Look for Securities Trading Below Par Value
Sell When It's Time
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What's the secret to building a strong high-yield portfolio? While there is no magic bullet, I do have some rules that I follow to create portfolios that pay nearly double-digit yields and see strong capital appreciation.
On average, these securities are yielding 7.5%. That's over three times the yield of the S&P 500. Try getting that amount from a money market or savings account.
But that's not the half of it. In tandem with those high yields, the capital gains have been great too. Twenty-nine of the thirty securities are showing positive returns. The best performer has gained 104.6%, yet still yields 5.3%.
This isn't the performance of some secret index or an exclusive hedge-fund's holdings. It's what is currently happening within the portfolios of my High-Yield Investing advisory.
What's the secret to that sort of performance? How can you build a similar portfolio for yourself? Don't get me wrong—I do an enormous amount of research and watch my holdings and the market like a hawk. But much of the good fortune comes from sticking to a few simple rules that you can use as well.
Over the years, these rules have proven their value in bull and bear markets. The techniques are not complicated. Anyone can follow them and potentially get the same results. So as a little holiday gift to my fellow income investors, I wanted to share with you the four basic rules I follow to build my winning High-Yield Investing portfolios. I'm confident these tips can work for you as well:
Rule #1: Look for High Yields Off the Beaten Path.
To find exceptional returns and yields, I frequently venture off the beaten path. Some of the best yields I've found have come from asset classes few investors know about. A case in point is Canadian REITs. These REITs delivered exceptional yields this year (some as high as 12%), but many stateside investors have never heard of them.
Other lesser-known securities I look at are exchange-traded bonds, master limited partnerships and income deposit securities. All of these usually yield more than typical common stocks. In addition, they can also be less volatile and hold up better during market downturns.
Rule #2: Consider Alternatives to Common Stocks.
It is a well-known fact that the vast majority of common stocks simply don't yield much. The S&P 500's average yield is only 2.0%.
So when I can't find the income I want from common stocks I like, I look elsewhere. My first stop is often preferred shares of the same company, which almost always yield more. Say you wanted to invest in General Electric (GE). The common shares of GE currently yield 3.0%, but you can find preferred shares of GE yielding upwards of 7.0%. You still benefit from the underlying company's backing, but enjoy a much higher yield.
Similarly, many companies offer exchange-traded bonds. While you don't get actual ownership of the business as you would with common stock, you will earn a much higher yield and have your principal backed by the underlying company.
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Rule #3: Look for Securities Trading Below Par Value.
Some of my highest returns have come from buying bonds when they trade below par value. Par value is simply the face value assigned to a stock or bond on the date it was issued. Most exchange-traded bonds (which you can buy just like a share of stock) have a par value of $25 per note.
But sometimes investors indiscriminately dump these bonds, pushing their prices down. By purchasing the bonds at a discount to par, you lock in great opportunities for capital gains in addition to higher-than-normal yields.
A case in point was Delphi Financial Group 8% Senior Notes. I purchased the notes in July 2009 for $19.27—a 23% discount to par value. During the 16 months I held, I collected $3.00 per note in interest payments while the shares rose to their $25 par value. In total, the notes returned over 45%!
Rule #4: Sell When It's Time.
This rule may seem the most obvious, but it is also the most difficult to follow.
Like everyone else, I hate to admit I was wrong about an investment. But I find it even harder to watch losses mount as a pick falls further. That's why I'm not afraid to take a loss. I swallowed my pride and closed out several positions for losses during the last bear market, and I'm glad I did. Continuing to hold these would have greatly reduced returns on my portfolio.
It may sound like a cliché, but knowing when to sell is just as important as knowing when to buy. A wise investor knows when to cut losses and move on to the next opportunity. If the security in question is falling with the market, I may not be worried. However, if changes in the company's operations mean it could see rocky times ahead, I want no part of it.
Editor of StreetAuthority’s High-Yield Investing
P.S. The rules I've shared above should help guide you to higher yields and better returns—they've certainly done well for my High-Yield Investing subscribers. I hope you can put them to good use in the coming year. And if you'd like to learn more about High-Yield Investing, including how to access my full portfolios, click here.