Smart Strategies For High-Yield Mutual Fund Investments

High-yield mutual funds are an attractive investment option for those seeking impressive cash flow, moderate price volatility, and broad diversification. These funds primarily invest in lower-quality bonds, which are riskier than those of higher-quality companies but offer higher yields. When considering how to invest in high-yield mutual funds, it is essential to understand the associated fees, such as expense ratios and sales loads, and to assess the fund's track record and investment strategy. Additionally, investors should determine their risk tolerance, time horizon, and portfolio needs before selecting a fund that aligns with their financial goals.

Understand the risks and benefits of high-yield funds

High-yield funds, also known as "junk bond funds", can be a great way to boost your portfolio's returns. However, it's important to understand the risks and benefits before investing.

Benefits of High-Yield Funds

• Higher Returns: High-yield funds offer the potential for higher returns compared to safer investments. This is because they focus on lower-quality bonds, which are riskier but can provide greater income.
• Diversification: High-yield funds invest in a diverse range of securities, including stocks, bonds, and other assets. This diversification can help reduce risk and provide access to a wide range of investments.
• Professional Management: These funds are managed by professionals who have the expertise to make investment decisions and monitor the portfolio. This can be beneficial for individuals who don't have the time or knowledge to manage their investments actively.
• Instant Diversification: High-yield funds typically own hundreds of individual bonds, providing instant diversification for investors. This diversification can help reduce the overall risk of the investment.

Risks of High-Yield Funds

• Credit and Economic Risk: High-yield funds are more vulnerable to economic downturns and credit risk. If issuers default on their payments during tough economic times, the value of the fund may decrease.
• Default Risk: High-yield bonds have a higher risk of default because they are issued by entities with low credit ratings. This means there is a greater chance that the issuer may not be able to make their interest payments.
• Volatility: While bonds are generally less volatile than stocks, high-yield bonds can exhibit stock-like behaviour due to the additional risk they carry. This means that the value of the fund may fluctuate more than that of a safer investment.
• Fees and Expenses: Mutual funds charge various fees, including expense ratios, sales charges, and management fees. These fees can eat into your overall investment returns, especially if the fund has a high expense ratio.
• Tax Inefficiency: Mutual funds distribute dividends and capital gains to investors, which can trigger tax events. This can be a disadvantage if you are not prepared for the tax implications.
• Poor Trade Execution: Mutual funds are traded only once per day at the closing net asset value (NAV). This may be a disadvantage for investors who require faster execution times or those who engage in day trading or short-term trading strategies.

Compare fees and sales charges

When investing in high-yield mutual funds, it's important to compare fees and sales charges to make informed decisions. Here are some essential things to consider:

Expense Ratios:

Expense ratios are annual fees charged by the fund management company, typically expressed as a percentage of your investment. These fees cover the costs of managing the fund, such as administrative, distribution, and marketing expenses. The expense ratio directly impacts your investment returns, so it's crucial to consider this factor when selecting a mutual fund. Look for funds with lower expense ratios to maximize your profits.

Sales Loads or Commissions:

Some mutual funds charge sales loads or commissions when you buy or sell shares. These fees can vary depending on the fund and are usually a percentage of your investment amount. There are three types of sales loads: front-end loads, which are charged when you buy shares; back-end loads, charged when you sell shares; and level loads, which are charged annually. No-load funds, also known as no-transaction-fee funds, do not charge any sales commissions, making them a more cost-effective option for investors.

Early Redemption Fees:

Mutual funds may also charge early redemption fees if you sell your shares within a specified period, usually within a month or a year of purchasing them. These fees are intended to discourage short-term trading and encourage long-term investments. Be sure to review the fund's prospectus to understand any applicable redemption fees and their potential impact on your investment strategy.

Other Fees:

In addition to the fees mentioned above, there may be other costs associated with mutual funds, such as account fees, transaction fees, or management fees. It's important to carefully review the fund's documents and disclosures to identify all potential fees. Understanding the fee structure will help you make informed decisions and avoid unexpected costs.

When comparing fees and sales charges, it's essential to consider your investment goals, risk tolerance, and time horizon. Remember that fees can significantly impact your overall returns, so selecting funds with lower fees and charges can help maximize your investment profits over time. Conduct thorough research and carefully review the fund's prospectus and disclosures to make informed decisions about investing in high-yield mutual funds.

Choose between active and passive funds

There are two main types of investing strategies: active and passive. Both have their own advantages and disadvantages, and it's important to understand the differences before deciding how to invest in high-yield mutual funds.

Active investing involves a hands-on approach, with investors or portfolio managers regularly buying and selling stocks or other investments based on their short-term performance. Active investors aim to beat the average returns of the stock market and take advantage of short-term price fluctuations. This strategy requires a deep analysis of investments and expertise in knowing when to pivot into or out of a particular stock, bond, or asset. Active investing can be more expensive due to the need for ongoing analysis and portfolio management, and there is also the risk of making costly mistakes. However, it offers the potential for higher returns and the flexibility to invest in "diamond in the rough" stocks.

