How These Hot Dividend Stocks Lost You Money

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In order to fight against low interest rates and get the income they need, investors have gravitated toward dividend-paying investments as one of the remaining ways to get good yields for their money. But too many of those investors never realized that they could lose -- let alone suffer losses so big that they'd overwhelm even double-digit dividend yields.

Yet that's exactly what happened this year to investors in the iShares FTSE NAREIT Mortgage Plus ETF. Although the fund owns a virtual dream team of dividend powerhouses that produced a yield for the fund of more than 11%, that wasn't enough to stop the fund from posting a total-return loss of almost 10% for the year.

The lineup
At first glance, the iShares ETF seemed like it had exactly the sort of stocks that any dividend investor would love. Real estate investment trusts with a focus on mortgage-backed securities make up the bulk of its portfolio, and with so many of its top holdings, including Annaly Capital (NYSE: NLY  ) , Chimera Investment (NYSE: CIM  ) , and American Capital Agency (Nasdaq: AGNC  ) , having dividend yields in the 15% to 20% range, all those component mREITs had to do was to keep their prices stable and let the payouts do all the heavy lifting to get positive returns.

Moreover, all the stars seemed to align for mREITs to prosper in 2011. Amid concerns that interest rates would eventually have to go higher, sabotaging the high-leverage business models that mREITs use, the Federal Reserve came to the rescue, promising low rates through the middle of 2013. Meanwhile, the economy limped along slowly, failing to put any real pressure on rates and further supporting mREITs' use of borrowing to take advantage of interest rate spreads.

The dividends are not enough
But when it came down to crunch time, the iShares ETF couldn't deliver what its component stocks had seemed to promise. Along with Chimera, other REITs such as RAIT Financial (NYSE: RAS  ) , Newcastle Investment (NYSE: NCT  ) , and Redwood Trust (NYSE: RWT  ) all posted total returns of around -25% even after taking their dividend payments into account. Real estate finance company iStar Financial (NYSE: SFI  ) did even worse, losing 30% and paying no dividend at all.

Not all of the investments that the ETF held lost ground. American Capital Agency, for instance, weighed in with only a tiny capital loss that left almost its entire payout as profit. But the sparse positive contributions from American Capital Agency and the other investments with marginally positive returns weren't enough to offset the losses.

The lesson you need to learn
It shouldn't come as that big a surprise that an ETF that focused on a single narrow sector of the market would prove to be riskier than many had thought. As with any performance-chasing investment, mortgage REITs had had a good run going into 2011.

But the broader takeaway from the iShares ETF's performance applies to everyone, whether or not you ever owned an mREIT in your portfolio: When it comes to dividends, you shouldn't blindly assume that a dividend payment is gravy over and above a positive price return on a stock. Often, an investment has a high dividend yield precisely because investors are expecting the share price to drop. Just as a high-yield junk bond pays a greater yield because of the higher probability that it could default, high-dividend investments often include an additional risk premium in their payout yields -- and while you won't always get burned, you should expect your fair share of price drops that offset at least part of your dividend income over the long haul.

Be a smart dividend investor
Don't let the experience of mREITs in 2011 convince you that you have to avoid dividend stocks entirely if you want to be a successful investor. Many dividend payers have also given their shareholders big capital gains over the years. But what you shouldn't do is to count on having those dividends all to yourself while maintaining your principal unscathed. If you know the risks, then you'll be a smarter dividend investor.

We're always on the lookout for strong dividend-paying stocks with plenty of safety and security. We've put together 11 of them in The Motley Fool's latest special free report on dividends. Don't wait until your post-New Year's hangover -- get your free copy right now and go into 2012 with the right information.

Fool contributor Dan Caplinger likes dividend income but always stays wary of the biggest payouts. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly Capital and Chimera Investment. Motley Fool newsletter services have recommended buying shares of Annaly Capital. 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 Fool's disclosure policy pays you dividends.

