Business

Retirees: The Risks, Dangers And Advantages Of Reaching For Yield [Part 2B]

Retirees: The Risks, Dangers And Advantages Of Reaching For Yield: Part 2B by Chuck Carnevale, F.A.S.T. Graphs

Introduction

There is an undeniable fact that differentiates investing when in retirement versus investing while you are still working.  When you are employed, you are working for your money.  However, once a person truly enters their retirement years, the situation reverses itself.  When in retirement you begin the stage in your life where your money must work for you.  In my opinion, this changes the investing dynamic considerably.

This change in the individual’s investing dynamic primarily relates to suitability.  When a person is younger and earning a paycheck, it can make sense to employ more aggressive growth-oriented investing strategies.  Both time, and ideally, a steady paycheck are working in your favor.  If you make investing mistakes along the way, as most everyone does, you have the luxury of time and fresh capital coming in to bail you out.

In contrast, when a person matures and enters their retirement years, the capital they have accumulated is logically more precious.  Consequently, preservation of the capital that you have spent a lifetime accumulating often does, and should, take precedence over making more.  This often reminds me of a couple of relevant quotes attributed to Will Rogers where he said: “I am not so much concerned with the return on capital as I am with the return of capital.”  And perhaps more apt to the thesis of this article: “Live your life so that whenever you lose, you’re ahead.”

At this point I want to clarify what I speaking about.  I am not simply suggesting that age in its own right should automatically change your investing dynamic.  In other words, I am not suggesting that a person automatically loses their edge or acumen simply because they have become older.  The central issue is time – not advanced age.  One of the most important benefits with investing is time in the investment.  Compounding is a powerful investment attribute; however, it is an attribute that functions best over long periods of time.

In the same vein, I am not a fan of the adage “I don’t buy green bananas anymore” that many mature investors often declare.  Stated more directly, I am not suggesting that retired investors should avoid taking any risk with their investment portfolios.  Frankly, all investing entails a certain amount of risk.  Therefore, avoiding all risk is literally impossible.  On the other hand, I am a believer in taking only calculated and thoroughly reasoned risks that are commensurate with your financial situation or status.

In other words, no investor, whether retired or still earning a paycheck, can avoid all risks.  However, they can to a great extent mitigate the risk they are taking by clearly understanding what they are, where they come from and how they can be controlled.  At the end of the day, and as it relates to all investing, there is no substitute for comprehensive research and due diligence.  Knowledge is power for every investor in every stage of their life.

To summarize, it is often okay and even appropriate for retired investors to assume a certain amount of risk.  However, it’s critically important that the risk taken is clearly understood, and even more importantly, continuously monitored.  Perhaps there is no area of investing where these principles more appropriately apply than in the high-yield investing arena.  Therefore, this article is offered to reveal and articulate the risks, dangers and advantages of reaching for yield.

Common Sense and Reaching For Yield

It is no secret to anyone that interest rates are near all-time lows.  As an alleged attempt to stimulate growth, the United States has implemented a zero interest rate policy (ZIRP).  In part 1 of this series found here I laid out the current yields on Treasury bonds from 6-month bonds up to 30-year bonds.

Almost unbelievably, a 30-year Treasury bond currently only yields a little over 2.9%, let’s call it 3% for expediency.  As I did in the above article, and will do it again now, knowing the yield currently available from the lowest risk fixed income investments should serve as a common sense and most conservative benchmark for the yields you can expect on your investments.

Consequently, when evaluating the yields available on any theoretically riskier classes of investments, the 3% available on riskless investments should serve as a guide.  In other words, when you come across any investments with yields above 3%, you should automatically recognize that there is greater risk involved.  In that context, the higher the yields are that you come across, it only logically follows that the risk taken to achieve them must become proportionately greater.  When the yields get extremely high, you should immediately recognize that the risks become extreme.

In part 2A of this series found here I also presented a broad review of the current yields available from what I consider 4 primary categories of quality dividend growth stocks.  Those yields generally ranged from a low of 1.1% to a high in the 7% range.  However, there were a few outliers above that in the REIT category.  Therefore, we have a perspective of what level of yield we can reasonably expect from riskless Treasury bonds and relatively high-quality dividend paying stocks.  My point being that anything significantly above that should automatically raise red flags.

Aggressive High-Yield Investments: Are They Suitable For Retirement Plans?

Just as I did with presenting the 4 categories of quality dividend growth stocks in part 2A of this series, I offer the following listings of the most prominent categories of extremely high yielding investments.  However, there is a material difference between what I’m offering here and what I offered in the previous installment.  With the quality dividend growth stocks, I screened the overall universe and only presented companies that I considered fairly valued or close to it.  With these more aggressive investments, I am simply listing the most prominent that I was able to find.

Therefore, I want it to be crystal clear that I am not recommending any of the stocks on the following lists.  Instead, I am simply offering a listing of what is available in high-yield investments.  Frankly, as a stickler for only investing in stocks when they are fairly valued, I will readily admit that I find it difficult if not impossible to value most of the entities listed below.  There are reasons for that which I will elaborate on as I discuss each category.

However, this also leads me to state that in the general sense, one of the great disadvantages of investing in the most aggressive high-yield entities lies in the complexity of analyzing them.  Consequently, and based on what I submitted in the introduction to this article, as a general rule I do not consider most of the following entities suitable for retirement accounts.

Of course, there are exceptions to every rule.  Therefore, I am not emphatically stating that retired investors should never invest in any of the following entities.  On the other hand, I do believe that they should only be invested in based on comprehensive due diligence and/or a clear understanding of the characteristics they possess, especially those relating to risk.

Aggressive Yield: BDCs and MLPs

For efficiency’s sake, I have grouped business development companies (BDCs) and master