Why Chasing High Yields Is the Fastest Way to Lose Money

For many Canadians, dividend investing is one of the best ways to build real wealth over the long haul. When you own high-quality companies that pay reliable dividends, you continue to receive consistent cash flow, which you can immediately reinvest back in the market and let compounding work.

Over the decades that continuously compounding stream of income can help turn even modest investments into significant sums. However, the key for investors is to ensure the companies you buy for the long haul are reliable, well-established businesses with reliable or defensive operations.

And while that might make sense on the surface, when it comes to actually picking individual stocks, many investors fall into the trap of trying to chase the highest yields they can find.

A stock offering investors a 10% yield looks far more compelling on the surface compared to a 4% yield. That’s exactly the trap, though. High yields are almost always a red flag for the market.

Dividend yields rise when share prices fall. So often, a high-yield stock that continues to trade cheaply and struggles to recover has a dividend that the market thinks is unsustainable.

This happens all the time when a company’s dividend becomes unsustainable. For example, last year, before BCE (TSX:BCE) ultimately cut its dividend by 56% in May, the stock’s yield had risen to more than 13%.

That’s why the most important thing when it comes to dividend investing isn’t the yield it offers today. It’s the sustainability of that dividend in the near and long term. You have to assess whether the company keep paying and ideally growing that dividend for years.

So, if you’re looking for a high-quality dividend stock to buy today, here are two high-quality picks.

Two of the best dividend stocks on the TSX today

Although BCE had to trim its dividend last year, the stock remains one of the best companies that dividend investors can buy and hold for the long haul. As a telecom stock, it consistently generates billions in cash flow each year by providing essential communication services to Canadians.

However, the telecom sector saw a period of significant investment over the last three years as companies rushed to build out their 5G and fibre infrastructure in order to stay competitive. This was a necessary move, but it also caused BCE’s free cash flow to turn negative for a few years, making a dividend cut necessary to improve the company’s sustainability going forward.

Now, however, with nearly all that heavy capital investment behind it, and with a much more sustainable dividend going forward, BCE is once again one of the best dividend stocks to buy now.

Plus, not only does it offer an attractive yield of 5% today, but with the stock in a much stronger position now than it was a year ago, it has the potential to begin increasing its dividend annually once again.

In addition to BCE, Freehold Royalties (TSX:FRU) is another high-quality dividend stock that investors can buy with confidence today.

The energy stock has a simple and low-risk business model that makes it ideal for dividend investors. It simply collects a royalty from other energy companies that use its land to produce oil and gas.

Therefore, it’s constantly generating cash flow without needing to spend any money on capital expenditures itself. Furthermore, the stock consistently aims to keep its payout ratio between 60% and 80% of its funds from operations, to ensure it remains sustainable. And right now, Freehold is offering investors a yield of more than 6.2%.

So, if you’re looking to boost your passive income with reliable, high-yield dividend stocks, there’s no question that Freehold is one of the best.

The post Why Chasing High Yields Is the Fastest Way to Lose Money appeared first on The Motley Fool Canada.

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More reading

• How to Invest in AI Without Buying Tech Stocks
• A Hands-Off Canadian Energy Stock That Cuts You a Cheque Every Month
• The Best Canadian Stocks to Buy and Hold Forever in a TFSA
• 5 TSX Dividend Stocks to Hold for the Next Decade
• 1 High-Yield Dividend Stock You Can Buy and Hold for a Decade

Fool contributor Daniel Da Costa has positions in Bce and Freehold Royalties. The Motley Fool recommends Freehold Royalties. The Motley Fool has a disclosure policy.