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Problems with Reaching for Yield

Have you ever played kickball? When you get up to bat, you have two choices. The first is to kick for the home run, and the second is to put the ball on the ground in a spot where no one else is so that you can run to first. Your natural inclination is to kick that ball as hard as you can. However, the odds are greater that you’ll hit a pop up that will be caught then you will kick a home run. So, you hold back just a little bit to get the finesse, and lower your risk of getting out.  You forego reaching for yield of a home run in favor of a single base.

In major league baseball you see something similar. The home run hitters get all the glory, but if you look closely most of the time they strike or pop out. Meanwhile, the most runs in the year are created by the single base hitters. You know the ones, they boringly get onto first a high percentage of the time and ultimately make it home as others like them hit. Usually, though not always those singles are what results in the game win. And yet we only seem to remember the homers years later.

Investing and Not Reaching for Yield

Investing is a lot like hitting. You have a choice. You can take more risk of loss, and be rewarded by a higher return in a riskier growth stock or a junk bond. You can hit a single by investing in a boring holding like an index fund. Just like when watching baseball, no one looks back on the index fund and 10 years later goes “Man, I set a record matching the market back in 2012”. However, studies show that the index fund ends up ahead of most active investments reaching for yield.

In the bond arena the same is true. Your risk free savings bonds are extremely boring as I highlighted in my post which probably put half my audience to sleep. They deliver year in and out so that ultimately my portfolio continues to climb.  If you invest in more risky junk bonds, then your returns are more correlated with stocks, and usually low quality stocks at that.  Sure, you see a higher return on those bonds, but the likelihood that the value of those bonds will go to zero can be substantial.  If just one junk bond went bust, you would need to have 20x that principle amount returning 5% to make your portfolio whole.

My Experience Reaching for Yield

Sure, I remember that long ago an internet stock holding that earned me 500% and then promptly imploded to nothing during the dotcom boom (for the record, in my case I sold it at 2 dollars a share down from 25). I also remember that real estate Mortgage Backed Security (pre 2008) went to 30 cents on the dollar and then recovered to almost par over the last 5 years. The ups were euphoric, but for obvious reasons these high yield items have not contributed to my long term portfolio return. So remember that when you go looking for yield, it’s so tempting to shoot for the high yield, but you’re probably better off shooting for reliable.

13 Comments

  1. DC @ Young Adult Money
    DC @ Young Adult Money December 5, 2016

    One thing I find interesting is that sometimes the blue chip stocks end up having relatively high yields. I work for UnitedHealth group and I took a look at the average annual yield since 2010 and it came out to 26%. That’s significantly higher than the S&P 500, but not only that but it has a decent dividend. Most wouldn’t look to a blue chip for high yield but this is one example where a reliable stock ended up having great returns.

    • fulltimefinance@fulltimefinance.com
      [email protected] December 5, 2016

      You never know, just like in baseball sometimes the fielder makes an error and you make it home.

  2. Mustard Seed Money
    Mustard Seed Money December 5, 2016

    I’m like you when it comes to investing. I am trying to hit singles and doubles. If I somehow get lucky and hit a home run, great. If not, that’s ok because I’m just trying to get on base 🙂

    Clearly I love baseball so I loved this article!!! Thanks for sharing 🙂

  3. Dividend Diplomats
    Dividend Diplomats December 5, 2016

    In kickball you always try to hit a double down the line or you kick it as hard as you can at the pitcher to catch them by surprise. Plus, once you show them you are aiming for the fences, then they will play back further and the odds of hitting a home run a second time decrease significantly. Can you tell I have put a lot of thought into this before?

    I think every good investor has a story about how they one time were caught reaching for yield and had to learn why that wasn’t a good idea the hard way. I had it a few years ago from ARCP and I will never base my decision predominately on yield. The lessons we learn the most from are typically the most painful; the key is to rebound and make yourself a better investor because of it.

    Thanks for the read!

    Bert

    • fulltimefinance@fulltimefinance.com
      [email protected] December 5, 2016

      Most definitely. The failures are painful, but the lessons learned probably caused me to avoid many additional mistakes.

  4. Andrew
    Andrew December 6, 2016

    I agree whole wholeheartedly. It’s much easier and usually better to hit singles than try to get a “10 bagger”.

    I’m always a little nervous when someone mention’s yield. I see a lot of dividend investors try to chase yield, but they have to understand that yield and risk are directly correlated. Sure a 15% dividend yield is great, but it’s probably not sustainable.

  5. Mr Defined Sight
    Mr Defined Sight December 7, 2016

    I’ve definitely learned the hard way about reaching for yield. I won’t touch a stock if it has higher than a 6 percent yield. Just my preference. I love that 3-4 percent yield sweet spot.

  6. DivHut
    DivHut December 13, 2016

    I like the kickball/baseball analogy. It’s so true that most reach for crazy yield when starting out on a DGI path. Why pick up the 2% yielding stock that grows its dividend consistently when you can buy a 12% current yield today. Of course, we know how those double digit yielding stocks eventually turn out. I think you can see from my portfolio that I favor the steady raisers much more so than the “sexy” high yielding stocks. Boring works for me.

    • fulltimefinance@fulltimefinance.com
      [email protected] December 13, 2016

      Boring may not be sexy, but it sure does the job. Thanks for adding your perspective.

  7. TJ
    TJ January 2, 2017

    Around these parts, bunting is a major kickball strategy! But there’s also some pretty intense pitching to kick against. Typically those who go for the homer realize they are just popping it up and adapt to the bunting strategy.

    Reaching for yield is dangerous, though I don’t think that going for a collection of dividend stocks instead of a broad index fund is a horrific expense. =)

    • fulltimefinance@fulltimefinance.com
      [email protected] January 3, 2017

      Bunting is definitely a useful strategy as well. Especially if they think you will go for the homer. Ahh for it to be spring..

  8. Ten Factorial Rocks (TFR)
    Ten Factorial Rocks (TFR) February 27, 2017

    Good post FTF! When I first read ‘high yield’, I thought you were referring to double digit yield stocks. But the same risk concept applies to FANG stocks as well. It especially applies to zero-profit making speculative stocks that can go up triple digit percentages and also decline to nothing. While I take calculated bets on double digit yielding stocks in mREIT sector (mainly NLY, which I consider bellwether company in the category), they are a tiny part of my overall dividend growth portfolio, which have other good yields (quality equity REITs and quality utilities that grow dividends modestly) along with strong dividend growers. At overall 3.7% portfolio yield, I try to balance between current income and dividend growth. I also look at portfolio beta, which is currently less than S&P 500, so I SWAN on that basis.

    • fulltimefinance@fulltimefinance.com
      [email protected] February 27, 2017

      I’m exploring getting more into reits currently. There is nothing wrong with a strong dividend, provided the earnings are consistently behind the dividend. The big issue in REIT’s imho is when you get to companies with a massive dividend payout ratio.

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