In a low-yield environment like what we see right now, it is tempting to chase yields. Looking for higher-yields, whether you are investing in dividend stocks, GICs, or corporate bonds, seems to be the thing to do right now. But, in the long run, will chasing yields really help you build up the wealth you want?
Looking for Account Yields
If you want to make sure that you receive your principal back, and that you have a regular rate of return, turning to high-yield savings accounts and GICs might be the answer. However, even the highest of yields are likely to turn out insufficient for your needs. While these types of investments can act as a safety net, eventually you will have to take a little risk, and focus on total return, rather than just hope for higher yields. It hardly seems worth it, in the long-run, spend time and energy looking for that small fraction of a percentage point in higher yield.
Higher Yields = Higher Risks
Just focusing on getting a higher yield also comes with its own risks. You might decide to purchase a corporate bond. However, corporate bonds with higher yields are considered riskier. The company is greater chance of default. The same risk is there when you look for high yield sovereign bonds. Just look what happened to the private holders of Greek bonds. Chasing yield in this case isn’t about milking as much as possible from a cash account. It’s about trying to increase interest income while still trying to be “safe”.
The same problem can be seen with dividend stocks. When looking at dividend stocks, it can be tempting to go for a company with a high yield. However, many of these companies offering high yields have problems. You run the risk of investing in a company that may not keep up with such high payouts, and the risk of losing some of your principal as well if the company turns out to be a loser and its stock prices crashes.
Look at Potential Returns
Instead, it might be worth it to look at potential returns. The types of companies with safer rated bonds are also the types of companies that are likely to offer solid stock returns over time. You have a better chance of seeing better overall returns if you decide to invest in the stock, rather than focusing on the bonds. With dividend stocks, you can look to companies with more modest yields, but histories of increasing payouts regularly. Not only are you likely to see returns in the form of regular dividend increases, but you are also likely to see solid returns in terms of capital appreciation. A company that has managed to raise dividends each year, even in times of recession, is probably doing something right.
You don’t want to completely disregard yield, but it’s important to avoid letting the yield chase dominate your strategy. Consider overall return, and watch out for the trap of getting too caught up in yield. In some cases, you might be better off with a lower yield now, but the potential for better capital appreciation later.
What do you think about chasing yields?