With Christine Benz, Personal Finance Editor at Morningstar.com, Author of The Morningstar Guide to Mutual Funds: Five Star Strategies for Success
Steve spoke with Christine Benz, Personal Finance Editor at Morningstar and the author of the Morningstar Guide to Mutual Funds: Five Star Strategies for Success about a recent article she wrote on the value of dividend growth funds. Also discussed were some tips from one of Christine’s articles on retirement planning.
What Dividend Growth Funds Offer
Christine explained that dividend growth funds—which can be mutual funds or ETFs—are funds that focus on companies that have a history of increasing their dividends over a period of years. “That tends to hone the funds in on a subset of companies that are financially stable, that generally have solid balance sheets. They tend to pay out some of their earnings to shareholders, but they’re also reinvesting in their business, so it tends to be a good balance relative to a strategy that’s focused strictly on high dividends.”
Steve added that Warren Buffett has likened investing in dividend growth companies to buying a bond with a rising coupon. They offer good protection against inflation: “When you buy a stock that raises their dividend over time, you get a raise every year, which is a very good way to keep up with inflation.” Christine agreed that the increasing dividends offer a way to guard against inflation and added a note on the importance of picking funds with low fees.
She noted, “Generally speaking, this group of dividend growth companies is a higher quality subset than the broad market, and in volatile times like these, I think there’s a lot to be said for that type of business.” Steve offered the caveat that these types of funds, because they’re focused on companies that have been around for a while, may not include some of the high growth companies that don’t have much of a dividend history. In response, Christine suggested that investors can diversify their portfolio with a growth fund or an index fund that would include those types of high-growth companies.
Steve said that one key characteristic of dividend growth funds is that they tend to fare better in bad markets. Christine agreed, pointing out that “Looking back at the last really significant market drop, back in 2008, these funds generally did hold up better than the broad market.”
Steve wrapped up that part of their conversation by noting to listeners that they can go to Morningstar.com to get information about specific funds, adding that Morningstar is a resource that he’s used for decades as a financial advisor.
How to Simplify Your Retirement Portfolio
The conversation next turned to the topic of how to simplify your retirement portfolio. A line from Christine’s article on this subject is, “Retirement planning is complicated, but your retirement portfolio shouldn’t be.” Simplifying your portfolio enables you to focus more on the things that really matter to you, such as achieving your dreams and helping your children. Christine stated, “It’s really important to understand that people’s retirement, the financial aspect of retirement, is inextricably linked to those life goals, and those goals depend on having solid financial resources.”
Steve elaborated on the benefits of simplifying your portfolio, saying, “If your portfolio is relatively simple, you can concentrate on more important things like the withdrawal rate, your insurance coverage, taxes, and you can make sure that you’re paying attention to fees—all of the important things that keep a portfolio healthy.” Christine enthusiastically agreed, “Exactly. There are a lot of moving parts when it comes to keeping up with your retirement draw-down plan.”
So, how can you simplify your retirement portfolio? Christine recommends streamlining your accounts by consolidating them into fewer accounts where possible. For example, you might be able to merge several tax-deferred IRAs and a company retirement account into a single account. Look to consolidate accounts that fall into different “tax silos”, such as tax-deferred accounts, Roth accounts, and brokerage accounts. By doing that, Christine says, “It’ll make it easier for you to see what you have. And it’ll make it easier for you to figure out how much to take out of those accounts, especially when required minimum distributions come due.”
To get more personal finance tips, see Christine’s articles at Morningstar.com.
Disclosure: The opinions expressed are those of the interviewee and not necessarily of the radio show. Interviewee is not a representative of the radio show. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by the radio show.
Steve Pomeranz: I’m always happy to bring back my next guest. She is Christine Benz from Morningstar. As a matter of fact, she is Morningstar’s Director of Personal Finance. She’s also the author of 30 Minute Money Solutions: A Step By Step Guide to Managing Your Finances and The Morningstar Guide to Mutual Funds: Five Star Strategies for Success. Christine, it’s been many years and we’re still talking. Happy to have you back on the show. How are you?
Christine Benz: Thanks so much, Steve. It’s always great to be here. I’m good. It’s been a few crazy days. The market’s-
Steve Pomeranz: Yeah. Yeah. You think so?
