Dear Mr. Berko:

I bought five high-yield mortgage stocks for $60,000 between late 2010 and early 2011 to yield between 14 and 16 percent because certificate of deposit and money market rates were so low and because I needed to replace the falling income. Most are still yielding 13 percent or better, but I have lost more than 35 percent of my principal. I have enclosed the names of the five stocks I bought and need to know whether I should buy more or I should hold what I have and take a loss. I also have some blue-chip stocks – including Johnson & Johnson, Avista, Kinder Morgan and AT&T – that you recommended two years ago, but they have also fallen. Please help me. My income is falling, and my stocks are going down. I don’t know what to do.

J.M., Jonesboro, Ark.



Dear J.M.: 

I always chuckled in disgust as touting services blasted unsolicited advertising across my monitor, such as “5 recommended high-yield REITs” and “stocks with 15 percent yields for current income.” These professional touts hawked their subscriptions, urging investors to buy high-yield mortgage real estate investment trusts (REITs) – e.g., Annaly Capital Management, Hatteras Financial, CYS Investments, Chimera Investment Corp. and Invesco Mortgage Capital – as long-term investments. They were irresistible to yield-hungry investors, who’d swim through blood for better yields and were honked by low-yielding CDs.

Those 13 to 17 percent yields were breathtaking. Folks wanted to believe they were sustainable, but the fall was inevitable, and as I frequently predicted, interest rates rose and mortgage REIT prices fell when everyone least expected them to. In 2010, Annaly Capital Management (one of the most recommended mortgage REITs) traded at $18.75. The dividend was $2.70, and the yield was more than 14 percent. A lot of water has passed over the dam in the past few years. It now trades at $13.20. The dividend has been reduced six times, to $1.80, but the yield is still close to 14 percent. Wise investors who purchased these shares placed good-to-cancel stop orders to protect their principal when prices fell below certain thresholds. Unwise investors didn’t. The unexpected rise in interest rates has caught many investors with their trousers near their ankles, and your $60,000 in CD money is probably worth about $40,000. The Federal Reserve’s extraordinary stimulus, about which I’ve often cautioned readers, dumped hundreds of billions of dollars on the bond market, keeping interest rates low while forcing investors to seek higher yields in risky equities. In the process, the market has overreacted and has taken your good dividend stocks (Johnson & Johnson, AT&T, Avista and Kinder Morgan), plus others, down with the bad.

I’m going to give you a guarantee, but it’s not comforting. If the economy continues to heal, interest rates will head higher, and the Fed must reduce its monthly $85 billion bond purchases. The resulting increasing interest costs will lower your REIT dividends, and those highly leveraged REITs will continue to fall in price, though they will do so more slowly than they have in the past few weeks. It’s a tough decision. You can sell those REITs now and protect your capital against future losses or continue to hold them as they fall more slowly in price and collect the dividends, which are certain to decline.

But keep Kinder Morgan, Johnson & Johnson, Avista and AT&T. Those good issues are like owning a small, profitable and fully rented apartment building. Though its value will rise and fall with the real estate market, the tenants’ rent is usually increased by between 4 and 10 percent when their leases are renewed. Likewise, each of your stocks has increased its dividends every year, though their current market values have recently declined. And if the market declines further, those issues will probably continue to fall in price; however, the probability is excellent that their dividends will continue to grow. It’s the income that you are spending, not the growth in principal.