth-quarter outlook to investors. Its 127-billion dollars in revenue sat in the middle of the guidance. This was supposed to be the quarter where the tech giant had finally overcome its pandemic-fueled issues. The performance of the cloud business known as A-W-S is Morningstar's greatest near-term concern. We continue to believe e-commerce’s rapid increase, A-W-S, and advertising are driving long-term growth. But a variety of macroeconomic issues like currency headwinds and high inflation are clouding the near-term. We believe these issues are likely to last throughout 20-23. We're lowering our growth and profitability assumptions. And we’re reducing our estimate of what we think the stock's worth to 150-dollars down from 192-dollars. We're not ready to throw in the towel on Amazon and see shares as attractive. But clearly the company has still not found stable footing on its path out of the pandemic.

Apple Is Eating Up Earnings

Meanwhile, Apple is out with another impressive earnings report for its fourth quarter beating Morningstar’s estimates. The tech company reported 90-billion dollars in revenue. Sales of iPhones and Mac computers led the way. We believe in the company's ability to pull revenue and profits from its products. But we think demand for its devices is likely to slow in the next few quarters. Management held off on giving explicit revenue outlook for the December-quarter blaming macro uncertainty. However, we expect slight year-over-year growth. We think the iPhone segment will lead the way and partially offset declines in Mac and iPad sales. Apple’s product sales are likely to slow down or decline due to high inflation or other factors. We’re also expecting weaker demand for gaming and digital advertising. We’re keeping our 130-dollar estimate of what we think the stock is worth and view shares as overvalued. Check out the show notes for more on Apple, Amazon, and Meta.

What You Need to Know About I Bonds

Investors are turning to I-bonds as inflation refuses to loosen its grip. I-bonds are U-S savings bonds with a variable interest rate that changes with inflation. The interest rate just changed this week. Morningstar Inc’s data journalist Katherine Lynch has written about what some call a “safe investment.” How do I Bonds work?

Katherine Lynch: I Bonds are a unique investment. They’re U.S. government savings bonds that pay a fixed interest rate in addition to a variable interest rate that changes every six months with inflation. The variable rate changes in May and November based off the previous six months’ inflation rate. Interest accrues monthly on the bonds and is paid out when you sell them.

Hampton: So, the interest rate changed this week. The last six months, it sat at almost 10%, but it has since dipped. What should investors expect over the next six months?

Lynch: Yes, so investors who purchase I Bonds through April 2023, they’ll receive a variable rate of 6.48%, but they also get this new fixed rate of 0.4%. Combined, that’s an annualized 6.89%. The variable rate, though, will change again in May based off the previous six months’ inflation rate.

Hampton: So, I Bonds do come with some limitations. What are those?

Lynch: Investors can only purchase up to $10,000 in I Bonds each year online, and you must hold them for at least a year. If you sell them before five years, you have to forgo three months of interest. But after five years, there’s no penalty if you sell them.

Hampton: So, there’s a way to use I Bonds as an emergency fund. Can you explain?

Lynch: Yes. One approach is to purchase I Bonds each year for five years. After the first year, that first batch of I Bonds can be used for emergency use. You’d still have to forgo that three months of interest. And after five years, there’s no penalty if you take money out. And if a new, more attractive interest rate comes out, you can sell the older ones and purchase new ones at that more attractive rate.

Hampton: And there’s a way if you’re a parent that you can use these I Bonds to help you save some money in the long run.

Lynch: Yes. So if you use the proceeds from your I Bonds on education expenses, you don’t have to pay federal income tax on them.

Hampton: So, if you want to buy I Bonds, where do you go?

Lynch: You can only get them in one place, and that’s through the treasurydirect.gov website.

Hampton: Well, thank you, Katherine, for explaining how this popular investment works. Thanks for your time.

Lynch: Thank you.

Hampton: Thanks, Katherine, for going into detail about this popular way to invest.

Dashboard for Preretirement

Pre-retirees may really want to envision what their retirement will look like. And ask themselves how they will spend their time, and how they will spend their money. Morningstar Inc.’s director of personal finance Christine Benz asks Vanguard’s retirement specialist Maria Bruno what should be on the pre-retirement radar.

Christine Benz:

Hi, I'm Christine Benz from Morningstar. If you're getting ready to retire, there are a few key items that you should be sure to have on your dashboard. Joining me to discuss them is Maria Bruno. She's head of U.S. wealth planning research for Vanguard.

Maria, thank you so much for being here.

Maria Bruno:

Hi, Christine. Good to see you. Thank you.

