The Independent Adviser for Vanguard Investors
•
April 2014
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13
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wouldn’t buy it blindly. I would turn a very specific eye toward names
that fitwhatwe do.
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?
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-
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
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
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-
Roth IRAsAgeWell
Age
$1,000
AYear
$2,000
AYear
$3,000
AYear
$4,000
AYear
$5,500
AYear
Gradual
Increase
15
$1,000
$2,000
$3,000
$4,000
$5,500
$1,000
30
$24,673
$49,345
$74,018
$98,690
$135,699
$37,284
60
$225,508
$451,016
$676,524
$902,032
$1,240,295
$612,935
70
$417,822
$835,645
$1,253,467
$1,671,289
$2,298,023
$1,174,517
Assumesa6%annual rateof return.
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