The big draw for investors in Ares Capital (ARCC 0.57%) is its huge 9.2% dividend yield. To put that into perspective, the S&P 500 (^GSPC +0.03%) only offers a yield of about 1.1%, and the average financial stock is at 1.6% or so. But before you run out and buy Ares Capital, you need to understand the risks that come along with that lofty yield.
What does Ares Capital do?
Ares Capital operates in the finance sector. However, as a business development company (BDC), it has a very specific corporate structure and purpose. Like a real estate investment trust (REIT), a BDC can avoid corporate-level taxation if it pays out at least 90% of its taxable income as dividends.
The trade-off for investors is that they have to treat the dividend as if it were earned income. Still, the entire purpose of a BDC is to pay dividends. That's the good news.
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BDCs like Ares make loans at high interest rates to smaller companies. Generally speaking, these companies have limited access to capital markets, so selling stock isn't an option. Banks, meanwhile, aren't inclined to lend to smaller companies because of the associated business risk.
Ares steps into the void and, because of the lack of other options, it can charge high interest rates. In the third quarter of 2025, the average interest rate on its loans was a lofty 10.6%.
That is how the company can support a 9.2% dividend yield. It is one of the largest players in the BDC niche and is a well-respected competitor. If you are interested in owning a BDC, Ares Capital is likely to be a strong choice right now. In fact, it is probably a solid choice most of the time.
The problem with business development companies
The problem with Ares Capital has less to do with the company and more to do with the BDC business model. When times are good, lending money to smaller companies can be lucrative. However, during a recession, BDCs often have to deal with many companies struggling to repay loans with high interest rates.
Ares is used to dealing with struggling companies. With more than 580 loans, there are always a few companies in the mix that aren't doing well. The issue is that an economic downturn can lead to a large increase in troubled loans, forcing the lender to cut its dividend.
NASDAQ: ARCC
Key Data Points
That is exactly what happened during the last two recessions. Even in calmer economies, the payout can bounce around a bit. If you are a dividend investor looking to build a steady income stream, perhaps to supplement Social Security in retirement, Ares Capital will likely be a bad fit for your portfolio.
However, if you go in with the understanding that it pays a dividend that's very large but highly variable, it could have a place in some dividend portfolios. Dividend cuts are just a normal part of the business model, but its payout, even after a cut, is also likely to be quite large relative to more conservative income options. And historically, the dividend has eventually recovered after cuts made during recessions.
How to use Ares Capital
Pairing Ares Capital with a lower-yielding but more consistent dividend stock could be a way to boost your income without taking on undue risk. That's especially true if the BDC's dividends aren't needed to cover daily living expenses. Essentially, if Ares Capital's income is spent on discretionary things like dining out and travel, a large but variable dividend may not be that big a deal.
