Investments

What Does Higher Yield Earning Mean

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 7 minute read

When investing, you want to maximize your return in as little time as possible. Some investors use the strategy of high-yield income investing to get there. This investing thesis centers on a single, straightforward notion. 

The best way to outperform the market is to put your money into undervalued businesses and communities. However, what is meant by high-yield income investment, and what are the benefits and drawbacks of utilizing this approach to building wealth?

What Is Investing in High-Yield Income?

An investment’s yield is the amount of money it brings in relative to how much you initially put into it, as part of an income strategy. For every $100 invested, if you receive $5 back each year, that’s a 5% yield.

Many different types of investments fall under the umbrella term “high-yield,” but what unites them all is the ability to produce higher returns than the market average. Although stocks and bonds are the most typical high-yield investments, there are other possibilities available. 

A breakdown would look like this:

How Do High-Yield Bonds Work?

High-yield bonds, sometimes known as trash bonds, are corporate bonds that provide bondholders larger returns than the market average. Investors that are ready to buy bonds from issuers with a weak credit grade, often below BBB, are rewarded with higher interest rates called coupon rates on their bonds.

These bonds are similar to other types of fixed-income investments in that they provide regular payments to their holders at a predetermined rate. However, the risk of buying junk bonds is higher than that of investment-grade bonds because they are issued by corporations with low credit ratings.

There are two different categories of junk bonds:

  • Lost Angels. Bond issuers that were once given a high credit rating but have lately had that rating lowered are called fallen angels. This is typical during economic downturns when businesses are unable to generate the same levels of profit as they did during times of economic growth.
  • Emerging Performers. A rising star is a junk bond issued by a corporation that has made considerable improvements as of late. This might lead to the issuer’s credit rating improving, which would make the bonds it issues eligible for the higher category of investment grade.

What Is a High-Yield Stock?

Like their bond equivalents, high-yield stocks are those that offer dividend yields above the market average. High dividend stocks are popular with income investors because they generate stable income with low volatility. But it’s also vital to know why a certain firm’s dividend payments are higher than usual.

It’s possible that a company’s high dividend yield is the consequence of nothing more than the company’s successful business model. Some companies know how much they are likely to expand and are able to allocate a considerable amount of their income to dividend payments.

On the other hand, some high dividends in the stock market may be a harbinger of disaster. Some companies have high yields merely because the value of their shares has taken a significant knock. This results in an above-average dividend yield for the stock price. 

Without investigation, it is impossible to determine the precise reason for the decreases; nonetheless, in most cases, it is due to operations concerns, cash flow problems, or uncertainty about a specific market.

Be sure you understand why a high-yield stock is paying out more dividends than typical before you invest in it.

Why Invest in Alternative High-Yield Securities?

Finally, there are various alternative investments that provide large dividends as well. 

Some common instances include:

  • Homeownership. Investing in real estate with the intent of renting it out might provide substantial monthly profits. Problems arise, though, because you won’t make money until a tenant is renting the house and paying the expenses. It will be challenging to find tenants for rental properties located in unfavorable locations, and as a result, you may have to lower your monthly rent, reducing your profits or perhaps incurring losses.
  • Liens are imposed by the tax authorities. Tax liens are similar to high-yield assets. The main reason why investors buy tax liens is to get their hands on the property owner’s back taxes and interest. The hazards associated with tax liens should be carefully considered. One possible outcome is a legal battle with the property owner over your returns if they do not pay back the taxes they owe.

Advantages and Disadvantages of High-Yield Investing

Investing in a way that will produce a high-income yield is a thrilling endeavor. Consistent, predictable income is just the beginning; provided you’ve made smart investment choices, you can also expect your portfolio’s valuation to rise over time, which will add to your wealth.

Not everyone should pursue high-yield income investing, though; that’s true of any strategy. Before committing to something, it’s important to weigh the advantages and disadvantages.

The advantages of high-yield investing

There are numerous benefits to investing in high-yield income assets. 

