High yield investments can play a part in your portfolio. Even though I am a fan of the 10-10 rule of investing which focuses on the growth of a dividend stock,a high yield dividend stock (or income trust) can have a part in a portfolio. In fact, I have high yield investments in my portfolio.
What are High Yield Stocks
Let’s start by defining what a high yield investment is.
What it isn’t
- It doesn’t mean that you chase investments based on yield.
- It doesn’t mean you take risks with unworthy high yield investment (think of Yellow Pages here – I once had it on my watch list … shame on me).
- It doesn’t mean you ignore fundamentals.
What it is – For me anyway :)
- The yield is above average and sustainable.
- The payout ratio will tend to be high which will limit growth appreciation.
- The business is usually stable such as real estate.
- The fundamentals are solid like other growth investments.
In the end, if you want to simplify the concept, it’s a stock (or income trust) that focuses on paying back the investors more than it focuses on growth. Dividend increases are usually limited and the price of the stock doesn’t move much under normal market conditions. A stock with a dividend yield above 6% will tend to fall in my high yield investment pattern such as Liquor Store (TSE:LIQ).
Avoid falling for really high yield stocks as it is usually a sign of trouble. I would say that a yield above 8% should be really scrutinized especially if it’s a corporation as opposed to an income trust.
Why Hold High Yield Stocks
In one simple word; DIVERSIFICATION. Again, it’s important to not just pick any high yield stocks. I find that REITs (Real Estate Income Trusts) fit the bill of a high yield investment. It’s usually a really good source of monthly income and at their price range, it’s usually easier to DRIP. The usually lower price of a REIT also leads to a better compound growth.
Based on your age, you may want to decide on a ratio in your dividend holdings:
- Dividend Aristocrats – 5 years of dividend increases in Canada and 25 years in the U.S. See the dividend aristocrats for a list.
- Growth & Dividends – Usually a yield between 2%-3%, a lower payout ratio and a strong track record of dividend increase. Canadian National Railway is an example.
- High Yield Investments – REITs fit the bill but some stocks such as LIQ.TO or CPG.TO also fall into that category. The stock appreciation is usually minimal since more money is pack back to investors in the form of dividends.
As an afterthought, I realized that I currently have a mix of those investments. It was a natural selection in trying to diversify my portfolio and it’s a result that I am quite happy with. I have a couple of REITs and some investments such as TSE:LIQ and TSE:CPG that pay high yields but I am otherwise focused on Aristocrats and looking at adding more “growth & dividend” stocks that fit the 10-10 rule.
DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.
Image courtesy of ddpavumba / FreeDigitalPhotos.net