Don’t Reach For Yield

“More money has been lost reaching for yield than at the point of a gun.” – Raymond DeVoe Jr.

In his article this week for the Wall Street Journal, Brett Arends goes over some of the dumbest money moves that people routinely make. One of them is reaching for yield. It’s hard to find high income-producing investments when short-term interest rates are basically pegged yield nothing . This can lead investors to take unnecessary levels of risk to make up the difference between the rates they desire and the rates that are actually offered. Higher yield rates equal higher risk and that’s especially true right now.

Remember that we have to invest in the markets as they are, not as we wish them to be. It would be nice if we were offered safe 5% yield on CDs or stocks that promised upside with no chance of loss. That’s not the world we live in so we have to make do with what is available. Unfortunately you have to play the hand you are dealt.

Studies have shown that two people making the exact same $100,000 a year in salary have very different views of risk depending on their net worth. Actually, the person with the lower net worth tends to be more speculative with their portfolio investments than the one with a higher net worth. That’s because they are trying to play catch up with their savings by increasing their level of risk. This can be dangerous game.

There are two ways to gauge your risk and that is through your willingness and ability. The person in the example with a higher net worth actually has a greater ability to take on risk because they have more in savings. But the person playing catch-up with their savings is showing a higher willingness based on their increased speculation. Trying to buy lotto ticket investments that have the potential for a large payoff to make up for a perceived shortfall in your savings can only lead to more problems.

It can be much more exciting over the short-term to try to hit home runs (enormous gains) but this also opens you up to the increased possibility of striking out (total loss of capital) more often by swinging for the fences. Hitting singles, doubles and taking walks (save, invest, rebalance) will help you attain your goals over the long-term and lower the possibility of making large mistakes. Over the short-term this will be a dull strategy but over the long-term it’s much more exciting.

Every investor makes mistakes over time. That’s understandable. But don’t try to make up for your mistakes by increasing your risk and compounding your problems. If you feel the need to increase risk in your portfolio do so marginally. And to make up for the increase in risk you should try to make an offsetting increase to the amount you save to balance things out. Saving more will always decrease your risk over time.

The moral of the story is don’t try to be a hero with your investments and reach for yield. Slow and steady wins the race.

Now onto your common sense stories this week from around the web:

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  1. Derek@LifeAndMyFinances commented on Apr 05

    Great posts Ben. Thanks again for writing the excellent piece for my site!

  2. Ben commented on Apr 07

    Thanks Derek. I appreciate you providing the platform.

  3. Bond Fund Performance - A Wealth of Common Sense commented on Jun 21

    […] as bond funds actually held stocks in their portfolios. I’m sure most of this has to do with yield chasing in preferred stocks, but this is a potential risk that I’m sure not too many investors are aware […]