I've been a self-directed investor since February of 2011. Since that time, I have consistently held High Yield stocks yielding more than 8%. Hey, who doesn't like yield. Right?
I wrote what I considered a soul-searching article for Seeking Alpha in 2012 after my first year of investing. During my first year as a dividend investor, I was clearly in retrospect more interested in yield than in safety. What follows are my top ten losers from that first year and their 2011 returns. I was lucky, I guess you could say, because I sold each after each lost no more than 4 or 5%.
I now feel strongly that retirees, particularly those new to managing their own investments, should avoid stocks yielding over 8% unless they plan to do a lot of trading, have a strong tolerance for risk, understand options and enjoy quite a bit of luck. The results of putting stocks like these into a "Buy and Hold" style portfolio can be devastating as you can see from the one year returns of stocks I owned in 2011.
First Niagara Fin.
By 2012, I had made the decision to embrace the dividend growth model, but again, I made exceptions. This time it was high yielding mREITS like Annaly Capital (NYSE:NLY) and American Capital (NASDAQ:AGNC) and American Capital Mortgage (NASDAQ:MTGE). I rationalized my behavior, convincing myself that it was alright as long as I sold as soon as the dividend was cut. They were each cut, and I ran; again, with a loss.
2013 was going to be different, or was it? This time I would only invest in stocks that held the distinction of being Dividend Champions, Challengers, Contenders or Near Contenders. I had a portfolio business plan in place with the requirement that I consider selling when a dividend cut occurs. I was disciplined and only invested in stocks that had positive year by year histories. This time would be different, I told myself.
Fast forward to later in 2013. mREITS are under attack. Dynex Capital (NYSE:DX), the last mREIT among the Dividend Champions, Challengers and Contenders, cut its dividend. What do I do? Again, I rationalize. The cut was small. The company deserves a second chance. So I hold. By now, I had moved on to the next "big thing" in high yield: Business Development Corporations, or BDCs. Triangle Capital (NYSE:TCAP) and Pennant Park (NASDAQ:PNNT) were Dividend Contenders, so I'm in. PNNT freezes their dividend, I hold. Once again I rationalize. The reason: I love that yield.
This month, during the exercise of conducting an annual assessment of my sister's portfolio, again I come face to face with the question: What role should high yield stocks play in a 'distribution stage" portfolio? Again the Seeking Alpha community has challenged me, and as always, I thank you for that.
I'm beginning to prepare for my formal end of the year assessment. As a first step, I reviewed the buy and sell guidelines as defined in my portfolio plan. Since I'm in the distribution stage of investing, there is no buying without selling, so first I examined the guidelines directing my sell decisions.
Investigate and seriously consider selling a stock for these reasons:
- It cuts, freezes, or suspends its dividend.
- It becomes seriously overvalued as determined by a dividend of under 2% or an evaluation by Fast Graphs. Re-capturing and re-investment of gains will likely be the first step.
- It underperforms stocks in its sector in total returns (price + dividends) for two years running.
- It incurs a price loss in excess of 10% and maintains such a loss for a quarter and where such a percentage represents a loss significantly greater than similar stocks in that sector or industry. If losses increase into the next quarter, suitable replacements will be carefully evaluated. A stock can continue on "probation" as long as it is showing a price improvement.
- Plans are announced to split or divide the company.
- Acquisition announcements are made.
- Announcements of an investigative inquiry.
The guideline that jumped out for me was the one dealing with underperformance. I quickly assessed one year performance figures for the nearly 60 stocks held by me and my sister, and it became clear pretty quickly. Those with losses were those with the highest yield. The majority of underperformers were again among the highest.
As a result of this assessment and additional soul searching, I have made a decision. Before the end of the year, I plan to sell the following from both my portfolio and that of my sister: DX, PNNT, PSEC and Linn Co (NASDAQ:LNCO). In the future I will no longer be purchasing stocks that yield more than 8%.
Am I saying all high-yielding dividend stocks should be avoided by all investors? Absolutely not. Whether to hold ultra high yield stocks is a personal decision each investor needs to make. Folks, I just made mine. What I am suggesting is that risk averse investors should probably pass on anything yielding more than 8% based on my experience with the world of high yield over the past two years. As retired investors, we are better served by building portfolios that can safely yield between 4 and 5% without the risks associated with owning the above.
I recommend that we always start by considering the Dividend Champions, Contenders and Challengers, a list of which is available here. Next do a year by year performance history for each stock under consideration for the period 2002 -2013. Look for stocks with strong performance histories during this period. Personally, I favor stocks with no more than three down years during this period. Stocks that fail to regularly be in the green are often candidates for continued poor performance and dividend cuts. Well that's it for now. As always, please do your homework and buy when stocks are fairly or undervalued.
I'd love to hear from you with your impressions concerning my decision.
Disclosure: I am long DX, LNCO, PNNT, PSEC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.