There’s an assumption that low risk, high yield investments don’t exist. It’s time to put that assumption to rest.
Bigfoot. Nessie, the Loch Ness monster. Unicorns. Mermaids. These mythical creatures make the rounds in the popular imagination on a regular basis. Every few years there’s a flurry of Bigfoot sightings. The Loch Ness monster appears on the front page of everyone’s favorite tabloids. In the world of stocks, you might add low risk, high yield investments to the list. They don’t actually exist, but it would be really cool if they did. What if we told you that they do exist?
Admittedly, you could also say unicorns and mermaids exist. You are certainly welcome to believe that if you like. It would make a lot of kids (and kids at heart) happy if they did. Our expertise lies not in the realm of mythical creatures, so we’ll leave that argument to someone else. Low risk, high yield investments, however, is well within our wheelhouse. And not only are they real, they are easier to find than many investors believe. Certainly, they are easier to locate than a unicorn. Think of them more as four leaf clovers.
All you need is a starting point and a little guidance to find them.
Low risk, high yield investments are out there, but beware of these mistakes
Like that photo of Nessie or Bigfoot, a closer look reveals that all is not what it seems. The pictures are blurry, inconclusive, or outright fake. Similarly, low risk, high yield investments aren’t always what they seem. While it’s true that dividend stocks are some of the safest on the market, and some of them do have high yields, that can be misleading.
On the surface it may appear that the bigger the dividend, and higher the yield, the better. But that is rarely true. More often than not, a very high yield is a red flag.
The first thing that to be consider regarding a high dividend, or any dividend for that matter, is whether it is safe and sustainable. Often times, a yield becomes high because the stock price has fallen considerably. A stock price usually falls because of poor operational performance, which imperils its ability to sustain the dividend.
Another mistake we see frequently is that investors reason faultily that low-priced stocks offer greater potential for advancement than high-priced stocks. But when you buy a low-priced stock, particularly one with low trading volume, what you actually buy is higher risk. Risk is higher because these stocks are unproven.
We’d all like to find the next superstar stock at a low price and watch it rise, but for the most part, high-priced stocks get that way by being successful, and that there’s nothing wrong with buying just a few shares of such a stock.
So don’t assume that a high yield or a low price will give you the benefits you’re hoping for.
How to add low risk, high yield investments to your portfolio
1. Make your list of low risk stocks
Stocks with low risk are not hard to find. First, search for companies with little or no debt. Companies with heavy debt loads generally produce lower earnings when interest rates rise. Safe investments vary from the nearly loss-proof, like short-term treasury bills, to the countercyclical, like consumer staples stocks.
These types of stocks can come from almost anywhere, but they tend to have a few commonalities:
- Low volatility - Volatility is basically a proxy for risk. Stocks that are more volatile have larger price swings, percentage wise.
- Industry - Consumer staples and utilities tend to be low risk because demand for their products is highly independent of economic conditions.
- Dividends - Dividends are an indicator of reliability: they mean the company’s business generates predictable income during a variety of economic conditions.
Search for companies that pay high dividends. A company’s ability to continually pay dividends provides concrete evidence that the company is healthy and is performing well. Look for companies paying dividends yielding at least 1.0%. Lower dividend yields add less value.
2. Look for high-yield dividends
As noted, focusing on companies that pay higher-than-average dividends comes with the risk that the stock’s price will fall by greater than the amount of the dividend, resulting in a net loss. How do you avoid that risk? Choose stocks that actually have real upside potential.
One place to find stocks with high, but sustainable dividends is the Dividend Aristocrats ETF (NOBL). The Dividend Aristocrats are a select group of companies that have increased their dividends every year for at least 25 straight years. The Dividend Aristocrats ETF is an easy way to secure an income stream that rises every year, and get broad exposure to American large-cap stocks, with a bit of an old-economy bias.
However, you may want to be more selective, and buy individual Dividend Aristocrats rather than buying the whole ETF. If you have shorter-term gains in mind, you may only want buy the Dividend Aristocrats with the best earnings growth, or strongest charts. If you invest primarily for current income, you may be interested in the Dividend Aristocrats that offer the highest yields.
3. Diversify—but don’t overdo it.
This is the oldest rule in the book, and there’s a reason for it. Nothing is certain. Even the best companies and stocks can be brought down by unexpected events. Smaller investors can do well with as few as five stocks, but you should never have all your eggs in one basket when investing.
When you put all three of these rules together, you will likely have a set of stocks that qualify as low risk, high yield investments. They will probably be names you recognize, and there’s a good chance they will improve your portfolio.
If you are looking for safety, dividend growth and current income, be sure to download our free report, The Five Best Dividend Stocks to Buy Today.
Do you have low risk, high yield stocks in your portfolio? What tips would you share for finding those stocks? Share your thoughts in the comments below.