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Retirement Strategy: Why Relying On High Dividends May Be Dangerous

August 25, 2019
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You’ve seen the numbers. The dividend yields within your retirement portfolio look fantastic. While a high-percentage yield on your latest stock pick may seem like a marvelous bonus, there are hidden dangers to choosing stocks based on their dividend yields alone. In the following article, we’ll explore the massive downside of dividend stocks which could eradicate your hard-earned savings. 

The Allure Of “The Yield”

When asked why they chose to add a preferred stock (high-yield investment) to their portfolio, many soon-to-be retirees respond with the expected rationale that they want to spend the additional income earned instead of the money used to buy the stock. That is - they anticipate that the money generated by the dividend yield will be enough to ensure they will not erode their principle investment. Before moving forward, let’s explore two major possibilities and pitfalls for the above rationale:

  • What if the preferred stock decides to cut their dividend entirely, as so many companies have and will continue to do?
  • What if the underlying price of the actual stock heads well below it’s purchase price (and stays there)?

So far, we have only scratched the surface for the dangers of dividend stocks. Continuing on… 

The Likely Reality Behind A High Yield

If you are concentrating your portfolio on stock-picks that are only high-yield, you may be putting your portfolio into a dangerous position. For example, diversification - a widely accepted and reputable strategy - is difficult to achieve if your choices for stock additions are limited to only those who pay a high dividend. Many sectors, such as tech, generally have lower dividend yields. By setting a strict criteria based on yield percentage, you are effectively limiting your opportunity to diversify. 

Additionally, firms who have high dividend payouts may also have high interest rates, a sign of volatility and risk. You should always venture out to ask the “why” factor behind a company offering a generous dividend payment. 

Lastly, the initial assumption that dividend payments alone will prevent the retiree from eroding their principle is flawed. The price movement of the stock may eradicate the principle altogether (and potentially even more than expected). 

What Proper Planning Looks Like

Although dividend yields are oftentimes an attractive bonus for a particular stock pick, we strongly encourage investors to consider all angles before making the decision. By doubling down on dividends alone, you are essentially putting all of your eggs in one basket - even if you choose an array of soley high dividend stocks. Price movement is key, and at the end of the day your dividend yield may be much further off than expected from recouping the loss incurred by a heavy price movement. 

Closing Thoughts

While there are different opportunities available to large investment accounts, the general thought process behind investing is similar. In closing, no matter where you are with your current financial position, we hope you gained valuable insight from our article! 

Here at Castle Financial, we understand that you ultimately decide what makes you happy. Whether spending money now gives you the most enjoyment, or taking console in the safety net of zeroes in your bank account, only you can decide what brings you happiness.

If you need help with financial planning and investment management, Castle Financial is here for you with a complimentary consultation. We have assisted hundreds of clients like you in establishing financial freedom and saving for the long-run. Check us out on our website to get in touch – www.castlefinancial.com 

While there are conflicting views on preferred stocks and high-dividend yields, we would like to take the opportunity to be clear that our article is based on possibilities, historical trends we have noticed, and hypotheticals. We are in no way, shape, or form providing absolutes. Please use the information provided as nothing more than a general guideline for any investment decisions.