Technology stocks got off to a rough start this year: by mid-January, the Nasdaq Composite (a tech-heavy index, considered a benchmark for the sector) had fallen 14% from its 52-week high. Many techies have rallied a bit since, but given that the Nasdaq followed an upward trajectory from 2009 through 2015, analysts are wondering if the sector is entering major correction mode in 2016.
No one likes to see the value of his or her portfolio drop, but that’s especially true if you’re retired and staring at a declining balance that’s supposed to get you through the rest of your life. Let’s take a look at whether it’s safe for retirees to take the risk on tech stocks in this market.
Safety in Numbers
You’ve heard it your whole investment life: diversify, diversify, diversify. Well, it’s still true.
"Every investment has risks, but the technology sector can be more volatile relative to other sectors,” says Tom C. W. Lin, a business law professor at Temple University in Philadelphia, who researches financial markets and regulations. “Instead of investing in individual tech stocks, retirees looking to invest in the tech sector should invest in low-cost funds that track the Nasdaq or a basket of tech companies to diversify their holdings.”
Index funds that follow tech stocks are one option for diversifying your tech holdings while minimizing your investment fees (a key factor in determining how high your returns will be). There are also plenty of low-cost exchange-traded funds (ETFs) that track technology stocks. They include:
- Vanguard’s Information Technology ETF, 0.10% expense ratio
- Technology Select Sector SPDR ETF, 0.14% expense ratio
- Fidelity MSCI Information Tech ETF, 0.12% expense ratio
- iShares US Technology, 0.43% expense ratio
Buy ‘Blue Chips’
While index funds and ETFs take much of the guesswork and expense out of investing in tech stocks, you might enjoy the challenge of researching and analyzing individual stocks and the satisfaction that comes from choosing a stock that performs well. You might enjoy it so much that you’re willing to deal with the disappointments and losses of bad picks.
Even if you’re buying individual tech stocks, there are ways to mitigate your risk. "The key is to invest in solid companies," says Alex Barrow, an investment manager at Foundation Investing. “Technology has a stigma attached to it from the Y2K bubble and subsequent crash. Many investors still consider all technology to be risky. But this isn't true. Many of the companies that survived the tech bubble are now some of the best in the market.”
An example he cites are the FANG stocks: Facebook, Amazon, Netflix and Google (now officially known as Alphabet). He says these stocks, which represent the industry giants, have strong cash flows backed by substantial operations and a growing market – exemplars of what retirees should choose. (For related reading, see Will "FANG" Stocks Outperform in 2016?).
A drawback of investing in individual stocks is that you’ll pay a commission each time you buy or sell. If you’re buying and holding, this expense won’t significantly lower your returns, but if you’re trading frequently, keep a close eye on your costs to make sure these constant little broker's cuts aren’t cutting too much into your returns.
Make a Covered Call
If you’re an experienced investor who is comfortable with a more advanced investment strategy than purchasing funds or equities, covered calls are an option (literally). A covered call is an options-trading strategy: It entails holding a long position in a stock, while selling a call option on that same stock to try to earn income (see The Basics of Covered Calls for details).
More specifically, the best way for retirees to invest in the technology sector is through a disciplined "in the money" covered call approach, maintains Mike Scanlin, CEO of Born to Sell, a covered call screener and covered call portfolio management tool. Basically, this means the option's exercise price, or strike price, is below the market price of the underlying asset. When executed properly, "covered calls have better returns with lower risk than a buy and hold stock strategy," he claims. Learn more in An Alternative Covered Call Options Trading Strategy.
"Start with a diversified portfolio of blue-chip, dividend-paying, large-cap stocks like the ones in the Dow 30, such as Apple," Scanlin advises. With an average dividend yield of 3% and another 7% from weekly in-the-money covered calls, Scanlin says it’s possible to earn 10% per year and to turn a profit, even when the underlying stock drops.
As with investing in individual stocks, you’ll need to be mindful of your trading costs.
The Bottom Line
No one knows how the tech sector will perform in 2016. But in the grand scheme of investing things, tech stocks are volatile creatures. "Retirees looking for more steady growth in their investments should generally invest in low-cost index funds that track the S&P 500 or the broader stock market for the long term,” Lin says.
That being said, not all tech equities are created equal. The degree of volatility depends on which companies you’re examining. Whether you can afford to take the risk of investing in tech stocks during retirement depends in part on how you’re investing in them: Are you buying individual shares of GoPro Inc. (GPRO) and hoping to turn a quick profit, or are you holding a tech stock ETF long-term?
It also depends on what your overall investment strategy looks like. If you’re well-diversified and only a small percentage of your portfolio is made up of tech stocks, you won’t be forced to sell them when they’re down to get the income you need for your daily expenses. You can avoid taking a loss and hang on to these investments until the time is right to sell at a profit.
Overall, it's probably best to stick with the big boys: more mature companies that have been posting profits, and offering dividends, for a while. “Retirees should avoid companies with no cash flows and/or profits,” Barrow says. “These are the dangerous tech stocks whose share prices get killed in bear markets. Promises of growth may propel prices in bull markets, but not bear markets.”