Please ensure Javascript is enabled for purposes of website accessibility

3 High-Yield Dividend Investing Tips That Could Earn You Thousands

By Brent Nyitray, CFA – Updated Jul 19, 2021 at 10:42AM

Key Points

  • A high yield isn't necessarily an opportunity.
  • Understand the big potential risks.
  • Understand how different sectors behave over the economic cycle.

Motley Fool Issues Rare “All In” Buy Alert

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Avoiding pitfalls is another great way to earn money.

Income investors are often older and principal preservation is their biggest priority. In investing, avoiding traps are a key way to make money. A 40% loss on one stock can wipe out a lot of 10% gains on your others. Value investors often talk about "value traps," and that concept is relevant to income investors. Here are some tips that can help you spot red flags and avoid the landmines.

Person tracing a virtual dollar sign.

Image source: Getty Images.

1. Understand the competition

If a stock's dividend yield is higher than its peers', it is often a danger sign that the dividend will get cut in the future. This generally happens when the business is struggling and the company doesn't have the earnings to cover it. We saw this in the spring of 2020 when Wells Fargo was yielding over 7% while its competitors were yielding around 3% to 4%. Wells eventually cut its dividend nearly in half. Whenever a high yield catches your eye, it pays to take a quick look at the company's competitors and see if the yield is way out of line. If it is, compare the annual dividend versus the earnings per share. If the dividend is higher than the earnings per share, it's a bad sign. This is a tip that might not earn you a lot, but a penny saved is a penny earned. 

Take a look at the chart below, which compares Wells' dividend yield versus that of JP Morgan, Citigroup, and Bank of America.In early 2020, Wells' yield was too good to be true, and the dividend was cut in half. 

WFC Dividend Yield Chart

WFC Dividend Yield data by YCharts

2. Understand the catalysts

The Federal Reserve has been supporting the economy by buying mortgage-backed securities (MBS) as part of its response to COVID-19. The Fed's buying is providing artificial support for the MBS market and that support will get taken away, eventually. In his prepared remarks in front of Congress, Fed Chair Jerome Powell said that ending MBS purchases was "a ways off" but is on the horizon. 

In 2013, the Fed warned about cutting MBS purchases, and investors threw the asset class overboard. The difference in price for MBS relative to Treasuries fell dramatically, and with it, the stock prices of Annaly Capital and AGNC Investment. Eventually the Fed will start cutting MBS purchases, and it will announce that well ahead of time. At that point, the party is winding down. Don't stay too late. 

3. Understand the macroeconomic environment

Not all stocks work over the entire economic cycle. Actually, most don't. Financials perform best when the economy is recovering from a recession, and do very poorly late in the economic cycle. The cycle for cyclicals, consumer discretionary, and defensives are all different. If the economy is strong, that is the time for consumer discretionary stocks and cyclicals. If the economy is lousy, defensives are the go-to.

Even real estate investment trusts (REITs) can vary; a net-lease company like Realty Income (O -1.24%) will perform differently than a mall REIT like Simon Property Group. Energy master limited partnerships (MLPs) will often react to oil prices. 

Trying to move in and out of sectors based on your personal economic forecast is hard to do, but a periodic check of your portfolio with an eye toward the current state of the economy may pay (or prevent losses of) dividends. 

 

Citigroup is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Brent Nyitray, CFA has no positions in the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Realty Income Stock Quote
Realty Income
O
$59.52 (-1.24%) $0.75
Bank of America Stock Quote
Bank of America
BAC
$31.92 (-1.42%) $0.46
Citigroup Stock Quote
Citigroup
C
$43.84 (-1.28%) $0.57
JPMorgan Chase Stock Quote
JPMorgan Chase
JPM
$110.39 (-1.24%) $-1.38
Wells Fargo Stock Quote
Wells Fargo
WFC
$43.31 (-0.53%) $0.23
Simon Property Group Stock Quote
Simon Property Group
SPG
$95.77 (-0.10%) $0.10

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
342%
 
S&P 500 Returns
110%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/06/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.