Investors nearing retirement have different needs than investors with many years remaining in the workforce. Retiring means losing the regular paycheck from work, and as a result, replacing that income is a key consideration. There are many investments that appeal to retirement investors, such as purchasing quality dividend stocks like the Dividend Aristocrats. But there are also many investments that retirement investors should stay away from. Retirement investors should avoid the following 16 investments.
“Cash is king” is a well-known phrase, but when it comes to retirement investing, cash is hardly king. Cash should be avoided by retirement investors because it earns no return. In stark contrast to bonds which pay interest or stocks that pay dividends, cash earns no interest. As a result, cash loses value over time due to the steady erosion of inflation.
While retirees have a number of pressing challenges to pay for expenses without a paycheck from working, keeping a great deal of cash on the sidelines is not the best idea. Ideally, retirees can generate enough income from their investments, in combination with other sources of income such as Social Security so that they do not need to hold a large amount in cash.
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#2: High-Yield Bonds
Sometimes referred to as junk bonds, high yield bonds are fixed income securities issued by companies with sub-investment grade credit ratings.
With interest rates still near historic lows, fixed-income yields have plunged over the past several years. As an example, the 10-year Treasury yields just 1.3% right now. With inflation running significantly above this level, retirees will see their purchasing power erode with low-yielding bonds.
Because of this, high yield bonds are appealing due to their higher yields. But investors may be reaching for significantly elevated risk in their search for yield. Bonds with below-investment grade credit ratings have a higher likelihood of default.
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Cryptocurrencies like bitcoin are all the rage these days. The massive rise in the value of bitcoin and other cryptocurrencies over the past few years is enticing for any investor. And cryptocurrency gets a lot of coverage in the financial media.
But retirees need to remember that volatility is a two-way street. The price of bitcoin has declined by nearly 50% from its 52-week high, a reminder that any investment can lose value. Bitcoin also does not pay interest or dividends, meaning investors will not generate income from their investment. And another reason retirees should avoid Bitcoin is simply the higher level of risk involved in buying cryptocurrencies, not to mention the tax implications.
#4: Oil & Gas Royalty Trusts
Oil and gas royalty trusts are niche securities within the stock market. These are companies that own oil and gas-producing properties. Investors receive distributions depending on how much income the trusts generate from these properties. Some well-known oil and gas royalty trusts include BP Prudhoe Bay Royalty Trust (BPH) and Permian Basin Royalty Trust (PBT).
As with any group, not all royalty trusts are bad investments. But the risks are high across the board—royalty trusts are essentially a bet on underlying commodity prices. Investors also have to face the prospect that reserves will decline faster than the trust had originally anticipated.
If oil and gas prices fall, share prices of the royalty trusts collapse, and their distributions decline, often to zero as occurred in 2020 during the coronavirus pandemic.
#5: Mortgage REITs
Real Estate Investment Trusts, also referred to as REITs, are a great way for retirees to earn higher levels of investment income. Many REITs have strong yields of 4% or more. Retirees might be tempted to buy mortgage REITs, a subset of the asset class that typically offers even higher yields.
Indeed, many REITs have double-digit yields in excess of 10%. But in many cases, sky-high yields are an indication of elevated risks, and mortgage REITs are no different. Mortgage REITs are extremely complex, financially architected business models that are not easy to understand, making them relatively poor choices for most retirees. In addition, mortgage REIT share prices and their dividend payouts can swing wildly based on changes in the yield curve.
Every few years or so, gold gets a lot of attention in the media, usually because the price of gold has risen over a certain period of time. But for retirees interested in generating sustainable income from their investments, gold should be avoided.
Gold pays no dividends or interest, which is why it is not attractive for many retirees. To quote legendary investor Warren Buffett on gold: “The idea of digging something up out of the ground, in South Africa or someplace and then transporting it to the United States and putting it into the ground, in the Federal Reserve of New York, does not strike me as a terrific asset.”
Some gold stocks like Barrick Gold (GOLD) do pay dividends, but their dividend track records are highly inconsistent. Many gold stocks have cut their dividends when precious metals prices decline.
#7: Momentum Stocks
Momentum stocks are those that have captured investors’ attention, most often due to a rapid rise in their share price. This causes other investors to jump in, perhaps because of a fear of missing out, which can push share prices even higher. But in many cases, momentum stocks fall back down to Earth, as their underlying fundamentals may not justify the rallying share price.
Momentum stocks that have gotten a lot of attention in the financial media in recent months include GameStop (GME), AMC (AMC), and more. In all cases, their share prices skyrocketed in a relatively short period of time. But retirees should resist the urge to buy momentum stocks, as they can be highly volatile and almost never pay dividends.
#8: Microcap Stocks
Stocks can be classified according to their market capitalizations, which is simply the current share price multiplied by the number of shares outstanding. Large-cap stocks have market caps above $10 billion, while small-cap stocks have market caps below $2 billion, with midcaps in between these ranges.
The smallest group of stocks is known as microcaps. These are stocks with market caps below $100 million. Microcaps are very small businesses, their stocks generally have low liquidity, and many are in questionable financial condition. As a result, retirees should stick to midcaps and large caps.
