Most investors who are close to or in retirement look for dividend stocks as a source of their retirement income. I believe that this is a great investment strategy, as long as these investors don’t chase high-yielding stocks. With the average market yields at 3%, stocks that yield more than 10% should not be automatically embraced in ones income portfolio, but examined more closely than usual. There are several reasons why a stock is yielding over 10%, one of them could be that the stock price has been in a severe down trend, which has increased the current yield on the stock.

Every dividend investor should be focusing not only on dividend income, but also evaluating the safety of their principal. If the high-yielding stock is paying a 10% current yield, but most of it is a return of capital, then chances are that the dividend payment will not be maintained in the future as the company’s capital base shrinks. Furthermore if a stock used to yield 3% but due to a decrease in its stock price is yielding 12%, the market might be sending a message that the current dividend payment is in danger of a cut. Financial companies like Bank of America (BAC) and Citigroup (C) in 2008 are a prime example of this scenario, as their current yields rose to 8%-10% because their stocks fell sharply in response to the softening of the general economy. Investors who purchased these stocks were hit on two fronts – the share prices dipped lower and the dividends were cut, which decreased yields on cost significantly. In other words if you are chasing a 30% dividend yield, then make sure that you don’t lose a lot in capital gains in the process.