As every veteran investor knows, investments that promise high yields should be approached with the utmost caution. At best, such investments are incredibly risky and should not serve as the backbone of anyone's portfolio. At worst, these investments could simply be shady schemes that may see short-term profit but are doomed to crash and burn eventually. However, as long as you can avoid the second category of investments, high-yield investments are a crucial component of every dynamic investment portfolio.
Given these issues, when it comes to investments with high yield, definition can be challenging. Let's look at some of the most common high-yield investments and discuss how they can help or hurt investors.
High-Yield Definition: The Good
By definition, there's no such thing as a good high-yield investment until it starts paying off. At the starting point, the vast majority of so-called "high-yield" investments are bonds or other categories of debt investments that either have been rated below investment grade or are sold by companies that have recently been trouble. Of course, there is very often crossover between these two categories.
The low status of high-yield bonds is the reason why they're sometimes referred to as "junk bonds" or simply "non-investment-grade bonds." Smart investors think twice before coming into contact with these volatile and high-risk investments, but it's important to realize that these bonds do have a place in good portfolios.
The key is not to put all your eggs in one basket. This tried-and-true bit of wisdom is fundamental to all good investment strategies, but it doesn't hurt to remind oneself every once in a while that a lack of diversity is the quickest way to lose money. Even if you find one high-yield bond that you feel 100% certain cannot fail, it's not smart to put all your funds into that one investment.
The key is to diversify your high-yield investments. For example, if you have investments in 10 high-yield bonds, it's important to realize that there's a high probability that one or two of them will fail, but you can hedge your bets by holding bonds by those companies' competitors as well as others in completely unrelated sectors.
High-Yield Definition: The Bad
Outside of the legitimate channels of the high-yield bond market, high-yield investments should only be approached with caution, and one should only participate in such investments with individuals or firms that can be trusted. If a stranger approaches you offering short-term high yields on an investment, this would be a good time to turn around and run away as fast as you can. Throughout the history of finance, such offers have been the lifeblood of scammers and shady dealers everywhere.
In fact, such schemes are so ubiquitous that there are names for them-for example, Ponzi Schemes, bubbles, and Pyramid Schemes-and there have been many high-profile cases of these schemes that should be instructive to beginning investors. The key to avoiding such investments is to always do your research. Rather than being rushed into things, take the time to check your investments out to make sure everything is as it should be.
Caterina Christakos is a published author and reviewer. Read her latest reviews of a Satellite radio mount and various satellite systems.
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