Biotechs are rarely "safe" investments, and it's no surprise why they're rarely at the top of anyone's list of good retirement savings vehicles. Failures during the drug-development process are common, unpredictable, and usually devastating for share prices. Few have recurring revenue, and many lack revenue altogether. And even when a company has a drug or a technology that's on the market and generating revenue, ongoing profitability isn't guaranteed.
Still, the possibilities for biotech investments brighten up quite a bit in the context of a well-diversified portfolio. If your retirement portfolio has a stable foundation of stalwart stocks and all it needs is a bit more exposure to growth, biotechs could be a great way to check the box, provided that you're willing to employ the right strategy.
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Investing in biotechs isn't for everyone
The trick with biotech investing is to understand what you're getting into and to act accordingly.
Whereas a pharma stock might have the benefit of a dividend to start repaying your investment principal immediately, the overwhelming majority of biotechs don't have any mechanism to put money back into your pocket. They also normally lack the robust cash flow necessary to pay for share buybacks, so it's not unheard of for investors to be sitting on deep losses for years before a turnaround. That means they're not exactly ideal for investors who are in retirement and seeking a reliable cash flow or stable accumulator.
Because the risk of any individual biotech failing is high, it's necessary to invest in a basket of at least five companies. That way, you won't be completely out of luck if one of them goes to zero. If you are a retirement investor and the idea of even one stock you own going to zero is frightening, then biotechs aren't for you. Likewise, if doing the work of balancing your portfolio and investing in several different biotechs seems daunting to you, biotech might not be the best place to look for retirement portfolio growth.
Furthermore, if you get nervous or irritated by your investments fluctuating in value quite a bit over the course of a week, biotechs will drive you crazy no matter why you're holding them. There's often a lot of spillover of positive sentiment from one biotech to another when one company makes a breakthrough, but the reverse also occurs. It gets old quite quickly to see your shares fall deep into the red because of the failures of a company you don't own.
Finally, even though their future earnings might not be tightly linked to the economic events of the present, biotechs are also vulnerable to the same slate of forces that affect most other stocks and the market as a whole. So, they'll get pulled down if the market crashes or if there's broad pessimism about something like economic growth or inflation.
In short, for investors who treasure stability, there isn't much to find with biotechs.
Use this strategy to maximize your chances
If you're comfortable with taking calculated risks and you're willing to accept all of what I've outlined above, read on, and you'll learn a valuable technique for getting the most out of your biotech investments. The first matter is picking the five companies for your biotech basket. Generally, they need to be small and early in the development cycle so as to maximize your potential upside from holding them for a long period.
That means it's probably a bit too late to invest in a successful player like Moderna, (MRNA 1.50%) 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 upwards of $56 billion. The biotechs to look for have market caps that are less than $2 billion.
But more than the market cap, look for enterprises that are still working on their first product. As the companies mature, most will likely stumble, and more than one may go to zero. But the survivors may still have the potential to become many times their size over time. Each report of progress in clinical trials toward commercialization will pump the stock price, and eventually, commercializing a medicine 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 far more than the 64% or so that a market-tracking index fund would have gotten you.
You don't need too many winners like that before your portfolio will be looking good for retirement. You'll need to be ready to hold your picks for at least five years to capture the benefits of their success, however. Developing drugs takes a long time, even under the best of conditions.
It might be better to buy something else
In closing, it's my view that biotechs can be a great tool to save for retirement even if they're not the best option for people who are actually currently retired. Still, the amount of effort that it takes to find suitable companies makes biotech a daunting field for most investors. And it takes a strong stomach to tolerate the losses that biotechs routinely incur.
If you do 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.