Benz:

Good to see you, too, Maria. So, you think at the top of the list, if you're kind of making a dashboard for preretirement should be a look at what you want your retirement to look like, kind of an articulation goals. Can you talk us through that?

Bruno: Generally speaking, I think a good baseline would be, yes, you would think that your taxes could go down, but it depends, really. I think the important thing to think about is that in your working years, typically it is you pay your income taxes through payroll deduction. Once you're retired, that goes away, and taxes actually become a line item in the budget. So, you need to think about that, plan for that, and also, depending upon your situation, you might have to make quarterly income tax payments. So, you want to be thoughtful in terms of now taxes are a line item and how you're going to allot for that. Generally speaking, you can expect your taxes to go down, but not necessarily. It depends upon what your spending and then, also, what your income sources are and how those income sources are taxed.

How Will Your Expenses Change in Retirement?

Benz: That’s important not just from a quality-of-life standpoint but also from a financial standpoint because the activities that you plan to undertake in retirement will affect your spending. So, you think spending and thinking about your in-retirement budget is another item that you should have front and center on that preretirement dashboard. How should people think about their expenses potentially changing in retirement versus what they were when they were working?

Bruno: Right. So, once you do that, you want to think about the budget or the cash flow. When you think about expenses, so as you shift from your working years into retirement, you want to think about, all right, what’s changing, what expenses are going away and what expenses potentially are going to be added? So, think about the work type expenses, whether it’s commuting or lunches out or work wardrobes, like, those types of expenses will naturally go away when you’re retired. But depending upon what you want to do in retirement--for instance, if you do want to travel or you do have more discretionary type expenses because you have more free time, it’s conceivable you want to do things--then you need to think about what those are and what those expenses are and then add those. But I would always encourage individuals to think about discretionary versus nondiscretionary. Nondiscretionary are things like housing, taxes, which become a line item, we can talk a little bit about that, food, insurance. Those types of things are nondiscretionary. Those things that keep the lights running, if you will. And then, the discretionary-type expenses are the things that might be more leisure-type expenses, where you might have more flexibility depending upon what your goals are.

How Are Taxes Going to Affect Your Retirement?

Benz: You referenced taxes, Maria. Should people expect their taxes to go down in retirement? Or is it completely individual dependent?

Bruno: Generally speaking, I think a good baseline would be, yes, you would think that your taxes could go down, but it depends, really. I think the important thing to think about is that in your working years, typically it is you pay your income taxes through payroll deduction. Once you’re retired, that goes away, and taxes actually become a line item in the budget. So, you need to think about that, plan for that, and also, depending upon your situation, you might have to make quarterly income tax payments. So, you want to be thoughtful in terms of now taxes are a line item and how you’re going to allot for that. Generally speaking, you can expect your taxes to go down, but not necessarily. It depends upon what your spending and then, also, what your income sources are and how those income sources are taxed.

Healthcare in Retirement

Benz: How about healthcare spending? I know that that is something that retirees worry about. Many retirees have seen those big, scary numbers of how much they might expect to spend in retirement. How should people think about how their healthcare spending might change once they eventually retire?

Bruno: You’re right, that is at the forefront of many retirees. We actually try to encourage retirees to move away from this big scary number. You often see this big number out there, and it’s really hard to plan around to that. Rather, we have actually done research. We’ve partnered with Mercer, who is an expert in healthcare costs. We’ve partnered with Mercer to create a model where we can help predict what healthcare expenses can look like in retirement. And that reframes the conversation around the big scary number to an annual cost. So, for instance, in 2020, a 65-year-old woman in moderate health status could expect to spend about $5,100 at retirement in healthcare expenses. That is a much more digestible number than a few hundred thousand dollars.

Benz: Few hundred?

Bruno: Right, exactly. So, it’s easier to think about that as part of the planning process as you would with any other expense. The other thing you want to think about if you’re retiring is, it’s not necessarily a net new cost. Many of us who have been with employer-sponsored plans, for instance, might have healthcare plans that have been subsidized. So, the employer might pay a part, we pay a part out of pocket. So, it may not be a net new cost. You do need to think about whether or not you’re in a highly subsidized healthcare plan. If so, then your out-of-pocket may be greater. So, those are the things to think about in the context of the healthcare costs, the mechanics of it as well as how you think about healthcare costs, whether if you are Medicare eligible and navigating the Medicare plan choice versus how are you going to pay for healthcare costs if you’re retiring before age 65 and then potentially going in the open market and looking for healthcare coverage there if you don’t have an employer-sponsored retirement plan package.

