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The Scariest Chart for Yield Chasers

As one reader recently told me, “I won’t even consider an investment unless it sports a double-digit yield.” Translation: I’m a risk taker!

Time and time again, I’ve warned against chasing yield. It’s a shortsighted and dangerous endeavor. It might net you an income bump in the short term. But in the long term, it’s destined to result in nasty losses.

How so? Well, high yield is often an indication of high risk. Just ask RadioShack (NYSE: RSH) shareholders. On July 25, the company suspended its dividend, taking its high yield of 12% to zilch in an instant. And in the process, shares collapsed almost 30%.

All it takes is one dividend cut and a resulting share price collapse like that to sabotage a portfolio for years to come. I don’t wish that on any investor.

Like toddlers, though, many investors learn by doing. They need to touch that hot stove to find out if it’s really hot.

But just maybe this chart will prevent some of you from learning the hard way. Or at least convince you not to press your luck any longer.

Yield Chasers Beware!

Each month, Bespoke Investment Group breaks down the S&P 500 in deciles (10 groups of 50 stocks each) based on dividend yield.

At the end of June and July, the highest-yielding stocks in deciles 1 or 2 were the market’s best performers, hands down. However, in August, the highest-yielding stocks significantly underperformed the market. Take a look:

The sharp reversal in the underlying trend suggests investors are growing weary of the potential for RadioShack-type losses. So get out while you can. If you don’t, you could get lucky and keep earning your high yield. But the income might be completely offset by a decline in the underlying share price.

Why expose our portfolios to such risk if we don’t have to? And we clearly don’t.

Look at the performance of the dividend stocks in deciles 4 through 7. The companies in these deciles line up perfectly with our investment mandate. They offer above-average – but not high – income. And guess what? They all outperformed the market. And they trounced the highest-yielding stocks.

Bottom line: High-yield stocks are no longer rewarding shareholders with income and capital appreciation. So instead of taking on the additional risk, stick with middle-of-the-road dividend payers. Ones with a history of increasing payouts, too. They offer the best of both worlds – above-average income and consistent capital appreciation.

If you don’t have the time to find such opportunities, fear not. I’m digging into the stocks in deciles 4 through 7. In next Thursday’s column I’ll share at least one attractive option from each. So stay tuned.

Safe investing,

Louis Basenese