With interest rates so low, it's no wonder why so many Australian investors are targeting the share market for a greater return on their money.
Indeed, when term deposit interest rates are just 2.5%, a dividend of 5% or more is hard to ignore.
However it doesn't matter if you're picking dividend stocks or growth stocks, investors must understand what their getting themselves into by researching the company they plan to invest in and determine whether or not it's good value.
I've seen it happen many times. An investor will look to try their arm at the share market and aim for the companies with the biggest dividend yields and best track records. Usually they'll come with the heftiest valuations and soon enough, the investor will walk away from the market with their tail between their legs.
Even though companies like Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) have strong track records and are trading on forecast dividend yields of 5.4% and 5.5%, respectively, there is a real chance their share prices could fall by much larger amounts, if they can't live up to expectations.
Rio Tinto Limited (ASX: RIO) is forecast to pay a 3.9% fully franked dividend in the next 12 months, although it could also prove to be a risky investment if the iron ore price continues its rapid fall.
Whilst there's no way of knowing where their share prices are headed in the short term, we can minimise the downside risks by ensuring we buy them only when the market is offering us a price which we can't refuse.
Warren Buffett refers to this as the 'fat pitch' and believes investors need not swing at everything that comes their way. Instead: "Wait for a fat pitch and then swing for the fences."
Buy, Hold, or Sell?
I believe ANZ, Westpac and Rio will be bigger and better than ever than in 10 or 20 years' time, but at today's prices they are not a standout buy, despite offering seemingly big dividend yields. Instead, investors should keep them on their watchlists and wait for the fat pitch, before swinging.
