Learn to spot red flags and avoid risky, unattainable dividend yields.
If you’ve ever come across a stock or fund boasting a sky-high dividend yield — say 10%, 12%, or even more — your first thought might be, “What’s the catch?” And you’d be right to ask. While the allure of juicy yields can be hard to resist, experienced investors know that in the world of dividend investing, too good to be true often is.
In this post, we’ll break down what makes a dividend yield unsustainable, the red flags to watch for, and how to protect yourself from dividend traps that could drain your retirement portfolio instead of growing it.
What Is Dividend Yield?
Dividend yield is a simple formula:
Annual Dividend / Share Price = Dividend Yield
For example, if a company pays $4 per year in dividends and the stock is priced at $100, the yield is 4%.
But here’s where it gets tricky — if the stock drops to $50 and the dividend remains the same, the yield now looks like 8%. That might sound like a great deal… but is it?
Red Flag #1: A Plunging Share Price
A high yield can be a sign of trouble, especially if it’s the result of a falling stock price. When investors lose confidence in a company, the stock may tumble. But if the dividend hasn’t been cut yet, the yield will appear artificially high.
🛑 Warning sign: A yield that’s unusually high compared to peers, with a steadily declining stock price.
👉 What to do: Investigate why the stock price is dropping. Are earnings falling? Is the company overleveraged? If something seems broken in the business, the dividend may be on borrowed time.
Red Flag #2: Unsustainable Payout Ratios
The payout ratio tells you what percentage of a company’s earnings go toward dividends. A payout ratio over 100% means the company is paying out more than it earns — a recipe for disaster.
🛑 Warning sign: Payout ratios above 80%, especially if earnings are shrinking.
👉 What to do: Look for companies with conservative payout ratios (typically 40–70%) and growing earnings. That’s a stronger signal of a reliable dividend.
Red Flag #3: Negative Free Cash Flow
Cash is king when it comes to paying dividends. If a company is burning through cash or consistently reporting negative free cash flow, it may be funding the dividend with debt — or worse, cutting corners on essential business operations.
🛑 Warning sign: Free cash flow trends downward or turns negative.
👉 What to do: Check the company’s cash flow statements. Healthy companies generate more than enough cash to cover dividends and reinvest in the business.
Red Flag #4: Declining or No Revenue Growth
A dividend is only as strong as the business behind it. If sales are shrinking year after year, there may not be enough fuel to keep the dividend engine running.
🛑 Warning sign: Flat or falling revenue, particularly in industries under pressure (like legacy media, brick-and-mortar retail, etc.).
👉 What to do: Favor businesses with strong brands, competitive advantages, and consistent or growing revenue streams.
Red Flag #5: A History of Dividend Cuts
Past behavior matters. If a company has a habit of cutting its dividend during tough times, there’s a greater chance it will do so again in the future.
🛑 Warning sign: Dividend cuts during mild recessions or business slowdowns.
👉 What to do: Look for companies with a track record of steady or rising dividends, even during downturns. “Dividend Aristocrats” — companies that have raised dividends for 25+ years — are a good starting point.
Red Flag #6: Overly Complex or Risky Business Models
Many high-yielding investments like mortgage REITs, leveraged closed-end funds, or certain energy MLPs generate eye-catching yields through debt, leverage, or derivatives. These models can work — until they don’t.
🛑 Warning sign: You don’t fully understand how the business or fund makes money (or pays such a high dividend).
👉 What to do: Stick with simple, transparent investments. If you can’t explain how the dividend is generated, you may be taking on more risk than you realize.
So, What Is a Safe Dividend Yield?
There’s no magic number, but for most sectors, a yield between 3% and 6% tends to be more sustainable. That said, the best dividend investments offer:
- A reasonable yield
- Strong financials
- Modest payout ratios
- Positive free cash flow
- A history of reliable dividend payments
- Room to grow
And remember: sometimes “safe and steady” beats “high and risky.” Chasing yield can lead to painful losses — or dividend cuts just when you need income the most.
Final Thought: Look Under the Hood
It’s tempting to fall for a 10% or 12% dividend yield, especially if you’re relying on investment income in retirement. But don’t let the headline number blind you. Always do your due diligence and look at the quality of the dividend — not just the quantity.
Because in retirement, dependable income beats sky-high promises every time.
Disclaimer: This post is for informational purposes only and does not constitute investment advice. All investments carry risk. Consult with a qualified financial advisor before making any investment decisions.