Christine Benz: … been testing our patience.
Steve Pomeranz: I don’t know what you mean. A thousand points here, a thousand points there. It’s amazing. What we’re going to talk about today are two different kinds of ideas, but they are kind of linked. What I want to focus on is an article that you wrote and published on morningstar.com about dividend growth funds and ETFs. First of all, what characterizes a dividend growth fund? What makes that different from, let’s say, an S&P 500 fund or just a plain old growth fund?
Christine Benz: Yeah. These are funds, it’s a subset of funds, that focus on companies that have a history of increasing their dividends over a period of years. So, a common framework for a fund to use is to own companies that have increased their dividends in each of the past 10 years, for example. That tends to hone the funds in on a subset of companies that are financially stable, so they generally have solid balance sheets. They tend to pay out some of their earnings to shareholders, but they’re also reinvesting in their businesses, so it tends to be a good balance relative to a strategy that’s focused strictly on a high dividend in absolute terms. Some of the high-dividend payers tend to be not very rapidly growing companies. These companies, the dividend growth firms tend to be more balanced.
Steve Pomeranz: Now, we may talk about individual stocks here, but we’re not recommending anything. If you take a company like Apple, let’s say, as they’ve grown throughout the years, they first established a dividend, and then they increased their dividends as their earnings have grown. Warren Buffett has likened this to buying a bond with a rising coupon. You know how you buy a bond and you have this fixed interest rate with, that’s called a coupon, and year in and year out you get your X percent. When you buy a stock that raises their dividend over time, you get a raise every year, which is a very good way to keep up with inflation. Instead of picking one stock, you can pick mutual funds or ETFs that have this kind of strategy in a diversified way, right?
Christine Benz: Right. It’s a way to protect against inflation. I would take pains to say I would not use a fund like this necessarily as a bond substitute because the volatility profile, even though they tend to be low volatility stock funds, the volatility profile will still be a lot higher than what you’ll earn from bonds. My bias would be to not use a fund like this to supplant fixed income exposure, but I think it can be a nice way to stabilize the equity portion of your portfolio, add to your portfolio’s inflation protection. There are a lot of attractions with a strategy like this. If people focus on a mutual fund, I would say one key thing to keep in mind is keep the expenses really low. The good news is is that there are some good index-tracking products, low-cost products that help ensure that a higher share of the return flows through to shareholders.
Steve Pomeranz: Well, I love that caveat because I didn’t mean to imply that this was anything like a bond. What I would say, though, is that over the years, if you just follow the dividend, you’ll notice that the payout of the dividend does increase over time. So, think of it as an income thing.
Christine Benz: You’re absolutely right that, with some sort of a bond with a fixed payout attached to it, over time, you will get eaten alive by inflation, whereas, dividend growth strategies do hedge against it somewhat.
Steve Pomeranz: Yeah. One other thing, when you buy a bond you have a contract with the borrower that they’re going to pay you back your principal X number of years later. Let’s say, it’s 10 years. Well, I mean, if I invest $100,000 and 10 years from now I’m going to get $100,000, what is the value of that $100,000 in 10 years? It’s not really worth $100,000 in real terms, and you’ve been getting the fixed interest rate all along. With stocks, over time, they generally do go up, and so you may get more or less than your $100,000 at the end of the term. I’m caveating our way through this stuff here. It’s important for people to understand the difference. When you take a look at these growth, these dividend growth funds, there are some characteristics. You mentioned that the companies within these funds have generally better or very good balance sheets because if they’re earning a dollar, they’re maybe paying out 30 cents or 40 cents of that to the shareholder, and they’re keeping the rest to reinvest, right?
Christine Benz: That’s right. It tends to give them a nice sense of discipline in that they need to make those payments to shareholders, but it also gives them some funds that they can reinvest in the businesses. Generally speaking, this group of dividend-growth companies is a higher-quality subset than the broad market, which in volatile times, I think there’s a lot to be said for that type of business.
