Investment Insights, Inc.

There’s No Such Thing As A Free Lunch

In October of 1968 I was excited as I sat in the first day of class of Economics 101 at Penn State.  It’s hard to overestimate how much I got from that class – from the very first day!

The professor turned his back to the class and walked to the blackboard, picked up a piece of chalk and in big letters wrote “There’s no such thing as a free lunch.”

I had to think about that.  I was a freshman at a commuter campus of Penn State near Philadelphia.  I still lived at home.  My family had always provided for me.  I started working as a paperboy at 12 years old, but lunch had always been provided so the idea that no one would willingly give me lunch was a new concept.  Wouldn’t members of my extended family or friends occasionally treat me to lunch?

Of course there were people in my life that would provide for me because they loved me, but, well, it’s not exactly free is it?  I mean, they love me for a reason, right?  They get something, a good feeling we call love, from the relationship.  I do realize this sounds cold and hard hearted but I think we all know at some level that one way relationships don’t work.  We have relationships because we both get something from it. 

As I grew into an adult and left college for the working world, I was frequently invited to lunch by someone.  My professor’s words always rang in my head, and 51 years later, they still do. 

Sometimes it’s obvious.  Someone wants to sell me something and they want to buy me lunch.  Lunch is not free.  Yes, they will pay the bill, but I will pay for it in the form of listening to their presentation.  I will be giving them my attention and the most valuable thing I have, my time.  Can you think of all the times you thought someone was giving you something, but really it wasn’t generosity?  They were paying for your time, your attention, your affection, the opportunity to sell you something or get you to do something.  That may not be an exhaustive list, but I think you get the idea.

Today I want to explore how this saying applies to investment return.  Recently I have had several conversations with clients and prospective clients about dividend yield.  Typically I am asked about some investment that pays 10% dividends or higher. 

Investors with little knowledge or experience see those yields as an opportunity to increase their income and they are, but – repeat after me, there is no such thing as a free lunch!

Although there is a similar saying that is a little closer to what I’m getting at here - “If it sounds too good to be true, it probably is”.

There is always a reason for a good deal.  As an investor, you need to know that reason, because a lot of the time, the reason is a bad one. 

Let’s consider those double digit dividend yields. 

Many companies pay dividends to their investors.  Those dividends are a part of their profit.  They can completely control how much of their profit they will share with their investors, but they cannot control the price that their stock sells for.  If ABC company decides to distribute $1 per share to their investors, that will represent a certain percentage yield based on their stock price.  If the market price for their shares is $100 per share, the $1 dividend will be a 1% dividend yield. 

If the market price for their shares is $10, then the $1 dividend is a 10% yield. 

In other words, if a stock has a 10% dividend yield, it’s most likely because the market does not value the company very highly, and also may not have much faith in future dividend payments.  

There are thousands of stocks.  In some very rare cases a high dividend yield occurs for benign reasons.  But normally, in a world in which the US Treasury’s 10 year notes yield 1.5%, anything that yields substantially more does so for reasons that may not be acceptable. 

Really, my mind keeps coming back to “There’s no such thing as a free lunch.”  There are no risk free 10% dividends.  There are trillions of dollars looking for a safe, but better yield.  Because of the amount of money involved, the moment something comes along that looks like it might be a low risk/high dividend opportunity, it gets investigated and if it looks relatively safe, it gets bought – fast. 

So if a 10% yielder got past all those people looking for safe but high yield, then I better know why.  Maybe the reason is acceptable to me, but most of the time, it won’t be. 

These two sayings, “There’s no such thing as a free lunch”, and “If it looks to good to be true, it probably is” can keep you out of a world of hurt.  And, the last thought above, “I better know why”.  In the markets, what I don’t know can and probably will hurt me so on those rare occasions I want to move past those two big sayings, I better know why this opportunity is there, and it better be something I can accept. 

Hal Masover is a Chartered Retirement Planning Counselor and a registered representative.  His firm, Investment Insights, Inc is at 508 N 2nd Street, Suite 203, Fairfield, IA 52556.  Securities offered through, Cambridge Investment Research, Inc, a Broker/Dealer, Member FINRA/SIPC.  Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor.  Investment Insights, Inc & Cambridge are not affiliated.  Comments and questions can be sent to hal.masover@emailsri.com  These are the opinions of Hal Masover and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Past performance is no guarantee of future results.  Indices mentioned are unmanaged and cannot be invested in directly.

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