#9: Stocks With Too Much Debt
Debt is a big concern for income investors such as retirees. Stocks with bloated balance sheets and too much debt are at high risk of cutting or suspending their dividends during recessions. Profits may decline substantially when the economy enters a downturn, but debt still needs to be repaid.
Stocks with excessive debt have high-interest expenses that may force them to cut their dividends. This is of particular concern when it comes to high-yield Master Limited Partnerships, many of which have leverage ratios above 5x.
#10: Tesla Inc. (TSLA)
Tesla is a blue chip stock on the S&P500 with a market cap above $600 billion. But just because Tesla is a mega-cap, does not imply a higher level of safety. Tesla still struggles with maintaining consistent profitability; the company reported a net loss of $862 million in 2019 and $976 million in 2018.
Tesla generated a profit of $721 million in 2020, but even so, earnings on a per-share basis came to just $0.64 for the year.
With such a low level of profits, Tesla has never paid a dividend and possibly never will. And while shareholders have earned massive returns from owning Tesla, whether retirees should invest today is a different question.
Based on Tesla’s $31 billion in 2020 revenue, the stock trades for a trailing price-to-sales ratio near 20.
#11: Netflix (NFLX)
Netflix is a major tech stock and a streaming giant. The company has grown its revenue at a very high rate over the past decade, as it has come to dominate the streaming industry. And while Netflix is a top growth stock and a beneficiary of the ongoing cord-cutting trend, retirees should avoid it simply due to its high volatility and lack of a dividend.
#12: USA Compression Partners (USAC)
USA Compression Partners is an example of an MLP flashing warning signs that the high distribution may not be sustainable. USAC is one of the largest independent providers of gas compression services to the oil and gas industry, with annual revenues of $668 million in 2020.
The partnership is active in several shale plays throughout the U.S., including the Utica, Marcellus, and Permian Basin. They focus primarily on infrastructure applications, including centralized high-volume natural gas gathering systems and processing facilities.
The company has struggled to recover from the pandemic, which has squeezed its financial position. First-quarter revenue fell 12% year-over-year, while its distribution coverage declined to 1.03x, meaning the current payout is barely covered by distributable cash flow. If DCF declines further, the payout may be reduced.
#13: Great Elm Capital (GECC)
Great Elm Capital is a Business Development Company, otherwise known as a BDC. These stocks are popular among income investors because they generally have very high dividend yields. But many BDCs are highly risky due to their eroding fundamentals and lack of dividend safety.
Great Elm Capital is an example of a BDC that should be avoided. Great Elm Capital is a BDC that specializes in loan and mezzanine, middle-market investments.
Net investment income decreased by 6% in the first quarter, a warning sign as the company can barely afford to maintain the current dividend. Furthermore, it has seen book value erode rapidly since going public in 2016.
While shares currently yield over 12%, investors should be wary of extreme high-yielding BDCs like Great Elm.
#14: GlaxoSmithKline (GSK)
International stocks are a great way for investors to gain diversification by geographic market, but not all international stocks are attractive for income investors.
Retirees should avoid GlaxoSmithKline in particular because the company has had a great deal of difficulty generating growth in recent years. GlaxoSmithKline reaffirmed its expectation that its earnings-per-share will decline by a high single-digit percentage in 2021, due to low expected growth in pharmaceuticals and vaccines.
As a result, the company is likely to have a very high dividend payout ratio, which could jeopardize its ability to maintain the dividend. GSK is relatively unappealing with so many better health care stocks for retirees such as Dividend King Johnson & Johnson (JNJ).
#15: Anheuser-Busch InBev (BUD)
Anheuser-Busch InBev is the largest beer company in the world. The company produces, markets and sells over 500 different beer brands around the world. Major global brands include Budweiser, Stella Artois, and Corona, generating nearly $50 billion in annual revenue.
But retirees typically want stable dividends and steady dividend growth over time, and AB-InBev is not an attractive stock for either. AB-InBev cut its dividend significantly over the past few years in an attempt to fix its balance sheet which had become bloated with debt after multiple huge acquisitions.
The company has stated that deleveraging is a priority for 2021 and beyond until a leverage ratio of 2x is attained, but AB InBev remains far from this goal with a current leverage ratio of 4.8x. With a very low dividend yield near 1% and a low likelihood of dividend growth, retirees should avoid this stock.
#16: Amazon.com (AMZN)
Amazon has been one of the best growth stocks in the entire market over the past decade—but for retirees who might want consistent portfolio income, Amazon is not an appealing stock. Amazon continues to grow its revenue at a high rate, and the company has become profitable.
In the 2021 first quarter, Amazon’s revenue increased 44% to $108.5 billion. Earnings-per-share of $15.79 more than tripled from $5.01 per share in the year-ago quarter. And yet, Amazon does not pay a dividend, as the company needs to reinvest as much cash flow as possible back into the business for growth.
Therefore, retirees could generate dividend income with other tech stocks like Apple (AAPL), Microsoft (MSFT) or Cisco (CSCO).