Read/Post Comments (10) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 30, 2011, at 9:56 AM, halito27 wrote:

    In any given year, the stock may suffer capital gains or losses. To a dividend growth investor, this is irrelevant, since capital gains are secondary to the income stream. So long as the dividends are providing a steady income, there's no reason to ever sell the stock - which means the capital losses exist only on paper.

    Now, if you were to tell me that mREITS are going to cut their dividends entirely, THAT'S something I'd listen to!

    Disclosure: I'm long NLY and AGNC.

  • Report this Comment On December 30, 2011, at 10:17 AM, halito27 wrote:

    In any given year, these stocks may post capital gains or losses, but from the perspective of a dividend-growth investor, this is largely irrelevant. What's relevant is the income stream.

    So long as the stock continues to generate income, there's no need to sell it – hence, the capital losses exist only on paper. In fact, I have stocks that have already paid for themselves in dividends; even if I were to sell the equity for less than I paid, it would already have turned a profit.

    The secret is time. Dividend-growth investing is a long-term strategy; that's why the focus on one year's stock price doesn't mean much.

    Now, if you were to tell me that mREITS are all about to cut all their dividends entirely, THAT is something I'd listen to!

  • Report this Comment On December 30, 2011, at 10:19 AM, halito27 wrote:

    Sorry for the double post; I thought the first one didn't take.

  • Report this Comment On December 30, 2011, at 10:33 AM, Emperor2 wrote:

    If one buys an ETF or mutual fund one pays a management fee for the convenience of the fund manager doing all the homework in managing the fund. if one does their homework, and buys stocks directly, it eliminates this extra fee. Consequently, the total return for those individuals will be higher than was delivered by iShares FTSE NAREIT Mortgage Plus ETF.

  • Report this Comment On December 30, 2011, at 12:03 PM, akakroke wrote:

    "The dividends are not enough" is true, as I've learned from ALSK. Dan is right-on. Some times even with time on your side, hurt can occur and other times, when looking for income as opposed to growth, it can be pulverizing and please don't talk about due diligence because been there and done that and what goes on behind closed doors is privy to the powerful. A stock that has a 13 million share sell-off in a matter of hours, well, that says it all.... I know Dan is talking about REITS but his lesson is really broad-based.

  • Report this Comment On December 30, 2011, at 8:06 PM, jgguru wrote:

    will definitely stick to

  • Report this Comment On December 30, 2011, at 8:16 PM, 1caflash wrote:

    I enjoy Dan's writings and I'm grateful to The Motley Fool's Crew for letting me type some thoughts. I understand high dividend-payers are risky, but you realize that if Chimera was a One Dollar stock paying One Cent-per-share Quarterly, then that would be a 4% yield before taxes and the other normal expenses. I'll stick with CIM and wish You and Yours a Safe and Sane 2012. Happy Investing!

  • Report this Comment On December 30, 2011, at 8:18 PM, 1caflash wrote:

    Correction: 4% per year.

  • Report this Comment On January 03, 2012, at 9:52 AM, yazzbro wrote:

    I wouldn't count RAS out yet. This stock narrowly missed going under back in 2008- 2009 and has really clawed it's way back from the abyss. RAS is a very well managed company, they unloaded a lot of toxic assets, have maintained a good occupancy rate for most of their assets and quickly becoming profitable again. They have maintained a $0.06 per share for the last several quarters now with probably increases in that dividend rate in the next quarter or two. This company is still a buy at under $5 especially when its book value is around $20. Only time will tell but, I think being patient with RAS will pay off in the relatively near future. Let me know what you guys think of RAS.

  • Report this Comment On January 04, 2012, at 11:42 PM, djswarm wrote:

    Capitals gains or loses are just gambling and while you wait on the dice, you get nothing. Paper losses are irrelevant when holding long term and generating revenue from dividends. At a 19% return it takes hardly any time at all to pay off the initial investment.

    After that its all gravy. Maybe more gravy. Maybe less gravy. But the gamble has been removed.

    And you still are making your return. Most investors are luck if they make 10% and 5% is more likely for the average Joe, if they are lucky. And then there is the personal investment of always tracking and worrying about the market.

    Buy and hold high dividends requires little personal investment and gives a solid return.

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