Thanks to the Fed's zero interest rate policy (ZIRP), baby boomers are facing a much tougher road to retirement than those in the past. While it may seem like an eternity, it was only 10 years ago when you could park your money in a savings account and earn interest of 5%. Retirees who worked hard and saved their money could safely invest their assets in retirement and not have to worry about suffering any losses.
Today is an especially challenging environment for investors who are looking to generate a safe income stream. No Treasury bond will pay a safe 5% return as a 30-year Treasury Bond yields just 2.69%. This is causing a massive gap between what boomers say they want in retirement and what they're doing to make it happen.
A new survey from Blackrock shows that even affluent retirees – those earning more than $250,000 a year – hadn't set aside enough to generate the income they said they needed to meet their retirement expectations.
Unfortunately because of ZIRP, retirees have been forced to chase yield to earn a return that used to be done using risk free instruments. This is a big problem because many unsophisticated investors don't understand the risks that they are taking when choosing higher yielding instruments. Some people just bought higher yielding stocks without regard to the companies' ability to pay dividends in the future and the quality of the overall business. This made Master Limited Partnerships (MLP) a hot choice for retail investors because many paid 7%+ dividends and the stocks were appreciating as well. But many of the MLPs were highly levered companies that were in the oil and gas business. When oil prices crumbled so did the stock prices and many cut dividends significantly or now don't pay a single dime. That 7% yield may have looked attractive two years ago but many retail investors didn't understand the risk and suffered in some cases almost 100% losses on their principal.
Recently I received a question from a reader asking which investment strategy is better: a bond ladder or dividend stocks. These two choices are like comparing apples to oranges. The only similarity is perhaps a similar yield on both strategies for the time being; but that is where the similarities end. A Treasury bond ladder carries zero risk if you hold the bonds to maturity. You will safely earn the coupon payments from each individual bond and you will collect your principal when the bonds mature. On the other hand, a dividend strategy carries significant downside risk if there is another severe bear market like 2008. For example, AT&T which was considered a “safe” dividend stock fell over 40% in 2008.
In the end, you better know what your risks are with any investment that you choose. For those nearing or in retirement, it is even more important because if you suffer a loss, you don't have as much time to recoup the losses.
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“Sinking Boat” by Dave Hamster is licensed under CC BY 2.0
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