3 Reasons to Avoid Stocks that Pay the Highest Dividends

Investing in a stock with a dividend yield above 10% will lose an investor a lot of money. Purchasing stocks that pay dividends is a smart way to invest for the future. However, an investor must be aware of some of the risks involved with this kind of investment, specifically stocks that pay the highest dividends.

Most stocks that pay a dividend above 5% or 6% should throw up a possible red flag. While the thoughts of earning a double digit return are great, history has shown us that these yields cannot be maintained. While there may be a few good apples in the bunch that have yields above 6%, the majority of the stocks are risky.

Here are three reasons why investors should avoid investing in stocks that pay the highest dividends.

1. Dividend Cuts - Investing in stocks that pay the highest dividends usually involves additional risks. Since the yield is high, there is a higher risk of a dividend cut. Companies paying 10% - 20% in dividends have a very difficult time maintaining that level. This leads to dividend cuts which impacts the investors bottom line. In addition, because the company chooses to slash their dividend, the share price normally drops making it a double edge sword. Many dividend investors view a dividend cut as a sign to sell which forces down the share price and the investors capital gains.
2. Speculation - Most of the highest paying dividend stocks come from speculative companies. Oil trusts for example account for many of the stocks that pay the highest dividends and are usually based on pure speculation. While the company may be profitable today, their fortunes rely speculation. This is why some of these types of stocks have a dividend yeild above 10% and sometimes reach close to 20%. Real Estate trusts also make up a lot of the other high dividend paying stocks and can carry a good amount of risk as well.
3. Dividend History - Investors who review a list of stocks that pay the highest dividends will find many OTC (over the counter) stocks and trusts. There is a reason why these stocks pay a high yield, as they have not been around for a long time and are considered high risk. Any good dividend investor will tell you to research the dividend history of a stock before investing. Many of these high yielding stocks have very little history giving the investor very little data to base their decision on.

Investors who can resist the temptation of investing in these risky stocks that pay high dividends will be much better off in the long run. History has proven that the best dividend paying stocks typically have a yield that falls between 2.5% and 6%. Anything above or below that number becomes a risky dividend investment, even though the stock may not.