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Protect Your Capital – Never Chase High Yield

This week’s AAII Weekly Digest highlights these “must-read” AAII articles:

 

Interest Rate Sensitivity and Bond PricingInterest Rate Sensitivity and Bond Pricing

How can it be that there are times when “safe” assets such as high-quality corporate bonds or U.S. Treasuries exhibit levels of price volatility that may normally be associated with the stock market? This article outlines a set of easy-to-calculate formulas that could reveal how much a bond’s price will change in reaction to an increase or decrease in yield.

Protect Your Capital: Never Chase High Yield

Donald Cassidy

While several versions of the “efficient market hypothesis” (EMH) have lost many adherents in recent years, the opposite proposition—that the market is definitely not totally stupid—is clearly valid. This is crucial for investors to remember when investing for yield. Higher current yield reflects greater risk. This article covers several income-oriented asset types: high-yield bonds, preferred stocks, so-called hybrid preferreds, real estate investment trusts (REITs), master limited partnerships (MLPs), closed-end funds and utility common stocks. While the capital soundness differs by asset type, one key caution is equally true for all: High yield means high risk.

Judging a Dividend’s Safety With the Free-Cash-Flow Payout RatioJudging a Dividend’s Safety With the Free-Cash-Flow Payout Ratio

Cash flow is an important part of an investor’s analysis and valuation process. Net income (earnings) may not represent cash flow that was generated from operations since the income statement is based on the accrual method of accounting. A company may report positive and growing net income, but it could be headed for insolvency if inadequate cash is being generated to fund operations and growth. Income investors need to be concerned with a company’s actual cash position and cash generation to assess the safety of a company’s dividend.

Chasing Dividend Yield for Income:
Three Reasons to Be Wary

Relying on dividends for income is a strategy that has served investors well in the past. Who hasn’t heard of the proverbial elderly widow living off the steady stream of General Electric (GE) dividend checks? And many investors believe that high-dividend-paying stocks are preferable to low- or non-dividend-paying stocks for portfolios intended to meet income needs. The dividend yield strategy has been so attractive because it professes to meet the “golden three” outcomes for retirement-oriented investing: income, capital preservation/growth and liquidity. But as markets have evolved and the retirement investing landscape has shifted, is there anything about this strategy that should concern investors?


Our Member Question for this week is:

How likely is it that fundamental tax reform will occur during the 115th Congress?

votenow

Vote to answer this week’s Special Question:

What could the new president and Congress do that would have the biggest positive impact on the stock market?

Last Week’s Results:


AAII Readers Reveal How They Select Mutual Funds & ETFs

A mutual fund is an investment vehicle made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. AAII readers tell us what attracts them most to mutual funds and ETFS as well as how they go about selecting them for their own portfolios.

AAII’s Guide to Dividend Reinvestment Plans (DRPs)

Dividend reinvestment plans have long been popular among shareholders interested in reinvesting dividends at a low cost. There are several advantages to investors who participate in these plans: Dividend payments are put to work, transaction costs are eliminated or held to a minimum, and the additional shares are purchased gradually over time. This guide to direct purchase and dividend reinvestment plans, available exclusively to AAII members, highlights some of the best AAII has to offer. It highlights different types of dividend reinvestment plans and how they work.

The AAII Weekly Digest is one of the many benefits of AAII membership. To learn more, consider a risk-free 30-day Trial AAII Membership to start becoming an effective manager of your own assets.

 

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