High-yield investments offer the prospect of additional return, but high returns go hand in hand with greater risk. When you evaluate investments that offer high yields, you should approach them with a healthy degree of skepticism. Do the work of learning how the high-yield investments generate their returns and what factors would cause those returns to go up or down. You should consider buying them only after you understand these factors, which could include financial operating condition, industry competitors, and overall economic conditions.
You may be rewarded for taking on greater risk—and for possibly watching the value of your principal investment fluctuate dramatically—with yields that are significantly higher than safer alternatives such as Treasury securities (which are backed by the U.S. government). Here are some investments that are generally considered to be high-yield.
- High-yield bonds, mortgage REITs, and closed-end funds can be easily traded through an exchange to add high-yield options to your portfolio.
- Peer-to-peer lending sites offer another way to get an above-average yield.
- Master limited partnerships are another high-yield option, but they can complicate your tax situation.
High-yield bonds are issued by companies whose financial strength may not be rock solid. Often referred to as "junk bonds," they must pay a higher yield than safer alternatives in order to attract investors. You can buy individual high-yield bonds, but most investors would find high-yield bond mutual funds or exchange-traded funds (ETFs) to be more attractive and diversified options.
Mortgage Real Estate Investment Trusts
Mortgage real estate investment trusts (REITs) make money by lending to property companies, purchasing mortgages, and/or investing in mortgage-backed securities. They're obligated to pay out 90% of their profits in the form of dividends in return for favorable tax treatment.
Mortgage REITs are considered to be riskier than those that own properties (which are known as "equity REITs"), because they're typically much more highly leveraged, meaning that they borrow lots of money. They're also vulnerable to interest-rate risk: When interest rates rise, the difference between the returns that mortgage REITs receive from lending and their costs associated with borrowing tends to shrink.
Shares of closed-end funds (CEFs) are available for buying and selling on exchanges, but unlike ETFs, CEFs are unable to issue new shares. Many closed-end funds use leverage to increase their available money for investing, which can contribute to their high yields and increase their risk profile.
When considering buying CEFs, you must pay close attention to their share price in relation to the funds' net asset value (NAV)—the value of their assets minus their liabilities. Unlike mutual funds and ETFs, which have much more liquid markets and whose share prices tend to closely track their NAVs, CEFs can experience a large discrepancy between their NAV per share and their share price. Make sure you buy CEF shares when they're trading at a discount to the per-share NAV.
Alternative asset investors who are looking for higher yields might consider peer-to-peer, or P2P, loans. An online portal connects investors and borrowers, and provides a platform that sets market rates for the loans. These loans can be pooled together or individually funded by a single investor, meaning you can lend small amounts to many people or a larger amount to one person. Just as with any loan, you take on the risk that borrowers might not repay what they owe.
Master Limited Partnerships
Master limited partnerships (MLPs) are publicly traded partnerships that pass their income through to investors without paying corporate tax rates. Most MLPs are in the energy infrastructure business, such as managing pipelines, and they often can provide higher yields for their investors than dividend-paying stocks.
MLPs lost some of their tax advantage over C corporations in 2018 following the Tax Cuts and Jobs Act, but most of it was maintained. Trading of MLP shares is less liquid than most other types of publicly traded securities, and MLPs can produce tax headaches for their investors: Owners of MLP shares must file a complicated K-1 form and may have to file state income tax returns in all states in which the MLP operates. In addition, if you own MLP shares in an IRA, you may be required to pay federal taxes on what's known as unrelated business taxable income (UBTI).
The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.