Dividend Yield's Dirty Little Secret: Why You're Probably Overpaying

I think we all want to believe in the power of passive income. The opportunity to get paid a regular dividend in your bank account just for holding a stock or token is tremendously exciting. That allure is all the more irresistible when the market looks like a rollercoaster. That, right there, is why dividend yield can be so toxic. It’s a siren song, one that is luring you towards the treacherous rocks of overvaluation and unseen risks.

High Yields Signal Hidden Problems

Let's be blunt. Just like a sky-high dividend yield isn’t an indicator that a company is strong and prosperous. Yet more often than not, it’s a red flashing warning light. Think about it: why is a company paying out such a large percentage of its earnings as dividends? Is it because they literally have no other better use for that capital? Are they struggling to find growth opportunities? Or, even more troubling, are they artificially inflating the yield to get investors to bite, regardless of whether it can be sustained long term?

Consider this unexpected connection: it's like a desperate retail store slashing prices to clear out inventory. You could still pick up a fantastic temporary opportunity. In reality, though, this is more an indication that the business is struggling, resulting in a dire long-term prognosis.

And it’s not only on the stock market. The same goes for the crypto industry. Today on Decentralized Finance (DeFi) platforms you can get absolutely amazing APYs for staking your tokens. These yields can be just too darn appealing, offering up rewards that far outpace anything you’d see in TradFi. But are they sustainable? Are you actually receiving free money, or are you being compensated for assuming too much risk?

Ignoring Risks? Yield Is a Trap

Here's the dirty little secret: focusing solely on dividend yield blinds you to the underlying risks. You get so focused on the income stream that you lose sight of the health of the underlying asset. Are you checking the payout ratio? A payout ratio over 60% is cause for concern. What about debt levels? Is the company or governance protocol just ‘laying on the debt’ to keep those yummy yields coming?

Think about it: a magnificent, juicy apple that looks perfect on the outside, but inside it's rotten.

In the bond universe, a very high yield could be covering up a business in free fall, out competing by a powerful industry or technological disruption. Companies in sectors such as utilities and REITs (Real Estate Investment Trusts) usually have mind blowing yields, above 4%. What do you think happens when interest rates rise, putting upward pressure on their debt while simultaneously making their real estate less attractive? All at once that dividend that appeared safe in practice and thought doesn’t seem so secure.

In DeFi, the risks are much more acute. Impermanent loss, smart contract vulnerabilities, rug pulls — these are only some of the dangers that one might encounter in the darkness. In one scenario, you can earn a 50% APY, but if the value of the token plummets, you incur a large loss. Do NOT underestimate market fluctuations! You saw the collapse of Terra/Luna right?

I've seen it happen firsthand. Investors were seduced by the yield. They invested millions into projects with questionable studies only to have the carpet pulled out from under them overnight. Don't let that be you.

Diversify! Active Management Is Key

The reality is that a passive, yield-chasing approach is almost never the best way to build lasting wealth over the long term. The S&P 500 Dividend Aristocrats index has delivered strong outperformance of roughly 10% per year over the last 10+ years. That doesn’t mean it’s the best place to invest their dollars.

Stock picking is part of the game. It’s not enough to just buy high-yield stocks. If you look at growth stocks, they don’t pay dividends today but yield the possibility of great capital appreciation in the longer term. Look at alternative investments such as crypto assets that have been very carefully vetted.

Be comfortable with active portfolio management. Don't just blindly chase yield. Do your research. Understand the risks. Adjust your allocations as market conditions change.

Think of it like this: you wouldn't just blindly follow a map without checking your surroundings or adjusting your course based on new information. The same principle applies to investing.

Here's where my blockchain expertise comes in. Even with the risks involved, DeFi provides opportunities for better risk-adjusted return than traditional dividend yielding equities. Only if you really grasp the technology and research rigorously. So don’t just front-run your peers by aping into the latest hyped-up protocol. Understand the underlying smart contracts. Assess the risk of impermanent loss. Be prepared to stomach some volatility.

Don’t be lured in by the dividend yield siren song. It's just one piece of the puzzle. Stick to the basics, know what you are getting into, and diversify your investments. Only then will you be able to create a truly sustainable and fulfilling impact investment strategy. And perhaps, if you’re lucky enough, that “dirty little secret” will take you on a journey toward a cleaner, more prosperous future.

The bottom line? Don't be seduced by the siren song of dividend yield. It's just one piece of the puzzle. Focus on the fundamentals, understand the risks, and diversify your portfolio. Only then can you build a truly sustainable and rewarding investment strategy. And maybe, just maybe, you'll find that the "dirty little secret" leads you to a cleaner, more profitable future.