Medicare and Healthcare for Retirees

Benz: In that case, your expenses may be high earlier on in retirement, your healthcare-related outlays, but then they might eventually trim down once you’re Medicare eligible?

Bruno: It could. The mechanics of it change, right? So, how are you going to pay for it until Medicare? Then, once you are eligible for Medicare—and we've done research on this topic, too, and have the paper to help think about how you navigate this Medicare maze of different types of plans. But then, also, it's important whether you determine a Medicare Advantage plan, or a Medicare supplemental or traditional type plan is more appropriate, and then, also, if you need a supplemental plan, which we would encourage in those situations and Part D. So, there are things that you want to think about with Medicare Plan choice and the corresponding costs there.

What Is the Right Time for Social Security?

Benz: OK. So, lots to think about in the category of spending and how spending might change in retirement. You think another key item to have on that preretirement dashboard is your nonportfolio sources of income. For many of us, this will be Social Security. For some of us, it will be a pension. So, how should people think about that Social Security claiming decision? If they’ve got Social Security income on their dashboard as something that’s going to provide part of their cash flows in retirement, how should they think about the timing? I know people really struggle with this.

Bruno: This is really one area where you need to do your homework, because you can start taking Social Security benefits as early as age 62. But if you do that, there is a reduction in benefits, and it can be up to a 30% reduction in benefits. And then, you can also defer until age 70, and if you do, then you can enjoy a very rich delayed retirement credit. I think many individuals have this mindset of, well, I paid into Social Security, let me claim as early as possible. Let me start getting those benefits, and that may be feasible. But really, the first thing I would recommend is go to the Social Security website, ssa.gov, look at what your estimates are and then understand what the implications are around the timing, whether it's an early claiming full retirement age, or at age 70, or somewhere in between. Don't jump the gun to just assume that one strategy may be best unless you actually look at what these amounts are. It may be best to work with (technical difficulty) to really understand the implications and the trade-offs of that are. Of course, if you defer Social Security, then the natural question is, well, I need money to live off of, what am I supposed to do? And that's where supplementing potentially with investment income, whether it's dividends and distributions or withdrawals, might be a complement until you begin taking Social Security benefits.

How to Plan for Your Retirement Spending

Benz:

If people have gone through the process of looking at their all-in spending and then spent some time looking at those nonportfolio sources of income like Social Security, the next step is to take a look at how much of that spending will be supplied by the portfolio. How should people approach the topic of what is a sustainable amount to take out, because it seems like that's definitely something you'd want to have on the dashboard as well?

Bruno:

That's a good one because right now with markets where they are, people are questioning how much can I spend as a sustainable? Flexibility is key regardless of what approach you take. It really is prudent to be flexible. And by that what I mean is in situations where the markets maybe in positive territory, then you want to think about how much you're spending, right? When the markets go down, for instance, and some of the volatility we're experiencing right now, that gives you then the flexibility to have a little bit more bandwidth to be able to spend in those situations. So, flexibility is key. For instance, have a spending target and then, flex around that. Probably the best source to do that would be with any type of discretionary-type spending that you might have. That is probably the first source to surgically go and see where you might need to cut back if you need to.

But there's a few things to keep in mind, too. It's not just the spending rate but also how are you asset allocated? So, you want to make sure you have a globally diversified balanced portfolio for your retirement that will give you growth and income. But depending upon what your goal is for those assets, your allocation should flex with that as well, and then, that will give you a good basis for determining what your spending rates are.

Benz:

Those two things work hand in hand. My spending rate, my asset allocation, I'd want to think about those two elements together.

Bruno:

Absolutely. But also, within that is--and this is part of what your goals are--is your time horizon. Is it spending for your retirement? Is it a shorter-term goal? Is it I'm thinking about passing assets to my heirs? So, what is this time horizon, and then personalizing that with the asset allocation, your risk tolerance, and then coming up with a prudent spending plan and adapting to that as you go through. It's not once and done.

Benz:

Maria, always great food for thought from you. Thank you so much for being here.

Bruno:

Thank you. Thanks for having me.

Benz:

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

Hampton:

Thanks Christine and Maria. Thanks to podcast producer Jake VanKersen who puts this show together. And thank you for watching “Investing Insights.” I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.

Read about topics from this episode.

Slashing Meta’s Stock Fair Value Estimate to $260 From $346 Apple Reports Strong Earnings, but Stock Still Overvalued Cutting Amazon Stock’s Fair Value Estimate to $150 From $192 on Disappointing Q3 Earnings How to Hedge Against Inflation Using I Bonds A Down-Market Survival Guide for Retirees Get a Tax-Smart Plan for In-Retirement Withdrawals