High Yield Investments

In low interest times, everyone's attention turns to high yield investments. If you are on what is laughably referred to as "a fixed income", based on earning interest on a lump sum, you will have seen your income more or less halved in the past 18 months.

Some fortunate retirees are on defined-benefit pensions, which means that the actual amount you get paid is the same every month. Of course, they are often not adjusted for inflation, which means that the real buying power of that pension is gradually eroded over time, but that's another article.

Even if you are still working, where is your 401K money? And do you have other investments? For those in the growth phase, returns are the key to being able to retire at all.

When interest rates slide, returns slide. It's that simple.

When you have become accustomed to getting 6% or even 8% on your cash at call, a sudden drop to 4% is painful. It can be tempting to look farther afield than cash management accounts.

Don't get me wrong - you should definitely diversify in any case. But avoid the temptation to swing a sizeable portion of your capital into corporate bonds, debentures, and securitization funds.

What Are High Yield Investments?

High yield investments, as their name implies, return higher yields than more conservative investments. If you can get 5% on cash at call, for example, you may be able to get 9% on a corporate bond or debenture.

Remember, though, that financial markets are completely based on risk and return. The reason that companies are willing to pay higher returns is because knowledgeable investors such as big mutual funds require a return commensurate with risk. If the return is not high enough to compensate for the risk, then companies won't get investment funds.

The market does a reasonable job of matching returns to risk.

What this means for you, the small investor, is that if you see a good return that seems nice and safe, you are missing something. That provider would not be paying that return if they could get away with paying less.

Examples Of High Yield Investments

Some classes of bonds are categorised as "high yield" - those from companies with a less than stellar rating from Moodys or Standard and Poors, for example. Only bonds from companies rated AAA are "investment grade".

Debentures are a method by which companies borrow money from lots of smaller investors, rather than borrowing it all at once from a bank. As you are providing an essentially unsecured loan to a company, this is a very high risk investment. Often, companies will offer a monthly payment to debenture holders. Do not be fooled by the similarity between this and an income-producing mutual fund or term deposit. There is a very real chance that your capital will simply vanish when you invest in debentures.

Securitization funds, hedge funds, currency trading funds, and other mutual funds which provide high yields do so by grouping together a range of high yield investments. In theory, this reducs the risk of losing all your capital, but it does so by increasing the risk of losing a portion of it.

The Place Of High Yield Investments In A Balanced Investment Strategy

High yield investments are not bad - they have their place. A portfolio which is entirely in cash and blu chip shares won't grow terribly quickly. Having a proportion of your funds in high yield investments is sensible - but limit it to no more than 10%, and be prepared that some years you will lose more than you gain. On the up side, though, you may double that 10% in a single year.

High yield investments are high risk investments. Use them warily, and sparingly, as part of a balanced portfolio.