(PUB) Vanguard Advisor

In contrast, when contributing to a Roth IRA, you invest with after-tax dol- larsnowandcanwithdrawfunds tax-free after the ageof 59½or if youmeet other IRS qualifications (for instance, if the distributionswill be used for a first-time home purchase—something today’s kid might appreciate tomorrow—or to help with a disability). Once you do hit retirement, there is no requirement on distributions—if you don’t feel like tak- ingmoney out or don’t need it, you can leave it in there to continue growing. Why do I continue to preach the benefits of IRAs as great starter invest- ments for teenagers or young adults? Simple: Taxes and the power of com- pounding. If your child is onlyworking for the summer, or just starting their professional career, they will likely be in one of the lowest tax brackets, mak- ing it a fantastic deal to pay taxes on their retirement savingsnowasopposed to when they are older and in a higher bracket. And, in this economy, many first-time jobs don’t come with 401(k) retirement plans attached, so there’s no other availablevehicle for forced retire- ment saving. Plus, for most, an IRA gives you more flexibility over where

Roth IRAsAgeWell

$1,000 AYear $1,000 $24,673 $225,508 $417,822

$2,000 AYear $2,000 $49,345 $451,016 $835,645

$3,000 AYear $3,000 $74,018 $676,524 $1,253,467

$4,000 AYear $4,000 $98,690 $902,032 $1,671,289

$5,500 AYear $5,500

Gradual Increase

Age

15 30 60 70

$1,000 $37,284 $612,935 $1,174,517

$135,699 $1,240,295 $2,298,023

Assumesa6%annual rateof return.

year. While this may not seem like an impressive amount, with each pass- ing year that earnings potential grows even higher, so long as the investment prospers. If you start actively investing a set amount each year, adding to the amount generated by what the invest- ment earns on its own, you create even larger potential earnings. In the tableabove, I set up several dif- ferent savings scenarios for illustration. All of them assume a 6% annual return, with thedifference in scenariosbeing the amount contributed per year, increasing in increments from$1,000 to$5,500 (the maximum currently allowed under IRS rules for investors age 49 and younger for 2014) from the age of 15 to70. Finally, the sixth scenario attempts to show a conservative, natural pro-

and how to invest. 401(k)s often have few, and sub-par, investment choices. The power of compounding is what really makes any kind of tax-deferred investment a superb bargain. The defi- nition of compounding is “the act of generatingearnings frompreviousearn- ings.” Confused? Here’s an example: Let’s say you make a $100 investment in a fund that rises 20% in a year.After that year, you’d have $120. Instead of selling your shares, you let them ride, and the fund gains another 20% the next year, bringing your investment value up to $144. That’s an additional $4 in gains over the first year (or 4% on the original $100 investment) gener- ated because you gained 20% not only on your original investment, but also 20% on all the gains earned in the first

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wouldn’t buy it blindly. I would turn a very specific eye toward names that fitwhatwe do.

Generally speaking, a good percentage of the portfolio is in a net-cash position, where cash exceeds debt. The cash positions relative to debt and relative to equity are very high. That is important tome; it is a very important source of safety or comfort or buffer. The risk, as always, iswhat the companywill dowith the cash. I used getworried if cash got too high, because thatwould tend to lead to aggressive behavior, typically inM&A [mergers and acquisitions]. I don’t think that’s a risk in this portfolio, as the trend inM&A seems to have slowed downmeaningfully. So I’m not uncomfortable that the cash is burning a hole inmanagements’ pockets at themoment. The presence of big net-cash positions is a really important factor inwhatwe own. Let’sgoa littlemoremacro.What’s your viewofwhat’shappen- ingoverseas, andhowdoes that impact thecompanies in the portfoliowhichhave largeexposure tonon-U.S. economies? We calculated this before, and on average you had something over 50% of operating profits outside theU.S., whether it’s in developedmar- kets like Europe andAsia, or emergingmarkets—China and so on. So, it’s a global portfolio from that perspective. How am I thinking about theworld right now? I’ll take a step back. I’m still pretty cautious, largely because I think the strength of themarket has reflected these global liquidity injections by central banks, whether in theU.S. or Europe or Japan. Themarket hasperformedwell inexcessofwhat theunderlying funda-

Other thanBGGroup, youdon’t haveenergy in your topholdings. Typically, we tend to look at the very large integrated oil companies— that’s the pondwe are fishing in. What’s attractive? First of all, you have had a several-year period of poor price performance in both an absolute and a relative sense. The big- ger integrated oil companies tend to spend a lot ofmoney, and it sort of makes itsway through the python, and once it comes out of the python, you get free cash. BGGroup is sort of at that point—you’ve got new managementwhomwe think very highly of, and on two big projects they are sort of turning the corner. I see ameaningful inflection point in free cash flow, and for them thatmeans dividend growth. Youwant to find those ideaswhere this enormous amount of spending is starting to ebb and you are going to start to see the resultant produc- tion growth and free cash flow. But you’ve got to be verymindful of the individual names, because thiswon’t be true for everybody. You’ve got a lot of heavy spending in the industry right now, and in some cases and in some companies, that spending is starting to slow down. That iswhen you play the dividend-growth game.

What’s thecash level onyourcompanies, anddoeshighcashactu- allymake thesecompaniessafer insome respects thanTreasurys?

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The Independent Adviser for Vanguard Investors • April 2014 • 13

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