High Yield Stocks

Each share of a company you buy represents a sliver of ownership. Some companies distribute their earnings to their owners each quarter through cash payments. A minority of companies go even further by sending especially generous payments to their stockholders. These are called high yield stocks and they may deserve a place in your portfolio.

(Fair warning before we go any further: High yield stocks may not always supply a high yield. Past performance does not guarantee future results.)

What are High Yield Stocks?

Some stocks pay dividends, which are shares of the company’s profits. If you own a dividend-paying stock, you receive the income from the dividend and the appreciation of the stock. If you don’t need the income, you can invest your dividends right back into your portfolio to purchase more securities.

The value of a dividend stock is measured by dividend yield: the amount of cash you’ll get from the stock expressed as a percentage. This tells you how much you get back relative to the stock’s price. The formula is simple.

Dividend Yield = (Annual Dividend Per Share / Stock’s Price Per Share) x 100

Let’s say a stock trades at $35 per share and the company pays an annual dividend of $0.75 per share.

Dividend Yield = ($0.75 / $35) x 100 = 2.14%.

So what’s a high yield stock? It’s a stock with an especially high dividend yield. Usually this means the dividend pays more than a benchmark security like a U.S. Treasury bond, but analysts and investors can define “high” any way they like. For instance, some consider a stock high yield if it pays more than 3% (although others think 3% is too low).

Unlike bond yields, dividend yields are not fixed. A dividend can fluctuate if the company’s share price changes. The company can also simply decide to change their dividend payouts. Most dividend stocks pay quarterly.

List of High Yield Stocks

Buying individual stocks is usually too risky for the average investor. Instead, it’s smarter to buy exchange traded funds (ETFs). These are funds that purchase groups of stocks, effectively reducing the inherent risk of investing. If one high yield stock fails to pay its dividend, you won’t lose all of your income.

Here’s a list of the top-paying high yield ETFs as of July, 2019.

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Pros and Cons of High Yield Stocks

High yield stocks may be great additions to your portfolio, but like any security, they come with risks. Make sure understand these pros and cons before buying.

Pros of High Yield Stocks

Here are some reasons to include high yield stocks in your portfolio.

Reliable Income Stream

The biggest advantage to high yield stocks is that they create a cash revenue stream right now.You’ll receive a quarterly check as your share of the company profits (you’re an owner, after all). You don’t have to wait for the company to launch a successful product, complete a merger, or reach a sales milestone. You don’t have to sell at the right time.

If you reinvest those dividends into stock, you’ll receive increasingly larger dividend checks andhave more stock to eventually sell.

Furthermore, dividends are reliable. They pay predictably for extended periods of time. This means you can make life decisions (how much to work, what to buy, etc.) based on your ownership, especially if you’re trying to live off your investment income.

Powerful Compounding

Dividends make great use of compounding income. Each dollar you earn through your high yield stocks is another dollar you can put back into the market. You could use that money to purchase other securities(good for diversification), or you could reinvest your dividends into the same stock, thereby increasing your dividend income and your total ownership.

If you use a dividend reinvestment plan (DRIP) to automatically reinvest your dividends, you can often purchase new shares at a discounted rate.

Historically Good Results

Even though high yield stocks come with additional risk, their performance has been historically comparable to the market as a whole. They’re also usually less volatile because people tend to hold on to dividend stocks that pay consistently.

Well-established companies do their best to pay their dividends because they know that’s the primary reason people buy their stock. In fact, they’ll go to great lengths to increase their dividend payouts to keep their stock strong.

Tax Advantages

Dividends are more tax efficient than ordinary income because they’re taxed at a lower rate in the United States, the United Kingdom, and Canada. In the US, for instance, people in low income tax brackets pay nothing for dividend income and people in the 35% tax bracket only pay 15% on their dividend income.

Cons of High Yield Stocks

Now let’s go over the drawbacks to high yield stocks.

Cap on Return

While dividends pay reliable income, they usually don’t have the same growth potential as a non-dividend stock. Few pay more than 10% per quarter, which means you won’t see massive growth that makes you rich overnight. In fact, it’s quite possible for a high yield stock’s dividend to decrease over time for a variety of reasons. This means its yield isn’t suitable for a growth-focused investment strategy.

Double Taxation

Dividends are essentially taxed twice: The company first pays income tax on its earnings before you get it. Then you have to pay income tax after you receive it. Essentially, you pay tax twice because you’re an owner and an individual.

Hard to Choose

Picking a dividend stock isn’t the same as picking a growth stock. When we select growth stocks, we look for evidence that the company will perform better in the future so the stock price rises. But great performance doesn’t always mean bigger dividends. For instance, a company may cut its dividend to pay for a new product launch. This makes choosing high yield stocks tricky.

Deceptively High Rates

High yields stocks are potentially dangerous. Since dividend yield is a fraction based on stock price and dividend payout, the dividend yield will go up when the stock price goes down. A dividend yield that balloon ups might mean the company is tanking.

Sometimes companies will use high dividends to attract investors if they can’t seem to sell their stock. Just because a company has a great dividend yield doesn’t mean it will forever.

Lack of Diversification

It’s never a good idea to fill your portfolio with one kind of security, even if they seem like a good deal. Diversify your portfolio with a mix of different kinds of stocks and bonds. This is the best way to protect yourself from losing your nest egg.

Furthermore, most companies who pay generous dividends are utilities and industrial businesses. Owning several of these is not safe diversification.

Buying High Yield Stocks

It’s important to conduct careful research before buying high yield stocks or ETFs. Consult with a financial advisor if necessary and make sure any stock you buy fits into your long term savings goals.

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