While there’s no rock hard definition for the term, it seems in today’s interest rate world that any security sitting above 5% is considered “high-yield.” It’s funny when you think about it – considering where interest rates stood during Ronald Reagan’s presidency some 30 years ago.
Referring to the chart below, on average, one could get a higher interest rate on a money market fund then, than can be had in a high-yield bond today. And the 10% rate on a 5-year CD in 1985 – well, you can get about 2+% on one of those from your local bank today.
To see a list of high yielding CDs go here.
But enough for the history lesson. Investors, for better or worse, have to take more risk in search of yield in today’s securities markets. If you are not blessed with movie star wealth and need elevated investment income, you have a number of choices, but none of them sit within the “risk free” realm. So as we exit the “risk free” milieu, we enter the elevated risk world of stocks and bonds. While I often opine that a diversified mix of securities is appropriate for most income investors, everyone has different risk tolerance and comfort level with the universe of traded securities. Stocks and bonds have various risks attached to them and thus what is appropriate for one person’s portfolio may not be appropriate for the next person’s portfolio.
High-yield bonds bring credit risk to the table since they are issued by entities with less-than-pristine balance sheets and business profiles. Bonds bring general interest rate risks to the table, which should be considered closely today as the threat of rate tightening looms. High-yield stocks bring both general business risk and market risk, via day-to-day equity value fluctuation, to the table. When looking at the general capital stack of a company, bondholders sit in a higher position to recoup capital in the event of a bankrupty, so from that respect, they could be considered less risky.
So, the answer to the question “should I invest in stocks or bonds” to some extent, is dictated by yield requirements. Unless one wants to delve into the deepest depths of junk bonds (CCC rated and below), there is generally a yield ceiling of 10 percent. If you want yields of above 10%, you need to look at equity markets. Mortgage REITs, some business development companies, option-income CEFs, and very risky levered ETFs and ETNs can provide low-to-mid-teens and sometimes higher yields.
As I mentioned above, I think most investors would benefit from a mix of income security types when looking at high-yield. Let’s hypothetically say an investor is targeting a yield of 8% from the high-yield portion of their portfolio. You could look at the secondary bond market for 8% yielders or you could purchase a closed-end fund like GHY – Prudential Global Short Duration High Yield which yields almost 8.5%, trading at a discount to net asset value with 25% leverage.
One could also employ somewhat of an equity barbell strategy to get to that 8% yield point. You could invest in a mortgage REIT like American Capital Agency (AGNC) currently yielding almost 11% and pair that with something with a much lower yield like Altria Group (MO) which pays out about 4.5 percent to get you to a blended 8 percent.
Whatever security selection strategy one employs, one needs to understand the potential pitfalls of higher-yield. Probably needless to say, substantial risk is being taken, in general, when one reaches for double digit yields.
While the days of 8% money markets are several decades gone, investors can still reasonably attain higher yields in today’s market. The reach for higher-yield today, unlike yesteryear, however, does not come with FDIC insurance.
Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.
About the author:
Adam Aloisi has over two decades of experience investing in equities, bonds, and real estate. He has worked as an analyst/journalist with SageOnline Inc., Multex.com, and Reuters and has been a contributor to SeekingAlpha for better than two years. He resides in Pennsylvania with his wife and two children. In his free time you may find him discussing politics, playing golf, browsing antique shops, or traveling.
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