The dividend yield is one of the most commonly used financial ratios by income investors today. While not perfect, understanding a company’s current yield can help give insight into what type of return on investment you may expect to receive.
As I put together my income investment strategy, dividend yield will be used as a selection criteria to help me find the best investment options. Starting out, I will be narrowing down my search to companies that have a current yield between 2.5% to 6%. The details of this criteria are further explained below.
Current Yield >= 2.5%
In order to maximize my return on investment, I plan to set my minimum yield of a dividend stock at 2.5%. Anything below that percent may not be worth the risk of investing in stocks. Even with low interest rates, I could invest in a certificate of deposit through my credit union for 5 years at 2.5% 1.7%.
As time goes on and I revise my selection criteria, I may lower this minimum yield threshold to further diversify my portfolio. However, as I begin to build the foundation of my income portfolio, I should be able to find plenty of blue chip dividend paying stocks that yield above 2.5%.
Current Yield <= 6%
To the novice investor, a stock with a rising dividend yield may seem like a perfect investment. What could be better than a stock that pays a double digit yield? Unfortunately, a stock with a rising yield could be an early sign of a possible dividend cut coming. Remember that as the annual dividend remains unchanged and the stock price goes down, the yield goes up.
I have gotten burnt in the past chasing high yielding stocks with dividend yields over 10%. In order to lower my possible risk, I am setting my maximum yield at 6%. While there are plenty of critics who will argue there are quality income stocks that pay 7%, I want to start out with a cap at 6%. As I review my criteria overtime, I could possibly open up this cap and include yields up to those levels as I grow my portfolio.
Dividend Yield Selection Criteria
I have seen experienced income investors use similar ranges to define their dividend stock selection criteria. In some cases, I have seen investors look for yields down to 2%, while others have allowed for yields up to 7% or 8%. Then there are those who invest in REITs and Income Trusts who are comfortable investing in dividend paying stocks that yield above 10%.
The important thing to remember here is that there isn’t any right answer in what dividend yield is the best. It all depends on the dividend investment strategy implemented by the investor and the amount of risk they are willing to take on. There are plenty of successful income investors pulling in double digit yields, just as there are others who take less risk but still earn hefty yield overtime.
Final Thoughts
I have been down the path of buying up CanRoys, which gave me a short term return on investment around 15%. I have also invested in stocks that don’t pay any dividends with the intent to profit from capital gains. Risky options trades also were once part of my investment strategy as I focused on short term gains instead of building a solid income producing portfolio.
Investing for instant profit may be ideal for some investors, but it is not for me. I have learned the hard way that focusing too much on short term gains from chasing high yield stocks and options trading is not the way to build true wealth. For that reason, I have started putting together a portfolio of dividend paying stocks that can withstand any economy and will provide a long term income stream.
Do you invest in dividend paying stocks? What type of dividend yield do you look for in a investment?
Related posts:
- High Yield ETFs – An Alternative to Dividend Paying Stocks?
- How to Find the Top Dividend Stocks
- How to Use the Dividend Growth Rate to Select Income Stocks
- How to Invest in Dividend Paying Stocks
- Use the Price to Earnings Ratio to Select Dividend Stocks
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Its also important to remember that when looking at dividend yield, the payout ratio should be the next number you look at. High yields are great, but can a company sustain it? Even REITs can have trouble sustaining it, especially since most are leveraged and are taking advantage of short term low rates.
@College Investor – I agree 100%! The payout ratio, P/E ratio, and the companies history of dividends will all be incorporated into my selection criteria.
At this time, REITs won’t make the cut, but I may open my investing up to them overtime.