Biotechs are rarely “safe” investments, and it’s no surprise that they rarely top the list of good retirement savings vehicles. Failures in the drug development process are common, unpredictable and generally devastating to stock prices. Few of them have recurring income and many have none at all. And even when a company has a drug or technology that is on the market and generating revenue, continued profitability is not guaranteed.
Yet, the possibilities for biotechnology investments become somewhat clearer in the context of a well-diversified portfolio. If your retirement portfolio has a stable base of strong stocks and just needs a bit more exposure to growth, biotech could be a great way to tick the box, provided you’re willing to use the right strategy.
Investing in biotechnology is not for everyone
The trick with biotech investing is understanding what you’re getting into and acting on it.
While a pharmaceutical stock may benefit from a dividend to start paying off your investment capital immediately, the overwhelming majority of biotechs have no mechanism to put money back in your pocket. They also normally lack the robust cash flow needed to pay for share buybacks, so it’s not uncommon for investors to sit on deep losses for years before a turnaround. That means they’re not exactly ideal for investors who are retired and looking for reliable cash flow or a stable accumulator.
Because the risk of failure of any individual biotechnology is high, it is necessary to invest in a basket of at least five companies. This way you won’t be completely unlucky if one of them drops to zero. If you’re a retired investor and the thought of even a single stock you own going to zero is scary, then biotech isn’t for you. Similarly, if doing the work of balancing your portfolio and investing in several different biotechs sounds daunting, biotech may not be the best place to seek growth in your retirement portfolio.
Also, if you get nervous or irritated by the fluctuation in the value of your investments over the course of a week, biotech will drive you crazy, no matter what you hold it for. There are often a lot of positive spillovers from one biotech to another when a company makes a breakthrough, but the reverse also happens. It gets old pretty quickly to see your stocks sink deep into the red due to the bankruptcies of a company you don’t own.
Finally, while its future earnings may not be closely tied to current economic events, biotechs are also vulnerable to the same list of forces that affect most other stocks and the market as a whole. Thus, they will be pulled down if the market crashes or if there is widespread pessimism about something like economic growth or inflation.
In short, for investors who cherish stability, there is not much to be found with biotechs.
Use this strategy to maximize your chances
If you’re comfortable with taking calculated risks and are willing to accept everything I’ve outlined above, read on and you’ll learn a valuable technique for getting the most out of your biotechnology investments. . The first thing to do is choose the five companies for your biotech basket. As a general rule, they should be small and early in the development cycle to maximize your potential benefit by keeping them for a long time.
That means it’s probably a bit too late to invest in a successful player like Modern, (NASDAQ: ARNM) which won’t be able to grow by the amount this strategy needs to work, even though it’s a great stock. Today, Moderna’s market cap is over $56 billion. The biotechs to look for have market caps below $2 billion.
But more than market capitalization, look for companies that are still working on their first product. As businesses mature, most will likely stumble, and more than one of them may fall to zero. But survivors may still have the potential to grow many times their size over time. Every report of progress from clinical trials to commercialization will drive the stock price higher, and eventually, bringing a drug to market will boost it even more.
In Moderna’s case, if you had invested in it as part of a basket of stocks three years ago, before it was a household name, you’d be sitting on gains of around 580%, which is much more than about 64%. that a market-tracking index fund would have gotten you.
You don’t need too many winners like this before your portfolio is looking good for retirement. However, you will need to be prepared to stick with your picks for at least five years to reap the benefits of their success. Developing drugs takes a long time, even under the best of conditions.
It might be better to buy something else
In conclusion, I am of the opinion that biotechnologies can be an excellent tool for saving for retirement, even if they are not the best option for people who are currently retired. Yet the amount of effort required to find suitable companies makes biotech a daunting field for most investors. And it takes a strong stomach to tolerate the losses biotechs regularly incur.
If you decide to invest, keep in mind that you should expect a long and bumpy road. But if you happen to invest in a company like Moderna when it’s young, you won’t regret your choice even if there are a few stumbles along the way.
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Alex Carchidi has no position in the stocks mentioned. The Motley Fool recommends Moderna Inc. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.