The Risks of Chasing High Dividend Stocks

A proverb from Wayne: “A fool invests in a dividend-paying company with limited growth prospects because of the dividend yield, but a wise man looks earnestly for earnings growth, dividend growth and a rational dividend payout ratio.

There are good dividend stocks, average dividend stocks and just plain rotten dividend stocks. As with all investments, even companies that pay a dividend are not without some type of risk. As this Investopedia article (see the link) says, there is the risk that a dividend could be skipped, reduced, suspended or eliminated. The reason that introduces risk is that those who bought the stock will want to sell. With more sellers than buyers, the price will often fall and fall rapidly.

Dividend stocks can also be affected by interest rates. When interest rates rise, dividends become less attractive to some investors. When that happens, those investors sell, potentially driving down the price of the stock, so that they can buy “safe” investments like CD’s or bonds.

My strategy is to avoid buying high-dividend stocks. There are exceptions, by sector, but you need to understand those differences. Don’t buy without knowledge. It is better, I believe, to find stocks that pay between 2-4% with a payout ratio that is between 30-70%. That doesn’t prevent the stock price from falling for the short term. However, when the price of the dividend stock falls, it is a good time to turn on automatic dividend reinvestment.

Don’t forget that you can get the same results and more diversification with dividend-paying ETF’s. Some examples are DGRO, DVY, VYM, SCHD and DGRW. I have investments in all but the last one.