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How do I Choose the Best High-Yield Investments?

John Lister
John Lister

The general principles of high-yield investments are the same as any investment: to maximize the potential return will minimizing risk. How these principles should be applied depends on the individual investor's approach to risk. Successful high-yield investment leaves less room for error both in selecting assets to invest in, and making sure the initial price is suitable given the underlying potential and risks.

As with any form of investment, a high-yield investment decision is primarily based on the balance between risk and reward. There are some forms of investing that are either literally risk-free, or are so practically close as to make little difference. These usually include government bonds and savings in bank accounts covered by a government protection scheme. While there is no specific definition for high-yield investment, these risk-free investments usually produce a return too low for most people to consider them high-yield.

Income stocks may post a higher yield over time.
Income stocks may post a higher yield over time.

There are two separate elements of risk to consider. One is the risk that the return will be as high as possible. The other is the risk that the investor may actually lose money. Which of these risks is more important depends both on the money the investor has available to invest, and how much he is relying on the potential return.

Although every investment is different, there are some general principle that determine whether a type of investment has the potential for high returns; note that this is potential rather than a guarantee. Generally, high-yield investments will aim to make profits quickly, will not be diversified, and will be more vulnerable to financial shocks such as the company behind a stock going out of business. Investors therefore need to first choose the general balance of risk and reward that they are prepared to accept. Then, they need to look for specific investments where the potential reward is uncharacteristically high for that type of asset, the potential risk is uncharacteristically low, or both.

One tactic for choosing high-yield investments is using pricing models, such as the Black-Scholes model for options contracts. These are mathematical formulas that attempt to consider what a fair price for a particular investment would be, taking into account factors such as the potential return, the likelihood of reaching that return, the volatility of underlying assets, and the current returns available on risk-free investments. In theory, if an investment is priced below the fair price model, it is a comparatively good bet. Of course, while a pricing model is an objective assessment, the choice of factors used in the model is both subjective and potentially flawed.

Another important tip is to avoid high-yield investments that seem too good to be true. These can usually be identified by the promise of returns far in excess of those either offered or achieved by other similar investments. These investments may well be scams such as the Ponzi scheme. In such a scheme, the supposed returns delivered to existing investors are not funded by investment activity, but rather from money collected from new customers. This is a form of pyramid scheme and is mathematically almost certain to collapse at some point, leaving investors out of pocket.

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    • Income stocks may post a higher yield over time.
      By: xy
      Income stocks may post a higher yield over time.