Protect Your Capital: Never Chase High Yield
While several versions of the so-called efficient market hypothesishave 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 is true across asset types and among securities within the same type. Investors who chase yield are gambling, knowingly or naively, that the market is wrong and that their principal will not be significantly impaired. In the current artificial low-yield climate, risk to capital is real but is being ignored more than usual, as investors seek to replicate the income streams available pre-2007.
This article covers several income-oriented asset types: high-yield bonds, preferred stocks, so-called hybrid preferreds, real estate investment trusts, master limited partnerships , 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.
Unfortunately, some securities salespeople gravitate to high-yield offerings since they are an ‘easy sell’ to clients, who seldom ask penetrating questions about attendant risks. Such pitches should be refused, as they are clues to the offerers’ character. The aftermarket, readily accessed via numerous screening tools, can be just as dangerous for do-it-yourself investors without a salesperson making titillating offers.
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