Succeeding with your investments doesn't have to involve investing harder. It requires investing smarter. (Leland National Gold Exchange)
Investing can be exciting for the avid investor, but for most it's more like... an Indiana Jones movie filled with spring-loaded arrows, pitfalls and angry blowgun-shooting natives. So what kind of writer would I be if I didn't warn you about some of these poison-tipped dangers?
Before I get into these dividend traps, I'd like to briefly go over the "value trap," which basically begins with a stock trading at a very attractive P/E ratio. Investors believe they've found the deal of the year and celebrate by buying the stock without any further research. The problem is that the stock may be worth a lot today, but the economics surrounding it can eventually make the company much less profitable. This actually limits any further growth on the P/E ratio and investors are simply stuck with those shares. Solution?
Folks, DO YOUR RESEARCH. Or even better, if you don't have time to do more research or don't even know what a P/E ratio is, maybe some diversification into cold hard gold or silver would do you some good. Let me just tell you from personal experience that gold or silver sitting in the palm of my hand ALWAYS beats the feeling of any paper stock certificate, or these days, that digital readout on my computer that says I 'partially own' a vestigial company via some vestigial shares.
Now dividend investing is one of the most popular and successful ways of investing, but it comes with a 'false guarantee.' Many who pride themselves on this instrument believe that it is safe because they get paid regardless of what is happening in the markets. What they don't realize, however, is that dividend investors can also experience heavy losses. Following are two common traps:
Trap #1 - The High Dividend Yield Trap
If you were already receiving 3% on a dividend and then saw that another one was paying out 6%, one could say that common sense dictates trading your shares out for the higher yield. In other words, your common sense has become governed by greed. Unfortunately, you probably missed the small print at the bottom of your trading slip, which states that the stock is unlikely going to continue paying its high dividend. You see, in the current market, there is usually only one reason why a stock would be paying higher than a 5% dividend and that is because the dividend payout is not sustainable.
If the market doesn’t think that the company will continue to pay its dividend, it starts selling the stock - and I don't care how much capital you have; the market does as the market wills. As the share price drops, the dividend yield rises by default. Make sense? So a couple of things you can do to be a little more causative over this is check to see if the dividend yield has increased significantly over the PAST 12 MONTHS and also if the increase IS NOT because the company is increasing its dividend. If these two factors exist, then you are most likely looking at a high yield dividend trap. Again, maybe it's time you truly diversify...
Trap #2 - The Being Paid To Wait Trap
Sometimes stock holders will brag that a bear market doesn't scare them because they can simply wait it out, while still receiving dividend payouts. So where's the harm? It's in the math, my friend. The math. So your stock has dropped 10%. But who cares about that if you're getting a 3% dividend yield right? I mean we buy dividend stocks for BOTH dividend growth and long term stock growth. And, well, it just wouldn't really be long term if we bailed on the first sign of a 10% drop and besides, in just over 3 years we'll make back that 10% loss.
Well guess what? I'm not judging that logic at all. That' right. You read correctly. The math makes sense there. If you're holding onto a stock for the long haul then 3 years and a quarter or two should be a drop in the bucket. No, the problem lies in the fact that you COULD HAVE BOUGHT SOMETHING ELSE THAT DID BETTER. Now of course hindsight is always 20-20 and so one could strongly argue that this is much more easily said than done. We've all been in that boat at one time or another (or still are!). The thought goes something like, "Man look at the huge bullish rise on that stock chart! If only I had bought that stock right there just before the big run!"
Well let me just stop you right there and mention that you have TWO solutions to this problem. One, is to actually DO your research or pay someone COMPETENT enough to do it for you. The other solution is to, yup you guessed my broken record correctly, DIVERSIFY into other instruments - like precious metals.
I know a lot of you long term value investors pride yourselves on not being trigger-happy day traders, but I'm not suggesting you day trade at all. I'm merely hinting that you shouldn't keep the wrong stocks in your portfolio for far too long. And how long is 'far too long' is up to you or your overpaid advisor. Some use 1 year as the time limit and others use as little as 6 months or as long as 2 years. But several years is just logically, mathematically and financially ridiculous. As nice as it is to get a check every 3 months, one should never become a lazy procrastinating investor that watches dividend yields more than, or exclusively over, portfolio value.
In conclusion, I suppose the most difficult task with investing is not to buy or sell a stock out of greed, but to manage the portfolio as a whole - look at the forest and not a single tree type of deal. You can invest pretty successfully if you discipline yourself into reviewing your portfolio on a regular basis AND by diversifying that portfolio on other trading instruments. Remember, don’t be a procrastinator waiting for each quarterly paycheck. Just GROW your portfolio like any sound investor would.
Over and Out,
Sponsored by Leland National Gold Exchange
Legal Disclaimer: The author has made every effort to ensure accuracy of information provided, however, Leland National Gold Exchange, nor any other affiliate website, nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Leland National Gold and all of its affiliates, agents and associative entities do not accept responsibility or culpability for losses and/or damages arising from the use of this publication.