Forget About CD’s: Here’s How to Profit from Risk

by Dennis Miller | May 2, 2013 12:23 pm

Live off the interest, and never touch the principal. Today’s retirees had this drummed into their minds long ago. It is, after all, a laudable goal, and something every retiree and person approaching retirement should aspire to. But how in the heck are we supposed to do it?

A friend recently told me he rolled over a five-year CD paying 1.2% because his banker said it was a good rate. Ah! I nearly fell out of my chair when I heard that. A 1.2% interest rate won’t even keep up with inflation, let alone allow someone to live off the interest. He may think he’s investing conservatively by keeping his money in FDIC-insured CDs, but his buying power is quickly slipping through his fingers.

So, what interest rate does it take? About 12%, that’s all. According to over 3,000 readers of my regular weekly column, our cost of living has risen about 8% in the last year. If that number is anywhere close to accurate — and I’m inclined to believe it is — our portfolios need to earn 8% to cover rising costs and 4% to supplement those measly Social Security checks.

My CD-investing friend is taking the biggest risk of all: ignoring the reality of the times we live in. Maybe he’s too paralyzed by fear to step away from the familiar. Maybe he doesn’t know where to find better options. And maybe he’s like so many of us who just want to bury our heads in the sand. Doing nothing, however, is a decision, and a particularly poor one during times of high inflation.

I advised my friend to start doing his homework. He can still take a conservative approach to his overall portfolio, but he should also consider putting up to 10% of it into a mix of speculative investments. Retirees certainly shouldn’t go overboard and risk more than that, but he won’t be wiped out if something goes wrong with a small portion of his nest egg. In reality, he’s already taking a much bigger risk without the chance of reward that speculative investments offer.

So where should we put our 10%?

First, do not put it all into one company. Slice it up into smaller pieces; the exact number varies according to the size of your portfolio and your personal risk tolerance. Then, pinpoint a few well-researched speculative investments, and get your toes wet. There are many specialty, sector-focused newsletters out there to help.

One newsletter I subscribe to focuses on the extraordinary profit potential in the technology sector. Many of the investments it recommends have one of two outcomes: investors see windfall gains, or they lose a little money. I’m excited about one recommendation in particular, a small pharmaceutical company that’s developing cutting-edge medical tests. Companies like this one function as research and development for the whole industry. Once the tests receive FDA approval, they will likely be purchased by a much larger company, and investors may see life-changing profits.

But before you start decorating your new beach house, remember, we must do our homework. High-quality newsletters have several pages of research explaining each of their recommendations. Read them carefully and be very selective.

And start slowly. Limit any one investment to no more than 5% of your portfolio. If it gains 50%, that’s a 2.5% gain for your entire portfolio. If it doubles, that’s a 5% gain. That takes a lot of pressure off the other 95%, and puts you a few steps closer to truly living off the interest.

Also, read the updates and constantly monitor your positions. Yes, retirees must take risks, but only educated and extensively researched risks with a small portion of your nest egg.

One final tip: mutual funds and exchange-traded funds stress diversification. That works for the low-risk portion of your portfolio, but their spreadsheet analyses won’t do the trick for speculative investing. I prefer to invest my speculation capital strategically, where I have a thorough understanding of the company, product, industry, and profit potential.

So how do you get from where you are today to where you need to be?

A good way to start is to build a portfolio based on dividend income. Speculative stocks are great (and fun if they’re giving you good returns), but the core of your portfolio needs to be stocks you can rely on for stability; and a little extra cash through dividend payments is a bonus.

Source URL: https://investorplace.com/2013/05/forget-about-cds-heres-how-to-profit-from-risk/