Beware The Dividend Trap — How To Protect Your Money From This Classic Investment Mistake
Dividends are often associated with safe, stable income. But that’s not always the case. And today’s article discusses a serious issue which often destroys the gains of any would-be income investor.
That’s right, we’re about to discuss dividend traps and how to avoid them.
What Is A Dividend Trap?
According to dividend.com:
A value trap (also known as a dividend trap) occurs when investors are lured in by a high dividend yield, only to find the underlying company was not such a great buy after all.
In other words, you think you’ve found a tremendous bargain when you’re actually buying junk. Unlike penny stocks however, many of these stocks are issued by well-known and established businesses.
Here are a few examples:
- Big oil companies (Occidental Petroleum comes to mind).
- Tobacco producers (Altria might be considered one).
- Highly controversial sectors (like private prisons).
- Certain real estate trusts and lending firms.
In other words, you’re buying into a real business with tangible assets and (in many cases) a proven track record. On paper, these investments often make sense. Americans consume 19.96 million barrels per day, how could you possibly lose with a bet on big oil?
In reality, these companies are cheap and offer high dividend yields for several reasons. The two biggest being
- Their stock prices continually fall, pushing up the dividend yield.
- Nobody wants to buy them.
Occidental Petroleum is down 65% in the past five years, and is currently trading at less than half its price from March of 2019.
Even with the high dividend yield ($3.16 per year), investors still lost tons of money.
Another company like this, and one which is often recommended to new or inexperienced investors, is…