Most retirees need to pull money out of their portfolios to help cover their costs of living, which makes income producing investments like dividend-paying stocks an attractive option. After all, dividends give retirees a chance to get income from their holdings without having to sell them -- it's almost like having your cake and eating it, too.
Still, a dividend is only as good as the company's ability to pay it, and dividends are definitely not guaranteed. In the investing world, when something looks too good to be true, it probably is. Particularly in today's yield-starved world, dividends that look too attractive may be at risk of getting cut. Here are three companies -- two Mortgage REITs and one energy pipeline -- whose temptingly high dividends signal risk to come.
Which mortgage REITs look dangerous for retirees?
Mortgage REITs, or mREITs, frequently carry temptingly high dividend yields, yet those dividends actually represent a risk for these businesses. Mortage REITs have to pay those high yields. In order to qualify for the favorable tax treatment that comes with a REIT structure, REITs must pay out at least 90% of their earnings as dividends. That makes it difficult for them to build a financial buffer to weather tough economic times.
In addition, because mREITs typically carry debt of their own, changing interest rates also present a risk, particularly for REITs that are not adequately prepared for the shift. For example, in a rising-rate environment, mREITs will see their costs of borrowing increase. At the same time, any existing fixed-rate mortgages they already invested in will see their market prices decline, making it harder for the mREIT to raise cash by selling off those mortgages.
The net result is that the dividends mREITs pay, while frequently high, can be unreliable. Here are two large mREITs that showcase that unfortunate reality.
Annaly Capital Management (NYSE:NLY) may boast a tempting 11% yield based on its $0.30 per share quarterly dividend, but not long ago its payments were substantially higher. Indeed, in 2009, it paid out better than $0.70 in one quarter before its payments started to sink. And despite years of dividend cuts, Annaly Capital Management's current dividend payment isn't reliably covered by earnings or quarterly cash flows. That makes additional future cuts a real possibility.
Chart by Author based on data from Yahoo! Finance.
American Capital Agency Corp (NASDAQ:AGNC) is another mREIT that has an unfortunate history of cutting its dividend. While its 12.5% published yield and monthly $0.20 per-share dividend may look tempting, its payment is on shaky ground. American Capital Agency's dividend payments had been above $1.40 per quarter before dropping over time to their current level. With earnings that have been negative over the past four quarters, there's no guarantee that the payment won't be cut again.
Chart by author based on data from Yahoo! Finance. Recent monthly dividends aggregated by quarter to provide apples to apples comparison with prior periods.
The next energy pipeline to stumble
With a yield of almost 11%, Williams Companies (NYSE:WMB) shares may look incredibly tempting. After all, the company operates energy pipelines, long considered the "toll roads" of the energy industry. Unfortunately, even the toll roads of the energy sector have seen their cash-generating abilities come under pressure due to sustained low energy prices.
Williams Companies is no exception. The company has indicated that its dividend is at substantial risk of being slashed if its planned merger with Energy Transfer Equity (NYSE:ETE) falls through. With that deal looking like it will fall apart, Williams Companies' dividend may well be the next casualty. That payout that has not been consistently supported by operating cash flows in recent periods, so the troubled merger deal may well be the final factor that causes Williams Companies' dividend to shrink.
Own great businesses, no matter what your age
Yield chasing can be dangerous for any investor, but it's especially risky for a retiree who needs to pull money from his or her portfolio to pay the bills. In retirement, your income should come from a far more guaranteed source than high-yield dividends that look too good to be true.
For your long-term money, dividend-paying companies can play a great role in your portfolio as a retiree. Nonetheless, focus your investing energies and effort on strong companies that pay reliable dividends, rather than chasing unsustainably high yields, and your dividend income should keep flowing in throughout your golden years.
Chuck Saletta owns shares of Annaly Capital Management. The Motley Fool has no position in any of the stocks mentioned. 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.