Redrick Terry:
It is now time for 4 Your Money. We’re joined by John Nelson, financial advisor at NelsonCorp Wealth Management. John, welcome back.
John Nelson:
Thank you, Redrick. Happy to be here.
Redrick Terry:
All right, so 2020, obviously, full of lessons for investors. So as we move forward in 2021, are there any of those lessons that you think are particularly relevant right now?
John Nelson:
Yes, lots of lessons learned in 2020. One of the biggest ones is the dynamic that we look at with clients that reaching for yield. That’s the dynamic where investors are in a place at a particular time where the return that they’re getting from current investments aren’t quite what they used to be. Think of CDs, think of bonds, where now I’m getting next to 0% in interest. They’re looking for other options for higher rates of return. But by doing that oftentimes taking on more risk and they may be realizing they are.
John Nelson:
So for example, you look at CDs. If I’m a CD investor getting next to nothing in interest rates, unfortunately right now. Moving out on that spectrum may be stepping into government bonds, corporate bonds, even some stocks in some cases. Just making sure that those who are reaching for yield understand many of the risks that they are taking on by doing so and how those dynamics can play out for them long term. Especially for those investors who may not have invested in say slightly higher risk type investments. They’ve been in CD and bonds their entire life. We’ve seen that dynamic play out with a lot of retail investors over the last few years.
Redrick Terry:
Sure. Do you have a specific example of that type of risk playing out?
John Nelson:
Sure. So graphic that we have with us today is just looking at the yield. So in the blue, we’ve got the S&P 500 High Dividend Index versus the red line, which is just the S&P 500 Index. So many people think that higher yield means more return. It most certainly does not. Yield is not return. As we can see in this graphic from 2016 through 2017, the blue line, the higher dividend index was outperforming the broad base S&P 500.
John Nelson:
But those were periods of time where there was very little volatility, no significant market events, and things can play out in that manner. This is very typical for what we’ve seen, not only over the last five years, but looking decades before. You can see that crossover where the red line then begins to outperform when market events take place. Volatility picks up in the market.
John Nelson:
You see a dramatic out-performance, especially in 2020 when the pandemic struck, where the high dividend index, which many people would think as a good thing, or a broad based market, or an index that would outperform those that are not paying high dividends. But that’s simply not the case where they’re under 50% of the return that just the S&P Index itself without the high dividends.
John Nelson:
So this is a dynamic, like I said, it is not unique to the last five years, or especially in 2020, this has played out many times before. So just investors understanding that yield is not rate of return. We much rather look at total return, which takes into account the yield as well as the price movements.
Redrick Terry:
So what can people do to avoid falling into this trap?
John Nelson:
Yeah, I’d say just what I stated, understanding the difference between yield and total return. The yield often means if it’s paying a higher yield, that means you’re taking on additional risk, and that’s very important for people to understand. There’s a lot of high dividend paying stocks that went into 2020 that ended up cutting or totally eliminating their dividend while a stock price is down 30 and 40% still. So those high dividends sound appealing and are certainly great and low volatility environments. But when you go into higher volatility market events take place, just knowing what you own and why you own it. And total return is a far better proxy than simply looking at the yield.
Redrick Terry:
We appreciate the good advice as always, John Nelson. Thanks for joining us.
John Nelson:
Thank you, Redrick, happy to be here.
Redrick Terry:
All right. If You missed any of our discussion, we will make it available to you at ourquadcities.com.