High Yield Instruments: What You Need to Know


High yielding financial instruments are something every investor in the markets salivates over. Even newbies to the market often set out in search of the highest yielding instruments, often throwing caution to the wind.


This article is going to give you an overview of the options available along with recommendations as to which ones are best suited for you, depending on your experience level.


What is a High Yield?


Before we dive in though, we need to first look at what exactly is a high yield. A lot of people come into the markets with unrealistic expectations and one of the first things they tend to look at is how soon they can double their money.


Generally those approaching investment with this mindset are unsatisfied with anything that doesn't double their money within 6 months or a year.


Needless to say, this is an extremely unrealistic way of looking at an investment, be it financial or in business. A high yielding financial instrument is something that pays out at a rate of 3-8%, with 8% considered extremely high.


The instruments highlighted below all fall within this range and their after tax return varies depending on the type of investment you choose to make.


Dividend Stocks


This is the evergreen choice when it comes to investing in high yields. Certain companies are comfortable with paying out a high percentage of their earnings as dividends and as an investor, such stocks are certainly worth getting into.


Its easy to get caught up just looking at the dividend yield, that is the ratio of the dividend to the price, and evaluate everything from that standpoint. This is true indeed of every option listed here.


You need to take into account the payout ratio (that is the ratio of dividends paid to total earnings) and also evaluate the ratio of dividends paid to the operating free cash flow.



This latter metric is perhaps the most important thing to look at since earnings can be given a boost with accounting gimmickry. Taking a 10 year snapshot of payouts, earnings and operating free cash flow should give a good picture of the company's prospects.


You should also ask yourself how well you understand the business the company is engaged in and whether you find it predictable.

Along with these numbers, you should also ask yourself how well you understand the business the company is engaged in and whether you find it predictable. In case you find the business model obscure, do you trust the management of the company to figure things out?


Such qualitative concerns should be at the top of every investment checklist.


Historically, the stocks which have performed best are the ones who have steadily paid out dividends as well as increased the amount of the dividends paid out. These stocks are collectively called the dividend aristocrats and you can either purchase them individually or via an ETF or index fund.


This latter method is the preferred and easiest choice for those looking to get into this type of investment. The biggest advantage with investing in stocks is that you expose yourself to both the dividend growth as well as capital appreciation in terms of the increasing share price.


Municipal Bonds


Municipal bonds or Munis are an excellent option for investors. While their overall yields are lower than dividend stocks, munis have tax advantages associated with them that common stocks don't.


Municipal bonds are simply bonds issued by municipalities to finance their projects. These projects might be building new roads, repairing infrastructure and so on. Usually, residents of these municipalities receive tax benefits by purchasing the bonds.


Muni yields are usually around 2-3% compared to stock dividend yields of 3-5%. In addition, given that these are bonds, your initial purchase price will be higher. However, there are a number of muni ETFs and funds which you can purchase.


The issue with purchasing funds or ETFs of munis is that you need to research whether you receive the tax advantages. A general muni fund may not provide you with any tax advantages even if it does invest in tax free bonds.


You should carefully read through the prospectus or offering document prior to purchasing any such fund.

As for the bonds themselves, it pays to research what the bond will finance, the interest payment (coupon) and the past history of the county or municipality issuing the bonds.


You also want to check with your CPA or a tax specialist as to how the bond will be treated come tax time since some munis may attract AMT payments. Always check with an expert prior to investing in individual bonds.


REITs


REITs are the easiest way to get a piece of the real estate pie. You don't need a mortgage, your initial investment is low and you can receive yields of around 7-8%. What's not to love?


REITs are obligated to payout 90% and above of their earnings back to their investors so you're always assured of a majority share of whatever income the company earns.


Generally speaking Equity REITs, that is companies that generate income from rental payments, are easier to understand since they own physical assets that are easily understood.


Mortgage REITs generate their income by investing in mortgage backed securities or by financing real estate projects themselves and their accounting is open to some financial gimmickry, or to put it correctly, more gimmickry than usual.


The advent of eREITs is a major move to providing access to investors of all capital levels to the real estate market.

REITs can also be general or highly specialized when it comes to the types of assets they invest in. So you could have a REIT that invests in only commercial office space, another that invests only in hospitals and clinic and another that invests in a cluster of properties in an area.


The advent of eREITs is a major move to providing access to investors of all capital levels to the real estate market. This type of REITs are also known as real estate crowdfunded instruments.


They are a great option if your capital is low. The downside is, they're usually not traded on an exchange so the liquidity, or ease of selling, is low.


Generally speaking, REITs are a great addition to a portfolio from a diversification standpoint since they follow the real estate cycle, independent of the usual market cycle.


Given their high yields and assets, they are something you must invest in right from the start.


Savings Accounts


No, this doesn't refer to savings accounts which pay out 1 or 1.5% and call it a high yield.


While you should have a portion of your money in these accounts, if you have some money to spare or money you can afford to lose, opting for an offshore savings bank account can be a great option.


There are a number of stable, emerging economies out there whose banks are willing to pay you a high interest rate for your dollar deposits. As an example, Georgia's (the country, not the state) banks regularly offer an interest rate of 6% on term deposits.


If you choose to invest in the local currency, your interest rates can be as high as 10%.


There are a number of countries out there poised to become the next India, China or Brazil.

These are all before tax of course and your interest received will be taxable as ordinary income. There is also the matter of political stability and currency fluctuation to take into account. As such, conservative investors ought to steer clear of this.


However, if you have some cash lying around doing nothing and if you won't miss it terribly if it disappears, these accounts are a great option. Not to mention it gives you an excuse to go visit the country in question.


There are a number of countries out there poised to become the next India, China or Brazil. This is a great way taking advantage of long term economic cycles.


Conclusion


Within the financial world these options are the safest way to gain high yields on your investments. As you can see some of them are tax free and some are not.


You need to calculate your after tax, after inflation return to truly evaluate them correctly. Additionally, qualitative concerns such as ease of investment and the "headache" factor need to be taken into account.


All in all, high yield investing is the best way to grow your portfolio and is something you should be taking advantage of vigorously.



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