High-yield investments provide the prospect of additional return, but high returns come with increased risk. When evaluating high-yielding investments, you should approach them with a healthy dose of skepticism. Do the research to understand how high-yield investments generate their returns and what factors cause those returns to rise or fall. It would be best if you only considered purchasing them after thoroughly researching these factors, which may include financial operating conditions, industry competitors, and overall economic conditions. You may be rewarded for taking on more risk—and possibly seeing the value of your principal investment fluctuate dramatically—with yields that are significantly higher than safer alternatives like treasury securities (which are backed by the U.S. government). Here are a few investments that are frequently cited as having high yields.
Important Takeaways
- To add high-yield options to your portfolio, high-yield trade bonds, mortgage REITs, and closed-end funds on an exchange.
- Peer-to-peer lending sites are another option for obtaining an above-average yield.
- Another high-yielding option is master limited partnerships, but they can complicate your tax situation.
Bonds with High Yield
High-yield bonds are issued by companies whose financial strength is questionable. To attract investors, "junk bonds," as they are commonly known, must pay a higher yield than safer alternatives. Individual high-yield bonds are available, but most investors would find high-yield bond mutual funds or exchange-traded funds (ETFs) to be more appealing and diverse options. Mortgage REITs are a type of real estate investment trust. Mortgage REITs make money by lending to property companies, purchasing mortgages, and investing in mortgage-backed securities. In exchange for favorable tax treatment, they must distribute 90% of their profits as dividends. Mortgage REITs are considered riskier than those that own real estate (known as "equity REITs") because they are typically much more leveraged, which means they borrow a lot of money. They are also vulnerable to interest-rate volatility: When interest rates rise, the difference between the returns mortgage REITs receive from lending and their borrowing costs tend to narrow.Funds that are closed-ended
Closed-end funds (CEFs) have shares that can be bought and sold on exchanges, but unlike ETFs, CEFs cannot issue new shares. Many closed-end funds use leverage to increase the amount of money available for investing, contributing to their high yields while also raising their risk profile. When considering purchasing CEFs, you should pay close attention to the share price in relation to the fund's net asset value (NAV)—the value of its assets minus its liabilities. Contrary to mutual funds and exchange-traded funds (ETFs), which have much more liquid markets and share prices that frequently follow their NAVs closely, CEFs' NAV per share and share price can vary significantly. Make sure to purchase CEF shares when they are trading at a discount to the NAV per share.Peer-to-Peer Finance
Peer-to-peer, or P2P, loans may be of interest to alternative asset investors seeking higher yields. An online portal connects investors and borrowers while also providing a platform for setting market rates for loans. These loans can be pooled together or funded individually by a single investor, allowing you to lend small sums to many people or large sums to a single person. You accept the risk, as with any loan, that borrowers will not repay what they owe.Master Limited Partnerships
Publicly traded partnerships known as MLPs transfer income to investors while avoiding paying corporate tax rates. The majority of MLPs operate in the energy infrastructure sector, including pipeline management, and they frequently provide investors with higher yields than dividend-paying stocks. MLPs lost some of their tax advantages over C corporations in 2018 due to the Tax Cuts and Jobs Act, but most of it was preserved. MLP shares trade less liquidly than most other types of publicly traded securities. MLPs can cause tax problems for their owners: MLP shareholders must file a complicated K-1 form and may be required to file state income tax returns in all states where the MLP operates. Additionally, if you own MLP shares in an IRA, you might have to pay federal taxes on taxable income from unrelated businesses (UBTI). We do not offer tax, investment, or financial advice or services. The information is presented without regard for any specific investor's investment objectives, risk tolerance, or financial circumstances and may not be suitable for all investors. Past performance does not predict future outcomes. Investing entails risk, including the possibility of losing principal.