You’re in your 50s and retirement looks closer every day. You’re now worried that you haven't saved enough for retirement, causing you to rethink your investment strategy.
While you might feel panicked, don’t worsen the situation by making some common investment mistakes.
"As we approach investing in our middle years, we should be more cautious with our decisions because we do not have the luxury of time that people in their twenties have in terms of making up their losses," said Leslie Bocskor, an experienced investment banker and member of the ArcView Angel Investing Network. "Therefore, investing in riskier asset classes is inadvisable for those that don’t have a wealth of experience across sectors."
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How to Spot a Bad Investment Strategy
Often, what looks like a bad investment strategy really indicates that the portfolio holds too many risky or illiquid assets — commodities, leveraged exchange-traded funds (ETFs), limited partnerships.
The Problem With Illiquid Investments
Locking money up for a long time period — more than 10 years — is a bad idea because it reduces access to an investment and increases risk, according to many financial advisors. Shorter time frames are most important in bonds since shortened maturities can reduce price volatility and improve liquidity.
“We have never seen interest rates at these low levels," said Jeff Tomasulo, head portfolio manager of Vespula Capital LLC. "For someone looking ahead to retirement, who eventually will need yield, this is not the time to tie up money for a long period — no matter how safe."
The improved liquidity argument also makes it important to avoid investing in private placement real estate investment trusts (REITs) or other similar vehicles because of the potential of "losing all their capital." Instead, investors in their 50s should be looking to possibly invest in callable preferreds yielding 6 percent to 8 percent that are at or below the call price, he said.
This was also stressed by Mitch Reiner, president and CEO of Atlanta-based Capital Investment Advisors. “Illiquid investments, such as non-publicly traded energy investments, often boast of a great promise of yield and opportunity around oil wells or drilling pads," he said, "but when these investments are not valued daily, and you have no understanding of the true economics of the business, you probably shouldn’t be investing your last dollars before retirement. These investments are not typically regulated and are highly risky."
Avoid Risky Investments and Boiler Room Operations
Mathew Dahlberg of Main Street Investments in Kansas City, Mo., and candidate for the chartered financial analyst (CFA) program said, “As a worker gets closer to retirement ... it becomes very important that they take steps to avoid a debilitating blow to their nest egg, as academic research shows that this is one of the most sensitive times in determining whether savings will last once the person is actually retired."
He added:
"In short, the most common mistake we see is that many older investors just don't know how much risk they truly are taking on. Sadly, much like 2008, many learn the hard way.”
Pre-retirement is also a precarious time because people in their 50s are often in their peak income periods. Their years of experience are finally paying off, but they might also feel the urge to make one big killing before retirement. This could make them vulnerable to high-pressure sales tactics where brokers try to sell stocks to unsuspecting individuals. These tactics are known as "boiler room operations."
"The 50-59 age bracket is a primary target for almost all boiler room operations for a number of factors," said Darryl Daugherty, a fraud investigator based in Bangkok, Thailand. These factors include:
This age group is generally at or near the peak of both their earnings curve and their savings curve.
With retirement nearing and insufficient planning, this age bracket might be more vulnerable because they have lowered their defenses against investments that promise high returns.
Some people in this bracket have already started to experience a decline in mental faculties and might be more prone to make unsound investments.
This age bracket might also have less time for research and lower familiarity with last generation technologies and can fall for buzzword investments, such as graphene, "nano" or medical products.
Read: 6 Most Safe Investments for Baby Boomers
Don't Be Too Conservative When Investing in Your 50s
Although it's important for people nearing retirement age to be wary of risky investments, they also shouldn't be too conservative. The reason: In today’s world, investors now assume all investment risk. But owning a conservative portfolio that's heavily weighted in bonds or cash ignores the fact that stocks outperform bonds over almost all time periods.
"Retirement will last 30-40 years for many boomers, and the growth of their investment portfolio is integral to their ability to cover their financial needs in the future,” said Eric J. Schaefer, a financial advisor with Everway Investment Management in Arlington, Va. “Though inflation is considered in today's environment, that won't always be the case. Inflation in education, health care and other areas is significant and will likely continue for years to come. While your account statement may not reflect losses, over time inflation will eat into the purchasing power and true value of your retirement portfolio.”
Schaefer suggests an “appropriately allocated investment portfolio” with enough in cash or short-duration fixed income to cover multiple years of retirement spending — three years to five years depending on age. The balance should be invested in diversified global equities and alternatives.
“While the equities and alternatives may be volatile in the short term, over time they have a much higher expected rate of return," he said. "The bond and cash side of the portfolio provides the cushion and peace of mind to prevent an emotional reaction in a down market."