The following are some of the potential advantages of doing so:

  • Income. These investments are aimed primarily at producing a steady stream of income, and who doesn’t like that kind of monetary inflow? The correct income investments can provide reliable cash flow on a quarterly or annual basis, depending on the specifics of the investment.
  • Stability. High-yield investments, such as dividend stocks, typically offer investors moderate but steady growth and are less affected by market downturns. Companies like this are ideal for inexperienced or risk-averse investors because of the reliability of their profits.
  • One should try to outperform the market. If you make smart judgments while investing in high-yield stocks, you may be able to outperform the returns of widely-followed indices like the S&P 500 and the Dow Jones Industrial Average.

The Disadvantages of High-Yield Investing

High-yield investments have many potential advantages, but there is no such thing as a risk-free investment. Before jumping in, there are a few potential disadvantages to think about.

  • Possibilities are higher. Real estate and REITs are examples of high-yield investments that also carry a higher degree of risk. Both REITs and other real estate investments depend on a wide range of variables, the most important of which is rental rates.
  • High Percentage of Default High-yield income investments, also known as trash bonds, is what most people mean when they talk about investing. Before you invest in junk bonds in the hopes of a larger-than-average return, keep in mind that their default rates are far greater than those of investment-grade bonds. When a company defaults on its loans, the investor isn’t paid back on time – and in extreme situations, may not be paid back at all.
  • Liquidity. To maximize your return, you may need to commit your funds to a high-yield investment for several years. You may have trouble getting your money out if you ever need it, or you may have to pay penalties to close your positions.
  • Over time, yields shift. The high yield that investment is providing at the present moment may not be sustainable in the future. Many high-yield assets are not easily traded, leaving investors vulnerable to being stuck with a losing investment.

The Secret to High Yield Investing Is Diversification

Income investors should always keep diversification in mind, regardless of the specific strategy they choose. Spreading your financial capital across many different types of assets can be thought of as a form of insurance, and is known as diversification.

If you have a diversified portfolio, even if one investment suffers considerable losses, the profits from the other investments will more than makeup for it.

Investing to maximize yield requires a diverse portfolio because most high-yield investments are in companies that have been dealt a bad hand or in highly speculative alternative markets.

If you’re an investor who wants to obtain exposure to high-yield trash bonds and stocks but doesn’t want to do the legwork of selecting individual investments, you can do so through exchange-traded funds (ETFs) that specialize in high-yield bonds or high-dividend equities. 

These funds aggregate money from a wide group of investors and invest it in a varied collection of high-yield investments. 

These funds’ most common examples are:

  • These are some examples of high-yield bond funds. iShares iBoxx $ High Yield Corporate Bond ETF (HYG), SPDR Bloomberg Barclays High Yield Bond ETF (JNK), and iShares Broad USD High Yield Corporate Bond ETF (USHY).
  • Funds Investing in High-Yield Stocks. Global X Nasdaq 100 Covered Call & Growth ETF (QYLG), SPDR Portfolio S&P 500 High Dividend ETF (SPYD), and WisdomTree Emerging Markets High Dividend Fund (DEM)

Do You Need to Expand Your Portfolio With High-Yield Investments?

The million-dollar question today is, given your familiarity with the basics of high-yield investing, whether or not you should add these income-generating assets to your investment portfolio. There is, alas, no silver bullet when it comes to monetary matters.

To begin, there is a wide variety of high-yield investments available, the great majority of which are high-risk. Quality high dividend yield equities, such as industry leaders in the energy sector, are the one exception to this rule. A diversified portfolio can benefit greatly from including these stocks.

Other high-yield investments, such as junk bonds, real estate, and tax liens, carry far higher levels of risk and aren’t suitable for most investors. Only those who are willing to take on the inherent risks of such investments and are intent on reaping the most possible financial rewards from their capital should consider making such investments.

Those with more time on their hands and a longer-term perspective may consider these assets. In their situation, a better-than-average return has the potential to grow substantially over time due to compounding. If things do go wrong, though, they still have time to make amends.

However, those who are nearing retirement age or who have a lesser tolerance for risk should avoid high-risk, high-yield investment vehicles.

Bottom Line

At first glance, high-yield investments may appear to be the best option. Everyone would like to increase their investment returns, after all.

On the other hand, you should weigh the potential consequences before making any hasty decisions. As is just about always the case in the market, in order to have the potential to earn bigger profits, you must be willing to incur a higher level of risk.

Additionally, not every high-yield investment is the same. It’s important to learn as much as possible about any investment opportunity before putting down any actual cash.

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