What is the dividend yield trap?

A dividend yield trap is when a high dividend yield makes you want to invest in a company without understanding why such a high yield exists.
What is the dividend yield trap?
What is the dividend yield trap?

Sooner or later, you will fall for the dividend yield trap.

I know, I did.

15% dividend yield? OMG. Your eyes will pop out and you will fire up the browser and head over to your brokerage and buy something you don’t understand and unknowingly walk into the dividend yield trap.

What is the dividend yield trap?

Basically, a dividend yield trap is when a high dividend yield makes you want to invest in a company without understanding why such a high yield exists.

Mind you, we are talking about individual stocks here. It’s a lot more grey when it comes to ETFs or REITs.

Good companies that pay dividends have low yields and consistent growth. Bad companies have high yields and uncertain growth.

For individual stocks, anything above 5% is BAD and unsustainable. My portfolio company, Wells Fargo, reached a dividend yield of 7.50% before it cut its dividend and the yield decreased to 1.60%.

That’s a sign of a good company. 7.50% is unsustainable.

So what is a decent dividend yield?

The answer to that question would depend on your definition of decent. For me, decent dividend yield is 5% or less.

Decent dividend yield combined with sustained growth in dividends over a long period is what we should all aim for.

Don’t fall for the dividend yield trap and for the sake of your portfolio, don’t chase high yield.

Let’s do the numbers.

Weekly Summary (7/13 – 7/17)

Value: $8,900Return: ▲2.27%
Gain: +$197Dividends: $4

I didn’t make any additional cash investment last week because I rebalanced my portfolio. Rebalancing a portfolio on M1 Finance means that I sold over-allocated positions, cashed in on the gains, and reinvested the gains into under-allocated pies.

For e.g. let’s say my Apple stock has appreciated and increased from 10% to 12%. Now, I want the stock to be only 10% of my portfolio. The 2% increase is due to an increase in the stock price. Rebalancing allows me to cash in on the 2% gain and reinvest the gains.

Portfolio All-time

Value: $8,900Return: ▲29%
Gain: +$927Link to portfolio: M1 Finance

This all-time portfolio takes into account the gains and dividends I have re-invested.

Projected Dividend Income

Annual: $395Monthly: $33
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