Chasing the highest yield lowers your income over time

The fattest yield on the list is the one most likely to shrink, and the habit of reaching for it shrinks the paycheck it promised.

Every screener lets you sort by yield. Click the arrow and the highest number rises to the top, and it is hard to look at a list like that and buy anything but the top.

A yield is a price the market put on a dividend, and the market is usually pricing in something. The names at the top of the list are there because their prices fell, and prices fall on dividends that investors expect to be cut.

So the reader who always buys the biggest yield keeps buying the dividends most likely to shrink. Each purchase pays well for a while, then pays less, and the pattern repeats.

The income line of a portfolio built that way slopes down. The reader chose it for income, and the choice is what took the income away.

Two readers, ten years, one habit

The chase wins for three years, which is exactly what makes it hard to stop.

Two readers each start with $100,000. The first buys the highest yield on the list, an 8 percent payer, and collects $8,000 in year one. The second buys a 3 percent payer with a habit of raising its dividend about 7 percent a year, and collects $3,000.

For three years the first reader looks smarter. Then the 8 percent dividend is cut in half, the stock falls 40 percent, and the reader does what a yield chaser does. The $60,000 that is left gets sold and moved into the next 8 percent name on the list, so year four pays $4,800.

The same thing happens at the end of year six and again at the end of year nine. Each time the capital shrinks by 40 percent and gets moved into a fresh 8 percent yield. Year ten pays $1,728 on about $21,600 of capital.

The second reader did nothing. With raises of about 7 percent a year, the $3,000 in year one became about $5,500 in year ten, paid on capital that was never sold at a loss.

Add up the first ten years and the chaser still collected more, about $48,800 against about $41,400. That is why the habit is so convincing while it is happening.

Look at the income line instead. One reader's checks are about a fifth of what they were and still shrinking, and the other's have nearly doubled and are still growing. By year twelve the patient reader has collected more in total, and the gap widens every year after.

The risk worth naming in plain language: the highest yields on any list are high because the price already fell, and the price fell because people who follow the company expect the dividend to be cut. Buying the top of the yield list means buying the dividends most likely to shrink.

A cut usually arrives with a price drop, so the loss lands on the income and the capital at the same time. The patient reader carries risk too, since a raise record can end, but that reader is at least not collecting the names most likely to break.

Illustrative example with round numbers and assumed figures, not a forecast. General education, not advice.

Today's yield is visible, and the cut is not.

A yield is one number, printed to two decimals, sitting on the screen right now. A cut is a number that has to be imagined, and most people do not imagine it while a bigger number is looking at them.

Minds weigh what they can see over what they have to picture, and the yield chase runs on that weighting. The 8 percent is real today, so it feels like the safe fact, and the cut is a story about the future, so it feels like a worry that can be set aside.

There is a second pull, and it is about keeping score. Income investors judge their portfolios by the yield, and a higher yield reads as a better job done, so the reader reaches for it to improve the score. The dividend that gets paid two years from now was never on the scoreboard.

The market sets the yield. The company sets the dividend. The number on the screen belongs to the first, and the money that lands in the account belongs to the second, and the reader who confuses the two ends up buying the market's opinion of a dividend instead of the dividend itself.

That is the issue. Short, on purpose. This week's move takes two minutes: find the highest yielding stock you own and look up the dividend it paid five years ago beside the dividend it pays today.

Most finance sites publish a dividend history. If the dividend today is the same or smaller, the yield you bought was mostly a falling price, and it is worth asking what the market knew.

If the dividend is larger, the yield came from the business rather than from the price, and that is the kind of high yield worth owning.

Hit reply and tell us what you found. We read every response, and it shapes what we write.

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