4

At work a couple of my colleges was talking about this board game where the goal was to produce the highest passive income. researching the term i learned it was exactly what i was trying to accomplish with my goal to earn $100k a year outside any sort of work so i wouldn't have to worry about loosing my income if something happens at work.

looking into ways i could make a passive income apart from my initial idea (getting $10mil into a bank account which generates at least 1% interest a year to make my $100k) i came across This page on Dividend-yielding stocks

Reading it though it seems more or less risk free, i can just buy some and forgot about them letting them generate over time. but this make no sense because something like this can't be risk free, if it was everyone would be doing it or talking about it in Get Rich Quick Schemes

So what are the risks involved in buying Dividend-yielding stocks?

Improve this question
8
  • 4
    One risk is that the company will stop paying dividends.
    – Pete Becker
    Oct 22, 2015 at 23:44
  • 4
    One other risk would be that of a cosmet coming to earth and wiping us all out.
    – oldergod
    Oct 23, 2015 at 0:38
  • Ever look at what happened to some big names like General Motors and Lehman Brothers that went broke? Both were a stock that had dividends at one point and yet went broke.
    – JB King
    Oct 23, 2015 at 1:48
  • 2
    @Memor-X - those are two separate things. There is no requirement that a company that has issued dividends in the past must continue to issue dividends, so, yes, they're free to stop all of a sudden. However, that would usually be the result of some sort of downturn, so, yes, there would probably be some indications that this was going to happen.
    – Pete Becker
    Oct 23, 2015 at 2:07
  • 1
    No, dividend paying stocks likely don't struggle that often but there can be exceptions and GM and Lehman would be a couple of examples of companies that people may have believed were too big to fail and yet they did. Thus, beware of thinking that something couldn't happen.
    – JB King
    Oct 23, 2015 at 2:08

6 Answers 6

Reset to default
3

Yep, there just is no free lunch.

So called high dividend stocks are usually from companies that have stable cash flows but relatively little or moderate growth potential. Utility companies come to mind, let's take telecommunications as an example.

Such stocks, usually, indeed are considered more conservative. In a bull market, they won't make high jumps, and in a bear market they shouldn't experience deep falls. I mean, just because the stock market fell by 10%, you're not going to stop using your phone. The stock might suffer a bit but the divided is still yielding you the same.

However, fundamental data can have a significant impact. Let's say a recession hits the country of the telco. People might not get the newest iPhone and lock in to an expensive contract anymore, they might use cheaper forms of communication, they might stop paying bills, go bankrupt etc. This will have a severe impact on the company's cash flow and thus hit the stock in a double whammy: One, the dividend is gone. Two, the price will fall even further.

There are basically two scenarios after that. Either the recession is temporary and your stock became a regular growth stock that at some point might bounce back and re-establish at the previous levels. Or the economy has contracted permanently but regained stability in which case you will again have a stock with a high dividend yield but based on a lower price.

In conclusion: High dividend stocks make sense in a portfolio. But never consider their income to be safe. Reduce your risk by diversifying.

Improve this answer
1

Dividend Stocks like any stock carry risk and go both up and down. It is important to choose a stock based on the company's potential and performance. And, if they pay a dividend it does help. -RobF

Improve this answer
1

The risk in a divident paying stock can come from 2 sources. The business of the company, or the valuation of the stock at the time you buy.

The business of the company relates to how they are running things, the risks they are taking with the company, innovations in their pipeline, and their competitive landscape. You can find all sorts of examples of companies that paid nice dividends but didn't end so well... Eastman Kodak, Enron, Lehman brothers, all used to pay very nice dividends at some point...

On the other hand you have the valuation. The company is running great, but the market has unrealistic expectations about it. Think Amazon and Yahoo back in 2001... the price was way too high for the company's worth. As the price of a stock goes up, the return that you get from its future cash flows (dividends) goes down (and viceversa).

If you want to go deep into the subject, check out this course from Chicago U they spend a lot of time talking about dividends, future returns from stocks and the risk rewards of finding stocks by methods such as these.

Improve this answer
0
1

Having a good dividend yield doesn't guarantee that a stock is safe. In the future, the company may run into financial trouble, stop paying dividends, or even go bankrupt.

For this reason, you should never buy a stock just because it has a high dividend yield. You also need some criteria to determine whether that stock is safe to buy.

Personally, I consider a stock is reasonably safe if it meets the following criteria:

  • The company is large, prominent and conservatively financed.
  • It has paid continuous dividends for the last 10 years or more.
  • It's not overpriced at the time. (Determined by the Price/Earnings ratio.)
Improve this answer
0

No stock is risk-free. Some of the biggest companies in the country, that seemed incredibly stable and secure, have suffered severe downturns or gone out of business. Twenty or thirty years ago Kodak ruled the camera film market. But they didn't react quickly enough when digital cameras came along and today they're a shadow of their former self. Forty years ago IBM owned like 90% of the computer market -- many people used "IBM" as another word for computer. Sears used to dominate the retail department store market. Etc.

Improve this answer
0

One strategy to consider is a well-diversified index fund of equities. These have historically averaged 7-8% real growth. So withdrawing 3% or 4% yearly under that growth should allow you to withdraw 30+ years with little risk of drawing down all your capital. As a bonus you're savings target would come down from $10 million to $2.5 million to a little under $3.5 million.

Improve this answer

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .