What are High Yield Investments?
The term “high yield investments” refers to the investment instruments that offer higher returns in exchange for higher risk. The issuers of such instruments attract the investors by offering relatively higher return as compared to safer investment-grade instruments given that these investments involve higher risk. Usually, non-investment grade investments are the ones that offer a higher yield and hence are considered as high yield investments.
Explanation
As a thumb rule, if an investment offers a high rate of return within a short period of time, then it means that the investment is risky. If things go according to the investors’ prediction, then these investments can grow multiple times the initial investment amount and that is what lures most of the investors to high yield investments. However, in an adverse scenario, the investors might have to incur huge unattractive losses and that is the risk component.
List of Eight High Risk Investments
Now, let us look at some of the major high-risk investment options available in the market.
- Options: Typically, options trading can generate high rewards for investors who can successfully time the market. Investors should be good at understanding the market sentiments and the underlying performances of the stocks. The investors can earn high returns in a short period of time if the price of the underlying securities behaves in the originally predicted way. However, this form of investment is risky as it is highly dependent on the ability of the investors to time the purchase or sale of the securities.
- Initial Public Offerings (IPO): IPOs of less high-profile entities can offer investors the chance to earn high returns by purchasing the shares when they are severely undervalued. The investors can later exit or monetize when a correction in the valuation occurs resulting in high short and long-term returns. However, IPOs can still be risky because there is always a high degree of uncertainty pertaining to the ability of the company’s management to perform and achieve the desired goal, which is the basis of the company’s valuation.
- Venture Capital: The primary risk revolving around venture capital is that the future of most startups remains unstable and uncertain. The risk is also due to low transparency about the management’s ability to productively carry out the necessary business functions to achieve the desired outcome. While many of the startups fail, but the ones that are successful are able to generate returns in multiples of the initial investment.
- Foreign Emerging Markets: A growing or emerging economy is one of the best investment opportunities The interested investors can purchase either bond (corporate or government) or stocks as the country is probably in the middle of hyper-growth.However, the greatest risk in such a market is that nobody can predict how long the period of extreme growth is likely to continue. The political environment in these countries can change rapidly deteriorating the growth prospects previously seen in the economy.
- Real Estate Investment Trusts (REITs): REITs invest in pools of residential or commercial real estate and offer high dividends to the investors. Typically, REITs are prone to fluctuations as real estate ventures are primarily dependent on developments in the overall economy. The levels of interest rates in REITs oscillate between being flourishing and severely depressed. Hence, these investments are considered to be risky.
- High Yield Bonds: High-yield bonds usually offer extremely high returns to the investors in exchange for the potential loss of the entire investment. Many of the high yield bonds are considered to be junk bonds (high probability of default) and the investors are aware of that. But investors are particularly attracted by the significantly higher returns as compared to the investment-grade bonds offered by the government or reputed corporates.
- Currency Trading: The option of currency trading is best suited to professionals and certainly not for beginners because the currency exchange rate market is very fast-paced can result in significant losses to amateur investors. Investors who have the capacity to handle the high pressure of currency trading can reduce the risk by understanding the patterns of some of the currencies before putting their money into it.
- High Risk Mutual Funds: As the name clearly suggests, high-risk mutual funds carry a high degree of risk. However, the level of risk can be largely reduced by investing in the best-of-the-class high-risk mutual funds, which can deliver higher returns as compared to other mutual funds. So, it is advisable to conduct a proper market study before investing in this type of investment instrument.
Advantages
Some of the major advantages of high yield investments are as follows:
- These investments offer higher returns to the investor, which in turn increases their earnings. As such, in spite of their weak credit quality, high yield investments are very popular among investor communities across the world.
- In some cases, the investors are able to invest in undervalued companies at attractive prices as they are in their initial growth phase. Over the period, the issuers credit quality improves resulting in significant growth in the invested money.
Disadvantages
Some of the major disadvantages of high yield investments are as follows:
- There is a high probability that the issuer might default and the investments might become worthless. This risk perception leads to high return requirements.
- In some cases, the investors find it difficult to sell high yield instruments in the market resulting in liquid risk. Transaction costs, lower frequency as well as volumes of trading contribute to the liquidity risk.
Conclusion
So, it can be seen that high yield investments involve higher risk and hence they offer higher returns to attract investors. It is important that traders or investors understand the risk-return trade-off in high yield investments before they start investing in these instruments. High yield investments are best suited for investors who are willing to take the risk.
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