Dividends of 8%, 10%, or more offered by companies like mortgage REITs and business development companies, or BDCs, sure can be tempting. However, are they worth the risk?
We asked three of our analysts what they think about investing in high-paying stocks, and here is what they had to say.
Matt Frankel: It depends which high-dividend stocks we're talking about, as well as your personal goals or risk tolerance.
For example, mortgage REITs come with double-digit yields, but also have tremendous risk related to interest rates and other variables. They may be worth the risk for a small, speculative portion of your portfolio, but I don't think they are necessarily worth the risk in a retirement portfolio.
Business development companies, or BDCs, are another variety of high-paying companies that have a pretty substantial risk level, but in my opinion are better long-term investments than mortgage REITs. They aren't quite as sensitive to circumstances beyond their control, such as interest rates.
Finally, there is another class of high-dividend stocks known as "closed-end funds," with an objective to produce a high level of income for shareholders. These are funds that put their money to work in certain types of investments, such as "global high-dividend stocks", and can use derivatives and other complex investment methods to boost returns. These tend to pay from 8% to 12% and are generally a little more stable than the other two types of stocks mentioned due to the types of stocks they hold (e.g., preferred stocks, large dividend-paying companies), though they still have a relatively high level of risk.
The important thing to remember is that no stock that pays so well is without significant risk. If you do choose to invest in high-dividend stocks, the best thing you can do is spread your money among several different companies with a variety of business models. This way, if one of them has to cut its dividend, your portfolio won't suffer too much.
Patrick Morris: I couldn't agree more with Matt, as I too think the answer is, "it depends."
A company like New York Community Bancorp (NYSE:NYCB) doesn't carry a double-digit yield. But I would still consider it as high-yield because it pays a dividend yield above 6%, which is an absolute rarity for banks these days.
And it's not only that it pays a high yield, but as noted earlier this year, it has many compelling reasons -- including high profit margins, remarkable safety, and a proven ability to deliver great returns -- that make it a great investment.
Annaly Capital Management (NYSE:NLY) on the other hand delivers a great dividend payout -- above 10% -- but as many of us have argued, all signs indicate it will make for a terrible investment in years to come.
The reality is -- as with any investment decision -- one number (in this case, dividend yield) shouldn't be the sole deciding factor. Examine the business of the company as well as its current price, and from there determine if it is worthy of your dollars.
Jordan Wathen: Investors should seek to do the opposite of what the crowd is doing. With rates low, investors are chasing yield in everything from junk bonds to dividend stocks. If you don't need income, you can probably find better-priced stocks, and thus better-priced risks, elsewhere in the market.
That said, I do think high-yield stocks can be worth the risk for people who absolutely need income on a current basis. But that comes with a disclaimer: You have to do it within the context of reasonable capital allocation. Don't buy a mortgage REIT or a BDC with money that would otherwise sit in a U.S. Treasury Bond fund. Do it with cash you'd typically dedicate to your stock portfolio anyway.
The only reason why BDCs, mREITs, or other high-yielding stocks can offer big paydays is because they require you to take big risks. Stock-like returns come from stock-like risks. Don't make the mistake of thinking high-yield stocks are good substitutes for bond investments. Their risk profiles couldn't be more different.
the_motley_fool has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. Matthew Frankel owns shares of Annaly Capital Management. Patrick Morris has no position in any stocks mentioned. 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.