Steve Pomeranz: One of the downsides, however, is they’re basically going to focus on companies that have a long operating history. Now, that’s a good thing. But, you may miss out on some of the really big winners, the Facebooks of the world, and some of these new growth companies, the Amazons of the world because they’re not going to put those in the portfolio until much later, until they’ve matured. In a market like we’ve seen of late, a lot of the stock market has been driven by these kinds of companies. Generally speaking, dividend growth funds may not have them in the portfolio.
Christine Benz: That’s very true. Even though dividend payments are now more spread around sectors, so you’ve got more technology firms paying dividends than was the case say 20 years ago because most of these funds are looking for a history of dividend growth; the newer flashier companies won’t tend to make it into the portfolio. For investors who truly want that sort of diversified exposure, they may want to add some additional growth fund or maybe just use a total market index, which would encompass exposure to some of those companies.
Steve Pomeranz: The one characteristic of these funds, and we’re talking in general, is they tend to do better in bad markets. They tend to outperform the market. When the market goes down X, these tend to go down X minus some number, right?
Christine Benz: That’s right. Looking back over the last really significant market drop, back in 2008, these funds generally did hold up better than the broad market. So I think that that’s another reason to consider them, especially if we’re concerned that volatility could be somewhat persistent over the next couple of years.
Steve Pomeranz: Okay, so we got a good idea about these dividend-growth funds. You can go to morningstar.com, and they have some recommendations for you to look at and to understand. You can actually look at the, once you sign in, you can take a look at the fund in tremendous detail, but very well organized, very easy to understand once you get used to the graphs and so on and so forth. Morningstar’s been doing this for a long time. I can tell you, as a financial advisor, I’ve used them for, I don’t know, 30 years, I don’t know. A long time, Christine.
Christine Benz: Me too.
Steve Pomeranz: All right, let’s change the topic here because you wrote an article that states, “Retirement planning is complicated, but your retirement portfolio shouldn’t be.” You do state that what is most central to you is that the money aspect of retirement is linked with crucial life issues, achieving your dreams and travel, helping children. Why don’t you just take us through that a little bit. What does money mean in the context of which you wrote?
Christine Benz: Well, it’s really important to understand that people’s retirement, the financial aspect of retirement, is inextricably linked to those life goals, and those goals depend on having solid financial resources. I’ve really tried to focus on how people can get to those goals, but also in retirement, simplify their plans a little bit so that they can focus on things that they enjoy and that add meaning for them.
Steve Pomeranz: Yeah. Simplifying is, I think, a good place to start. So therefore, if your portfolio is relatively simple, you can concentrate on more important things like the withdrawal rate, you can look at outside the portfolio, you can start to look at your insurance coverage, make sure you have the right amount of insurance, not too much, and so on. You can look at taxes, and you could make sure that you’re paying attention to fees, all of these important things that keep a portfolio healthy, and then keep your retirement healthy as well.
Christine Benz: Exactly, exactly. Social security claiming decisions, there are a lot of moving parts when it comes to coming up with your in-retirement draw-down plan.
Steve Pomeranz: So number one, you recommend streamline your accounts. What do you mean by that?
Christine Benz: Well, I think one key thing to think about, as retirement draws close, is to think about trying to consolidate the number of accounts that you’re bringing into retirement. So necessarily, most of us will have more than one account in retirement because we have different tax silos. We might have traditional tax-deferred accounts, Roth accounts, maybe taxable brokerage accounts. There’s only so much consolidation you can do. Within each of those silos, I think it does make sense to try to collapse accounts together.
A great example would be, say you have several IRAs, tax-deferred, as well as your company retirement plan. Think about merging those into one large account. It’ll make it easier for you to see what you have. It’ll make it easier for you to figure out how much to take out of those accounts, especially when required minimum distributions come due. Do what you can to try to reduce the number of accounts. Many people have multiple taxable accounts, so it’s not uncommon for folks to have maybe a small brokerage account where maybe they play around with individual stocks as well as other accounts. See if you can’t consolidate with providers and within accounts.
Steve Pomeranz: Wonderful advice. My guest, Christine Benz, Morningstar Director of Personal Finance, and a frequent guest on our show. Thank you for sharing your thoughts with us, Christine.
Christine Benz: Thank you, Steve. It was great to be here.
Steve Pomeranz: Okay, thank you.
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