On the other hand, passive investing involves buying and holding investments over a long period, often in the form of mutual or exchange-traded funds. Passive investors limit the amount of buying and selling within their portfolios, making it a cost-effective strategy. Passive funds aim to mirror the performance of a specific index, such as the S&P 500, by holding the same or similar securities in the same proportions. This approach benefits from ultra-low fees, good transparency, and tax efficiency due to the buy-and-hold strategy. However, passive funds may offer limited investment options and smaller returns compared to active funds.

When deciding between active and passive funds for high-yield mutual funds, it's essential to consider your investment goals, risk tolerance, and the amount of time and expertise you can dedicate to managing your investments. Active funds may be suitable if you are comfortable with a more hands-on approach and are willing to take on higher risks for potentially higher returns. On the other hand, passive funds could be a better option if you prefer a more passive approach, lower fees, and a more straightforward investing strategy.

Additionally, it's worth noting that many investment advisors blend active and passive strategies to take advantage of the strengths of both. This blended approach can help minimize wild swings in stock prices during volatile periods and further diversify a portfolio.

Decide where to buy your funds

You need a brokerage account when investing in stocks, but you have a few options with mutual funds. If you contribute to an employer-sponsored retirement account, such as a 401(k), there’s a good chance you’re already invested in mutual funds.

You could buy directly from the company that created the fund, such as Vanguard or BlackRock, but doing so will limit your choice of funds. You can also work with a traditional financial advisor to purchase funds, but it may incur some additional fees.

Most investors opt to buy mutual funds through an online brokerage, many of which offer a broad selection of funds across a range of fund companies. If you go with a broker, you'll want to consider:

• Affordability: Mutual fund investors can face two kinds of fees: from their brokerage account (transaction fees) and from the funds themselves (expense ratios and front- and back-end “sales loads”).
• Fund choices: Workplace retirement plans may carry only a dozen or so mutual funds. You may want more variety than that. Some brokers offer hundreds, even thousands, of no-transaction-fee funds to choose from, as well as other types of funds like ETFs.
• Research and educational tools: With more choice comes the need for more thinking and research. It's vital to pick a broker that helps you learn more about a fund before investing your money.
• Ease of use: A brokerage's website or app won't be helpful if you can't make heads or tails of it. You want to understand and feel comfortable with the experience.

High-yield bond funds can be bought at almost any online brokerage, but some brokers may have a wider offering. Bond ETFs will generally be available at any of the best online brokers. So, if you’re looking to invest in one, you’re likely to find what you’re looking for at a top broker.

But the situation differs for mutual funds. Since not all mutual funds are offered at all brokers, it can make sense to see if a potential broker offers the mutual fund you’re looking for. Start with the best brokers for mutual funds to see if it has access to the bond fund you want to buy.

Consider alternatives to mutual funds

Mutual funds and ETFs are some of the easiest ways to get exposure to high-yield bonds. However, there are other alternative investment opportunities that can make you a lot of money or provide more modest profits. These can be a good option if you want to avoid investments that trade through a broker or online discount broker.

• Peer-to-peer lending: Also known as P2P lending, this is a relatively new phenomenon. Online P2P services offer loans for various purposes. If you join the pool of investors who are willing to loan money, you can fund a loan to an individual once they qualify. The returns from P2P lending can often be higher than those from standard savings vehicles. However, the main risk is that you're loaning to people who may not have been able to get a loan from a bank, which could increase their likelihood of default.
• Real estate: You can buy and own property, such as a house, duplex, or multi-family dwelling. Being a landlord can come with its challenges, so you may want to hire a property management company to deal with tenants, collect rent, and make repairs. Alternatively, you can form a partnership with like-minded investors to spread the risks and responsibilities, or use an online investment platform that focuses on real estate, such as PeerStreet or Fundrise.
• Gold: Gold is often sought after as a tangible inflation hedge, a liquid asset, and a long-term store of value. It is considered a great diversifier due to its low correlation with other asset classes, especially stocks. There are various ways to invest in gold, such as buying physical gold, gold ETFs, gold accounts, or investing indirectly through gold mining stocks or futures and options.
• Owning your own business: Investing in your own business can produce high returns but also carries the risk of failure. Some businesses have low startup and ongoing costs, such as virtual or online businesses (e.g., teaching, consulting, coaching, IT support). You can also start a part-time business to bring in extra money while maintaining the security of your regular job.
• Equity crowdfunding: If you don't want to own your own business, you can own a part of someone else's through equity crowdfunding websites like AngelList, CircleUp, SeedInvest, and Wefunder. If the company succeeds, you will be rewarded, but if it fails, you may lose part or all of your investment.

It's important to remember that alternative investments may not be suitable for all investors and can carry significant risks, including the potential for substantial losses.

Frequently asked questions