Diversification challenges in high-yield stock investing

of S&P500 Currently, the index offers investors an average dividend yield of just 1.4%. Of course, unless you have a particularly large nest egg, you probably won’t be able to survive on an income stream that produces that kind of yield. Therefore, most dividend-focused investors, especially retirement investors, will likely be looking for stocks with significantly higher yields.

There are many high-yield products like this to choose from, but there are potential issues that need to be addressed before deciding which one to add to your portfolio.

A good place to find income stocks

Real estate investment trusts (REITs) and utilities are great places to look for dividend stocks. Financially strong REITs have been increasing their dividends every year for decades. real estate income (oh -1.92%), which can be purchased at a yield of 5% or more. In the utilities sector, you can buy Dividend King. black hills (BKH -2.61%) The yield was 4.9%.

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These are also normal. These are just a few examples of the attractive dividend yields often offered in the REIT and utilities sectors. However, there are other options for finding dividend stocks. Sometimes sectors suffer, and when they do, you can pick up some of the strongest companies at a bargain with historically high yields. For example, it could have bought an integrated energy giant at the beginning of the coronavirus pandemic. exxon mobil (XOM -0.41%) and chevron (CVX 2.94%) It boasts a historically high yield of close to 10%.

However, there is a potential problem here, and that is diversification. REITs and utilities are typically filled with high-yield investments for the most part. And distressed industries, by definition, have concentrated investment opportunities. If you focus only on dividend yield, you may end up with too many stocks in a few industries. You may need to cast a wider net, and to do so you may need to consider lower-yielding investments.

it’s all relative

As an example, texas instruments (Texas -0.31%) The current yield is approximately 3.1%. This doesn’t compare to the 5%+ returns you get from Realty Income and its peers. NNN (NNN -1.28%) and WP Carry (WPC -1.75%). But the chipmaker has been increasing its dividend every year for decades, and today’s dividend yield happens to be near the highest in the company’s history.

TXN Dividend Yield Data by YCharts

Is it better to own three companies doing roughly the same thing or two companies in completely different industries? From a diversification perspective, it’s better to put your eggs in different baskets. would be a safe choice. High-yield technology companies like Texas Instruments are hard to find right now, so if you can find one, you might want to consider adding it to your portfolio to diversify your stake a little more.

gold and silver streamers franco nevada (FNV -3.19%) is another example. The yield is 1.2%, near the highest level in five years. Although yields are modest in absolute terms, gold is a hard asset that investors often include in their portfolios, especially for diversification purposes. Franco-Nevada may be worth a closer look.

FNV Dividend Yield Data by YCharts

Importantly, to view Texas Instruments and Franco-Nevada as options for your portfolio, you need to think beyond yield. There are also more that you can add to your list.For example, medical device manufacturers medtronic (MDT -0.52%) It boasts a historically high yield of 3.1%. This 3.1% yield isn’t as attractive as the yields currently available from many utilities, but buying just a utility exposes you to concentration risk. This risk can be easily avoided by taking a slightly broader view of your dividend approach and opportunistically adding companies in other sectors, such as healthcare.

Yield is important, but not the only consideration

There is no one right way to invest, but there are methods that have a history of causing problems. One of the biggest mistakes investors make is focusing too much on yield and failing to properly diversify their portfolios. The reason is simple. This is because high-yield stocks are often found in the same sector. Look at your portfolio. If you’re focused on just a few sectors, you may want to broaden your investment horizons. You may have to lower your yield expectations, but the long-term diversification will be worth it (and you’ll sleep better at night, too).