Most people like a good dividend. While it’s nice to get soaring stock prices, a steady dividend pays the bills during more difficult markets. Given the collapse in interest rates recently, more investors have turned to dividend-paying stocks. Many investors own these higher-yield dividend stocks to replace bonds. That’s fine. It’s a valid strategy.
However this approach exposes investors to more risk. With a bond, you are guaranteed to get your principal back at maturity. Sure, the interest rates are low, as of late, but your capital is safe unless the issuing company defaults. With government bonds or CDs, the risk is virtually nil. Stocks, by contrast — even conservative ones — run the risk of dramatic capital losses. Many of the U.S.’ soundest companies still fell 30%-40% during the financial crisis.
In today’s market, we again find big risk in many beloved dividend-paying companies. It makes sense to try and grab decent dividend stocks … but you must avoid ones where there is sizable risk of large capital losses, offset by only modest potential upside.
These three stocks appear to be yield traps, and should be avoided heading into 2017.