Conventional wisdom says that investing in biotech is too risky for retirees. Biotech stocks are too volatile. They can crash and burn. Retirees should stick with bonds and boring high-yield stocks. Despite these warnings, I think that there is a biotech investing strategy for retirees that could help make retirement much more enjoyable.
Let me first be clear that I agree with most of the conventional wisdom. Many individual biotech stocks are too volatile for investors seeking to preserve capital. The advice frequently given that retirees allocate significant percentages of their portfolios to income-oriented investments like bonds and dividend stocks makes a lot of sense.
But there is a smart way for retirees and soon-to-be retirees to gain exposure to the heart-pounding, pulse-quickening world of biotech without taking on an inordinate amount of risk. This strategy is to invest a modest amount into a biotech exchange traded fund, or ETF, as opposed to buying individual biotech stocks.
One good pick is the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB). iShares started this ETF back in 2001 to track the performance of the NASDAQ Biotechnology Index. The fund usually has at least 90% of its portfolio invested in biotech or pharmaceutical stocks. Its annual expense ratio stands at 0.48%.
Currently, the top 10 stocks in which the ETF is invested comprise more than 55% of total assets. Sure, there are some speculative names included in the full list of holdings. However, the largest stakes are in big biotechs with long track records, like Gilead Sciences (NASDAQ:GILD), Celgene (NASDAQ:CELG), Amgen (NASDAQ:AMGN), and Biogen Idec (NASDAQ:BIIB). These top four holdings make up almost one-third of the ETF's total assets.
Over the past five years, the iShares Nasdaq Biotechnology ETF has performed well against these major components. Only Biogen outpaced the ETF by a wide margin.
More importantly, though, is how the ETF performed against the broader market. Take a look at how the iShares biotech ETF stacks up against the S&P 500 in terms of total return during the last five years.
There were very few times during the period where the S&P outgained IBB in cumulative total return. As of now, the ETF's gains are more than double (and almost triple) those of the S&P 500. And what about that risk mentioned earlier? You might be surprised.
Let's look at one of the best measures of risk vs. reward -- the Sharpe ratio. The higher the Sharpe ratio is for a given investment, the better its risk-adjusted performance has been. Using the SPDR S&P 500 ETF as a proxy for the S&P 500 index, the five-year Sharpe ratio is 0.45. The five-year Sharpe ratio for the iShares biotech ETF is 0.92 -- more than twice that of the S&P 500.
Buying an ETF like the iShares Nasdaq Biotechnology fund provides retirees an investing strategy to profit from skyrocketing biotech growth in a way that incurs much less risk than buying individual biotech stocks. There is even a tiny dividend yield of 0.3% thrown in, thanks mainly to Amgen's dividend payments. It's not for everyone, but for retirees who want a little more sizzle in their portfolios, biotech investing ETF-style could be the way to go.
Fool contributor Keith Speights has no position in any stocks mentioned. The Motley Fool recommends Celgene and Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.