High-yield investments may seem attractive to many investors, especially after years of low interest rates on less volatile options. But there are many risks associated with high-yield investments that could damp returns and even wipe out your investment.
Understanding high-yield investments
The term “high-yield investments” usually refers to corporate bonds issued by companies with low credit ratings. Companies issue bonds to raise money as an alternative to selling stock or taking out a bank loan. Often, these companies are deeply in debt or face other financial stress. Investors who purchase bonds receive interest payments (also called the coupon rate) until the bond’s maturity date, at which point the borrowed amount is repaid.
In the same way that a consumer with a low credit score will pay more to borrow, companies that are deemed to be greater credit risks will be required to pay higher rates when they sell bonds. The good news for investors is that several credit-rating agencies evaluate the risk associated with high-yield corporate debt and assign each one a grade. This makes it easier to research and compare different investment opportunities.
Credit rating of high-yield investments
The credit-rating agencies break down their classifications into two categories: investment and speculative grade. Within each of those categories, you’ll also see a range of grades similar to school grades, with AAA being the best and C or D being the worst (depending on the agency).
Speculative-grade investments, also known as junk bonds, may have a higher yield but they also are considered to be at a greater risk of default. Even if the company itself doesn’t default and go out of business, it’s still possible for them to default on the terms of the bond agreement. That means you may not receive any or all of the interest or principal repayment when the bond’s maturity date arrives.
“High-yield investments” can also refer more broadly to a variety of assets that offer the potential for returns that top the market average. These assets are often volatile, making them a risky addition to an investor’s portfolio. There could also be a great deal of price fluctuation, making it stressful to monitor and manage a high-yield investment account. And because high-yield bonds and other instruments have the real potential for defaulting, it’s possible for investors to lose everything.
What is a high-yield stock?
In addition to high-yield bonds, you may also come across high-yield stocks and wonder how they differ from other types of high-yield investments. These typically refer to stocks that pay dividends, meaning investors receive a regular payout for each share. These aren’t necessarily all that risky and may simply signify that a company isn’t in an aggressive growth mode; instead of reinvesting profits in the business, they are returning cash to investors.
Advantages of high-yields investments
High-yield investments come with a few different advantages.
1. Higher yields
The primary attraction of junk bonds and other high-yield investments is the potential for loftier returns compared to investment-grade bonds. Evaluate each investment to determine the risk and reward. Bonds are popular, but there are other types of high-yield investments.
2. Potential for credit-rating upgrades
Another benefit is that not all companies that issue high-yield debt are failing. Some are actually deemed so-called rising stars, meaning they are either new or regrouping and have the potential of earning a credit- rating upgrade. So although a company may be considered a junk bond today, it could evolve from speculative grade to investment grade.
In addition to looking at a company’s credit rating, you should also evaluate its disclosure documents, including the prospectus. These give insights into the company’s financials and cash flow to gauge how likely you are to receive your interest payments and the initial principal at maturity.
3. Diversification with funds
Finally, it is possible to diversify high-yield investments so you don’t put all your eggs in one basket. High-yield bond ETFs and mutual funds are available to help spread the risk across multiple companies and industries. Funds typically include hundreds of companies. Even if some default, you have a better chance of earning gains overall.
Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Titan has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; Titan has not reviewed such advertisements and does not endorse any advertising content contained therein.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any strategy managed by Titan. Any investments referred to, or described are not representative of all investments in strategies managed by Titan, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see Titan’s Legal Page for additional important information.