Investing for Retirement in Your 50s: Investments to Avoid
Based on interviews with multiple financial advisors, here are some of the worst investments a person in their 50s can make:
1. Real Estate
Michael Clark, a CFP in Orlando, Fla., said real estate “can be a wonderful investment, but do not get a new 30-year mortgage since you will be making payments well into your eighties. Time your mortgage payoff with your retirement date. This way, you can avoid debt payments in retirement.”
Another danger comes from excessive borrowing at a later age. “While real estate is a great asset to invest in, I warn investors nearing retirement of the risks that leveraging yourself could bring if things don’t go right," said Reiner. "Because you don’t have time to recover from a loss because you are too exposed to leverage at the wrong time — if a market turns — you will be looking for more work at age 65 as opposed to less."
2. Annuities
Few investments generate as much emotional reaction as annuities. Whether fixed, variable or immediate, annuities seem to elicit debate and some sad stories.
For example, Karen Benz said she was working as a new financial advisor for Wells Fargo Advisors in Long Island when she was sold an annuity from another Wells Fargo financial professional. “I was coerced to purchase an annuity when I was 50," she said. "Not only did I pay high fees of over 3.50 percent, but the broker was incented with an up-front commission of over $15,000. It took me four years to dump it without heavy fees."
She added:
"Anyone under 60 should steer clear of any financial person trying to sell an annuity to them.”
Fixed annuities are essentially the purchase of a contractual obligation from an insurance company, explained Schaefer. The life insurance company credits your account value with a fixed rate of return, eliminating any market-related risk. But in exchange for providing this guarantee, the life insurance company requires a minimum time commitment of usually seven to nine years to custody the account.
In addition to locking up your money for that period, you are also subject to a penalty if you withdraw some or all of your funds before the "surrender period" is over. When a withdrawal happens, your account is charged a surrender fee. "Many annuity contracts charge redemption fees of as much as 10 percent if withdrawals are needed during the surrender period," said Schaefer.
Immediate annuities also pose a problem, said Jeremy S. Office, a CFP with Maclendon Wealth Management in Delray Beach, Fla. In an immediate annuity, the purchaser gives an insurance company a lump sum of cash and receives payments until they die. While this may sound attractive initially, "if terms are not in place, the insurance company stops payments after your death, which could be a large portion of your initial investment,” said Office.
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3. Universal Life Insurance Policies
"Many investors are attracted to universal life policies because they provide both a life insurance benefit and a built-in investment component," said Schaefer. "The investment piece is particularly attractive as dividends, interest and capital gains are not taxed in the current year. For high-income earners in particular, this tax feature concerning investment income can result in thousands of dollars a year in savings."
But, there is also a problem with these universal life insurance policies.
People in their 50s who consider using life insurance to create tax-free income should be careful because it will typically take at least 10 years for sufficient cash to build within the life insurance product, said Steve Lewit, CEO of United Advisors based in Buffalo Grove, Ill. If you find yourself needing funds earlier, you cannot have access to them without jeopardizing the life insurance itself.
There is also a problem with how insurance companies calculate your premiums. “First off, this is a permanent insurance policy, meaning as long as you pay your premiums, the policy should never lapse,” said Schaefer. “This means the insurance company calculates your premium for the life insurance component with the expectation of paying your death benefit at some future point. The premiums can be very high in comparison to comparable term insurance."
He added, "In addition to the premiums, the policies often carry administrative expenses ranging from 1 percent to 3 percent annually, which reduces the earnings in the investment account."
Schaefer also said he does not recommend universal life insurance as an investment because of the tax treatment of future withdrawals. “As many taxpayers know, capital gains and qualified dividends in a taxable investment account are taxed at 15 percent or 20 percent, depending on adjusted gross income," he said. "As investors, we do not pay tax on our initial investment — only the earnings. The same goes for future withdrawals from life insurance contracts that are tax-free up to your basis, or total net investment, in the account.
Unfortunately for universal life policyholders, earnings in excess of basis are taxed as ordinary income rates. With the top federal tax rate now at 39.60 percent, the difference in being taxed at 20 percent now vs. almost 40 percent later will greatly reduce the after-tax value of the investment."
It’s Not Too Late to Start Investing Smartly
Thanks to some IRS rules, if you have a 401(k) plan and are 50 or older, consider taking advantage of the IRS catch-up contributions. These rules allow you to contribute an additional $6,000 to your account for a total of $24,000 in 2015, said Yvette Butler, president of Capital One Investing.
Butler also said pre-retirees should think about what’s changed since you first established your retirement portfolio 20 or 30 years ago. “Make sure your investment allocation reflects your current goals, risk tolerance and timeline," she said. "If you haven’t been periodically rebalancing your portfolio, now may be a good time to review your strategy with a financial advisor. A financial advisor can also talk you through decisions like rebalancing, rolling over an IRA, establishing a trust or beginning to de-accumulate assets.”
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This article originally appeared on GOBankingRates.com: The Worst Investments to Make in Your 50s