The Quest For Higher Yields

Getting “more bang for the buck” from one’s investment comes in two forms, capital gains and income, making up the basic total returns’ equation. A branch of methodology called income investment (or commonly known as dividend investment) focuses on the income part, which not only consisted of dividends (from equities), but also distributions (from real estate investment trusts or REITs), coupons and interest (the latter two being fixed income terminologies).

Picture generated by Meta AI

The attraction of this investment methodology lies in its simplicity; the ease of calculation of the expected amount and it being entering one’s bank account is visible. Across the income spectrum mentioned in the previous paragraph, investor attention is paid to dividends from equities and distributions from REITs as their yields are usually higher than that of those from fixed income (bonds and cash). Resultingly, it is common for income investors to go for instruments with higher yield, since (naturally) this translates to having more money in the bank.

However, those who are in the markets long enough would know that higher yields meant higher risks. Something has got to give to gain that much of a yield from a given set of capital, even if the deal does not sound “too good to be true” in the first place. For instance, high yielding bonds are so because of the low credit worthiness of the borrower. On the other hand, a positive example of high yield could be due to capital distribution and/or special dividends being announced. These occurrences do not happen every time, so it is prudent to check on the dividend components if a company/REIT reported a high payout for the moment.

In looking for higher yields, a main factor to think about would be consistency, i.e., the ability to give that level of yield over a longer period, and preferably not too much compromise on the underlying capital (remember that returns = capital gains + income). Also, do not just look at published yield figure itself, for it is typically displayed as a ratio of past annual payout over the current share price. Sometimes it can be misleading, too, where there are cases of yield rising but the underlying payouts and share prices are reducing, particularly when viewed across preceding periods (see this post for more information).

An honourable mention is given to financial instruments that utilise derivatives and/or cryptocurrencies to generate unusually high yields that outmatch the traditionally super low-grade junk bonds. As of the writing of this post, the highest yield encountered stood at slightly more than 280%, which is an exchange traded fund (ETF) that sells call options of a company whose main assets are cryptocurrencies. While they look attractive, due diligence is required on understanding how these products work, what are the underlying assets, and the historical performance in deriving the yield numbers.