Investors warned to be wary of risk if chasing yield
In 2016, my co-author and I decided to publish a book called The Intelligent REIT Investor. The book was published just in time, as U.S. REITs were elevated to a new real estate sector in the closely watched Global Industry Classification Standard (GICS), making it the 11th headline-level sector under GICS.
Remember that GICS serves as the de facto classification system for equities worldwide, providing an organizational framework for everything from performance analysis to product development. The move validates the strength of real estate and, in particular, that listed equity REITs provide investors with dividends, seasoned leadership, sound returns and diversification benefits.
Our book was recently published in China, of all places. Meanwhile, my Forbes Real Estate Investor newsletter has thousands of subscribers all over the globe, including quite a few in the United Kingdom where I will be travelling soon.
U.S. REITs: A Great Alternative
Today, I wanted to take the opportunity to discuss one of the most important topics of my investing universe: managing risk.
Risk tolerance is an important component in the investing process. It’s important to be realistic about your ability and readiness to stomach big swings in the value of your investments.
As an investor, it’s also critical to assess the returns you expect as well as the time horizon you have to invest. I know you’ve heard me say this before, but I’ll say it again: the number one rule in investing is to always protect your principal at all costs.
There’s no shortage of media headlines instructing investors where to find high-yield investment opportunities. And I’m not going to debate the pros and cons of various strategies for yield — except to remind you there’s no such thing as a “free lunch.”
Investments don’t pay 8% and up in this environment unless there’s risk. I don’t care how smart the investor is; it’s critical that when you’re taking a more aggressive approach, you should double down on the knowledge of the prospective company.
As Sure Dividend points out, “Chasing yield can be a recipe for disaster. You can’t target higher yields without reducing your exposure to other favorable metrics. High-yield stocks tend to have lower quality and growth scores, as an example. Extra caution must be taken when analyzing and investing in high-yield stocks.”
A high dividend can signal that a company is in distress, and investors, who buy solely on the dividend, may experience losses when the dividend’s cut and the stock price declines in response. Ultimately, Mr. Market is forward-looking and usually detects the underlying problems, which, of course, are what made the stock “appear” attractive.
Yet, the high dividend yield is often temporary, as the same catalyst that cratered the stock price would likely lead to a reduction in the dividend. At other times, the company may elect to keep the dividend and reward dedicated shareholders, but savvy analysts and investors should be smart enough to look into the financial statements and question if the dividend can be maintained. It’s also critical to look at the management’s track record of paying dividends.
As my loyal followers and subscribers know, I am a conservative investor primarily because I have experienced my fair share of losses. In the past, I have bet big on leverage and higher-yielding investments, but the days of instant gratification are in the rear-view mirror for me.
I’m perfectly content watching the high rollers play on the dangerous tables while I sit back adopting a balanced approach with intermediate-term time horizons of five to 10 years. I’m not retired yet, but I have begun to think like a retiree, unwilling to allow any type of risk to principal.
Sure, temptations are there almost daily, but my risk-averse mindset has allowed me to be cautious. And before I hit the buy button, I always ask myself, “Is the thrill of victory worth the agony of defeat?” and always remember to think like an intelligent REIT investor.