Why Retirees Keep Falling for the Same Yield Trap
3 Red Flags to Look Out For and How To Tell If The Yield Is Too Good To Be True
High-yield dividend stocks are tempting—especially in uncertain markets. Who wouldn’t want a 7% or 8% annual return, paid in cash, while everyone else waits for stocks to recover?
But that promise of income often masks a harsher reality: Many high-yield stocks aren’t built to last. And for income-focused investors, particularly those in or near retirement, mistaking a payout mirage for a reliable stream can be catastrophic.
The good news? The warning signs are often hiding in plain sight. You just need to know what to look for.
In this article we will cover the 3 red flags to look out for and how to tell if the yield is too good to be true.
Red Flag #1: A Payout Ratio That’s Pushed to the Edge
Start here. A company paying out 85%, 90%, or even 100% of its earnings as dividends is walking a razor’s edge. One earnings miss—or one economic hiccup—and that dividend gets slashed.
While the rule of thumb is a payout ratio below 75%, the real trick is understanding what the payout is based on. Earnings? Cash flow? Adjusted metrics?
In capital-intensive businesses like utilities or REITs, earnings can understate available cash. But that’s no excuse to ignore the fundamentals. If a company is constantly borrowing or issuing shares to cover its dividend, you’re not investing in income—you’re subsidizing it.
What to check:
For traditional companies: payout ratio on earnings per share (EPS)
For REITs: payout ratio on funds from operations (FFO)
For BDCs: payout ratio on net investment income (NII)
If it’s consistently above 85% and rising, beware.
Red Flag #2: Cash Flow That’s Headed the Wrong Way
Dividends aren’t paid out of good intentions. They’re paid with cold, hard cash.
If a company’s free cash flow is declining—or worse, negative—then every dividend check is another step closer to a cut. That’s especially true when operating cash flow is stable, but capital expenditures (capex) are rising. Eventually, the math stops working.
It’s not just about where the company is today. It’s about where it’s going—and whether the business can sustain those payments through a downturn.
What to check:
Free cash flow trends (TTM and 3-year average)
Operating cash flow vs. capex
Cash flow coverage of dividends (free cash flow ÷ dividends paid)
If the dividend is eating up more than 100% of available cash—and has been for multiple quarters—run, don’t walk.
Red Flag #3: Declining Revenues or No Business Growth
Even a healthy balance sheet won’t save a company that’s slowly bleeding customers.
The most dangerous dividends often come from companies with flat or shrinking top lines. They’re not reinvesting in growth. They’re not innovating. They’re just maintaining appearances—until they can’t.
This is especially common in telecoms, energy MLPs, and fading global conglomerates. These firms can look “cheap” because the market has already priced in the decay. But retirees relying on those dividends are often the last ones to find out.
What to check:
3-year revenue growth trend
Market share in core business
Management’s capital allocation priorities (dividends vs. reinvestment)
If a company is paying high dividends instead of fixing its problems, the dividend isn’t a reward—it’s a bribe.
How to Tell If the Yield Is Too Good to Be True
Start with one question: Why is the yield so high?
Sometimes it’s because the stock price has dropped—but for good reason. Other times, it’s because the company is stretching to hold investor interest while its fundamentals deteriorate.
High yield itself isn’t bad. But without quality underneath, it’s just leverage in disguise.
Here’s how to sanity-check a dividend:
Compare yield to peers. Is this company offering twice the income of competitors in the same sector? That’s often a warning.
Check dividend history. Has the payout been cut or frozen in past downturns?
Look at debt levels. Is interest expense eating into profits? Are bonds trading at a discount?
Use a dividend safety tool. Morningstar and Simply Safe Dividends both provide risk ratings that highlight potential cuts.
Bottom Line
In retirement, your dividend income isn’t just a line item—it’s your paycheck. And just like in the working world, you can’t afford to count on an employer who might stop paying.
Instead of chasing the highest number, focus on the businesses behind the yield. Are they built to survive? Are they positioned to grow? Are they paying you because they can—or because they have to?
Because in this game, the real risk isn’t missing out on income. It’s building a plan around a promise that won’t be kept.
Disclaimer: This analysis is for informational purposes only and does not constitute financial advice. Investors should conduct their own due diligence and consult with a financial advisor before making investment decisions.