3 Investing Mistakes Retirees Must Avoid At All Costs

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Senior Hispanic man reading financial newspaper
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For five years now, retirees have suffered from rock-bottom interest rates that have dramatically reduced the income they could earn from safe investments like bank CDs. Combined with below-average increases in monthly Social Security checks in recent years, the pressure of falling investment income has made it difficult for many retirees to make ends meet.

As a result, many retirees have shifted into dividend-paying stocks as an alternative to fixed-income investments. But in doing so, though, they've added substantial risk to their portfolios and left themselves open to questionable strategies that could produce massive losses if things go wrong.

Let's take a look at three of the biggest mistakes retirees must avoid in using dividend stocks to generate income.

Mistake 1: Indiscriminately Picking the Highest-Yielding Stocks

When you're hungry for income, there's nothing more appetizing than a high current yield. Even with bank account interest rates as low as they are, you can find several dividend-paying investments that offer yields above 10 percent. For retirees who got used to the 5 percent to 6 percent rates that used to be common on CDs, finding double-digit yields can seem well worth taking on some risk.

What many investors don't realize, though, is that just how great their danger is. For instance, mortgage REITs Annaly Capital (NLY) and American Capital Agency (AGNC) earn their high yields by using vast amounts of leverage to maximize income from much lower-yielding bond investments that they hold. As fears about rising interest rates have hit the market, both of these mortgage REITs have cut their dividends and seen their share prices decline. Moreover, rural telecom company Windstream (WIN) recently paid a 12 percent yield, but it produces far less in earnings than it pays out in dividends. That raises questions about whether the company will be able to sustain its payouts, especially as competitors in the industry have had to cut their own dividends in recent years.

Mistake 2: Overpaying for Stability.

At the other end of the spectrum, many retirees feel more comfortable buying blue-chip stocks that pay more modest -- but still attractive -- dividends. Companies like Procter & Gamble (PG) and Coca-Cola (KO) are household names that have been in existence for decades, and retirees in particular feel comfortable with their longevity and their yields in the 3 percent range.

But demand for dividend stocks has been so high that many of the most popular dividend stocks have seen their valuations get expensive. Both P&G and Coca-Cola have share prices that are more than 20 times what they earned over the past 12 months, a level that's fairly high compared to past valuations.

Before you just buy a familiar name, check the P/E ratio and other related data make sure you're not overpaying for the stock, or else you could be in for some ugly losses the next time the stock market stops feeling exuberant.

Mistake 3: Ignoring Companies' Lack of Growth Potential

One threat retirees understand is that rising rates can hurt the value of long-term bonds. But what they don't realize is that many dividend stocks are tied to the same forces that affect long-term bond values. In particular, those companies that don't have strong growth prospects tend to trade much like bonds, falling in value when rates rise.

To avoid that phenomenon, you need to look beyond dividends to identify stocks that also have future growth potential. Public Storage (PSA), for instance, pays a yield above 3 percent based on the income it generates from its self-storage units. But it has also seen earnings grow substantially as demand for space has grown. That combination gives dividend investors two ways to profit.

Be Smart About Dividend Stocks

Retirees can use dividend stocks to help them bridge their income gap and get the money they need for their everyday living expenses. But you have to avoid these big mistakes in order to protect yourself from the lifelong financial damage that can result from bad choices.



You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. He doesn't own shares of the stocks mentioned in this article. The Motley Fool recommends Coca-Cola and Procter & Gamble. The Motley Fool owns shares of Coca-Cola.

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18 Comments

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m_salah48

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November 26 2013 at 6:00 AM Report abuse rate up rate down Reply
vlady1000

If you are thinking of do some "Handyman" work. Might want to think about owning some rentals then. Make more, inflation protected and steady income.

November 16 2013 at 11:29 PM Report abuse rate up rate down Reply
willypfistergash

4) Don\'t vote for liberal democrats.

November 14 2013 at 11:53 PM Report abuse rate up rate down Reply
SPQR

If you walk a dog you will make more than any bank on the planet will pay you for 500k invested

November 14 2013 at 12:20 AM Report abuse +3 rate up rate down Reply
betty_brock

Dems have stolen money from your paycheck your entire working life. What your employer paid in IS YOUR MONEY, TOO. You will never get it all back. Your grandkids will pay and NEVER COLLECT.

November 13 2013 at 8:31 PM Report abuse +3 rate up rate down Reply
toosmart4u

You will have social security and medicare during your retirement. Oh yea, if you are on both of these fine programs thank a democrat, if you want to end these 2 fine programs vote republican. Semper Fi.

November 13 2013 at 6:12 PM Report abuse -1 rate up rate down Reply
2 replies to toosmart4u's comment
betty_brock

Can you guarantee that?
The U.S. government can't.

November 13 2013 at 8:30 PM Report abuse +1 rate up rate down Reply
willypfistergash

not according to their respective trusts.

November 14 2013 at 11:51 PM Report abuse rate up rate down Reply
1 reply to willypfistergash's comment
hgeorgech

take the cap of of SS (all income subject to it) and the life span of SS will extend to 2060-65 without raising % of withholding ...

November 17 2013 at 5:42 AM Report abuse +1 rate up rate down
mauigarycia.gary

Aloha
Thank you for all the good info. I am thinking about doing my own investing. I have about $500,000 invested with brokers. I think the class structure you have available will help make that decision. I'm 70 and can't afford to loose it. Mahalo Gary

November 13 2013 at 3:26 PM Report abuse +1 rate up rate down Reply
4 replies to mauigarycia.gary's comment
yolobster

Indexes are at an all time high. Many people need to grow their money but don’t want to loose the gains they have made in the last five years. There is no guarantees against stock or mutual fund loss and a market correction may just be around the corner. For investors that don’t want to loose hard earned money, there is a credible solution that offers safety, higher yields than a bank CD and amazing tax differed growth potential. Email me for your free information guide.

November 13 2013 at 2:47 PM Report abuse rate up rate down Reply
ilsek1357

I like AOL

November 13 2013 at 12:47 PM Report abuse +1 rate up rate down Reply
1 reply to ilsek1357's comment
SPQR

AOL was fun at one time. It is now a piece of crap

November 14 2013 at 12:19 AM Report abuse -1 rate up rate down Reply
1 reply to SPQR's comment
hgeorgech

realistically, what's the alternative? be honest

November 17 2013 at 5:38 AM Report abuse rate up rate down