Wednesday, May 13, 2009

Don't Be a Yield Hog

One of the things many investors, particularly older, income oriented ones do is look first at the yield of investments. It is natural to see 8% as better than 4% and count those chickens long before hatching. The piece of the puzzle not on the page is risk. All those synthetic Merrill Lynch preferred shares looked pretty good once. Even the Lehman Brothers money market funds paid a little more than the average. Today we have an extreme example of why 8% is not 4% and why sometimes less is more.

General Motors. I have a friend who accumulated GM bonds for retirement and despite my groans and cautionary nudges held them. Today those 9.4% bonds due in 2021 are paying (excuse me, calculating) 196% yield to maturity. I could eat caviar everyday of retirement on that! I can only wince at her decision.

You have to buy a lot of bonds at 8 cents on the dollar to get much beluga. Of course that 196% is completely illusory and that 8 cents will shortly be 0 cents. The same thing happened in the latter part of last year (though not so dramatically) when a scan of stocks paying dividends over 5% produced a slew of well know companies. Alcoa, Citigroup, PNC, all have cut dividends to reflect cash constraints and market realities. A lot of chickens have crossed the road in the past months and more than a few didn't make it across.

High yield is as much a yellow flag as a semi-annual check so choose carefully.

John Barnyak