Older and wiser investors know better than to engage in price chasing, but they still sometimes fall into the much more subtle trap of yield chasing without realizing what is happening. Attempting to get an extra percent in interest or dividends is surprisingly dangerous. It turns out that yield chasing can ruin your retirement.
The most obvious form of yield chasing occurs in the bond market so we can see the folly of it more clearly there. Even longer duration government bonds yield only about three percent today, which means that retirees need to look elsewhere for a sustainable retirement. You can get a little over four percent on higher quality corporate bonds, and that seems like a definite improvement. If you focus on high yield bonds, the interest rate goes up to six percent. The problem with this sort of yield chasing is that it assumes bonds will not default. High yield bonds are much more likely to default when the market declines, which is why they have high yields. You cannot afford to bet your retirement on high yield junk bonds.
Yield chasing can also wreak havoc on your stock portfolio. Many experienced investors learned to avoid high flying tech stocks with no dividends after the Dotcom Crash. If stocks with no dividends were bad, then stocks with high dividends must be good. Unfortunately, the stock market is never that simple. While stocks that have grown their dividends over time tend to be higher quality, stocks with temporarily higher dividend yields are often extremely dangerous. A high dividend yield is not necessarily a sign of corporate health. Like junk bonds, stocks with high dividend yields often have higher yields because they are more likely to fail.
Worst of all, the yield chasing mentality causes some investors to forsake the protection that only precious metals can provide. These investors avoid gold and silver because they do not pay any interest or dividends. Junk bonds must pay higher interest rates to offset their higher probability of default, while government bonds can pay lower rates because they are lower risk. Gold does not need to pay any interest because it does not have any risk of default. The price of gold has increased an average of about 7.7% per year since 1971, which is better than the six percent that junk bonds offer. What is more, gold protects your retirement from bankruptcies while junk bonds are more vulnerable to economic downturns.
