As tempting as it may be for retirees to increase their income by reaching for dividend yield, there are dangers on that investment path. But if you’re planning on exposing yourself to greater risk in hopes of generating more retirement income, there are a few strategies you should know.
From October 2007 through March 2009, when the Standard & Poor’s 500 index lost 55 percent of its value, many pre- and post-retirees felt the pain in their retirement savings. The effect was catastrophic for 25 percent of people between ages 56 and 65 and nearing retirement. They had more than 90 percent of their account balances in equities at the end of 2007, according to a study by Employee Benefit Research Institute.
Since then, many have been increasing the risks in their portfolios to recoup their losses.
But for senior investors hitting their 70s, reaching for greater yield often leaves them particularly vulnerable. Studies show that 22 percent of people 71 and older experience mild cognitive impairment. In addition, elder investment fraud and financial exploitation is a “very serious” or “somewhat serious” problem, according to 91 percent of attorneys surveyed by Investor Protection Trust in 2014. Americans older than 60 lost $2.9 billion to financial abuse in 2010, according to a study by MetLife.
When seniors try to rebuild their wealth, they often find the climate has changed significantly from what they’re used to, and their previous experience with the market may be outdated. Here’s what senior investors should know:
There’s an interest-rate risk to dividend investing. Before the Great Recession, many certificates of deposit, money market accounts and short-term treasury bonds were yielding more than 4 percent, says Chris Lewis, accredited investment fiduciary for Lewis Brown in Plano, Texas. High-quality corporate bonds were yielding upward of 5 percent.
Before 2008, building a well-diversified investment portfolio that provided a decent yield and the opportunity for long-term growth was much easier for most retirees.
“Fast-forward to 2015. As we headed into our sixth year of near-zero interest rates, investors who relied on investment income to cover their monthly expenses continued to struggle. Many of today’s retirees had been hit the hardest,” Lewis says.
The Federal Reserve’s first rate hike since the recession may subject yield-seeking investments to unforeseen risk and possible losses. “The most common are interest-rate risk and credit risk,” Lewis says.
When interest rates rise, bond prices tend to fall. The longer the term on the bond, generally, the more risk there will be. “For a quick, approximate calculation, for every 1 percent change in interest rates, a bond’s price will move approximately 1 percent in the opposite direction for every year of duration. For example, a bond with a duration of five years would decrease in value by 5 percent if rates were to rise 1 percent,” Lewis says.
Bonds with 10- or 20-year durations face significantly higher risk.
There’s a credit risk, too. One popular way to reach for yield is by investing in low-quality corporate bonds. A bond that is rated BB by Standard & Poor’s typically will have a considerably higher yield than a bond that is rated AA, but corporate bonds that are rated below BBB are considered non-investment-grade bonds, Lewis says.
“It is important to know that most corporate bonds are not secured by any collateral. Investors of such bonds must assume not only interest-rate risk, but also credit risk. Credit risk is the chance that the corporate issuer will default on its debt obligations. A default on a corporate bond can have a catastrophic impact on the bond’s value,” Lewis says.
Rising interest rates can also signal opportunity, as they are a sign of a strengthening economy. “A properly allocated and diversified portfolio can help reduce the impact of rising rates,” Lewis says.
“With today’s low yields, you need to go beyond traditional sources. Many nontraditional sources of income, such as preferred stocks, can provide meaningful diversification and potentially higher yields,” Lewis says.
Dividends stocks to buy. “You really need to be careful. People who are retired are really put off by volatility,” said Stephen Mauzy, principal of S.P. Mauzy & Associates in Aurora, Colorado.
Yet many investors look for dividend stocks from the S&P 500 with a current dividend yield of more than 3 percent as well as a strong history of consistent, increasing dividend payments, like Cummins (ticker: CMI), with an annual dividend of $3.90 and dividend yield of 4.5 percent. Its dividend has increased 1,100 percent since 2005.
Other good dividend stocks are American Electric Power Co. (AEP), with an annual dividend of $2.24 and a dividend yield of 3.9 percent, and CenturyLink (CTL), with an annual dividend of $2.16 and a dividend yield of 8.5 percent.
Mauzy also likes high-quality real estate investment trusts. “I think a lot of them are value-priced right now. I like Digital Realty Trust (DLR); they’ve held up well over the years. Another is Gladstone Commercial Corp. (GOOD), a small-cap REIT that has never lowered its dividend. It pays monthly, higher yield,” he says.
Focus on stocks that have a history of not cutting dividends when things go badly, and look for high-quality dividend growth with well-branded companies that make things that people consume regularly and that hold up well, like VF Corp. (VFC), Procter & Gamble Co. (PG) and Altria Group (MO), Mauzy says.
Altria, for example, has an annual dividend of $2.26 and dividend yield of 3.9 percent, and has increased dividend payments consistently for 46 years.
Be careful when reaching for yield. “You can’t get yield without having to endure some price volatility,” Mauzy says.
To take some of the volatility out of your portfolio, look into inverse exchange-traded funds, such as Proshares UltraShort S&P 500 (SDS) and Proshares UltraShort QQQ (QID). “You’re basically taking a short position in the market to offset your long portfolio … because when markets start to tank, correlations of most asset classes converge to one, which means everything goes down,” Mauzy says.
When interest rates are higher, the product selection for? chasing yield becomes a bit broader, but still doesn’t always offer the ?desired income, says Richard Zeitz, president of Bravias Financial in East Brunswick, New Jersey. “One asset class I look to for my clients’ portfolios is a fixed indexed annuity.”
The advantage they can offer clients is a much higher return compared with treasuries, fixed annuities, CDs and bonds, and they also have the ability to offer guaranteed, consistent income streams. They favor older investors because “the income is based on mortality credits; therefore the older the investor, typically the higher the payout,” Zeitz says.
Newer FIAs on the market today offer incentives that can range up to 10 percent for new money, income doublers for medical or long-term care expenses, and long-term returns over time that can be 5 or 6 percent.
“There are a lot of insurance companies that offer FIAs, and some are definitely better than others, so you need to get educated,” Zeitz says
Although they might sound like a good place to rest your whole retirement, Zeitz warns that “FIAs should not be a ?place where clients put all of their money — mainly due to their illiquid ?nature,” Zeitz says.
The Financial Industry Regulatory Authority has warned that it can be confusing to calculate the correct gain in the index linked to annuities because firms use several different indexing methods to calculate gains, which makes it difficult for investors to compare.
Also, if the index linked to your annuity declines, you can lose money on your investment. You also want to ask about their fees and expenses, and early surrender fees and penalties. You can also check to see if the person selling an indexed annuity is registered with FINRA.
Real estate-based partnerships. For those who really don’t trust the market, another option could be to form real estate-based partnerships, in which 20 or 30 people invest in a piece of commercial real estate, says Salvatore M. Buscemi, managing director of ?Dandrew Partners in? New York. “I would find a real estate attorney locally in town, and I would ask him if there any deals, partnerships that are being put together where people are investing in what we call stabilized commercial real estate, not value added.”
Some critics shy away from such partnerships because there is little protection for investors. And although all of these investments carry risks, value-added projects carry even more risk. Since it’s a form of crowdfunding, you will want to do your research and make sure you are investing in a developer with a good track record.
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Tips for Successful Senior Investing originally appeared on usnews.com
