There’s a misperception that equity income investing is as easy as ranking the market’s highest-yielding stocks and building a portfolio from that basis. While on the surface, stocks that yield in excess of 7% might look attractive, it may be a complete illusion if one looks closely at the market’s fundamentals. It is what we refer to as an ‘income trap’ or an ‘income illusion’.
There are countless examples of ASX100 companies that trade on attractive dividend yields. Often investors support these stocks based on yield alone, compounded further by passive ‘equity income’ ETFs.
In investing parlance, a ‘value trap’ refers to a stock that looks cheap on the surface, but the trap springs into action when the fundamentals continue to deteriorate and investors lose patience and sell out.