Invest in high risk investments and receive high yields. Invest in low risk stocks or funds and receive lower yields. It is a standard investing maxim. But ‘risk’ is the operative word and there are no guarantees in either class. The key to success is not simply sticking your money into a high risk investment and hope for the best. High yields investments require that you take into account several factors and research is key.
If you take the time to do your homework, you can reduce the risk in high risk investments and maximize yields.
In reality, most high risk investments will potentially fail to make you the money you expect and return disappointing yields. And this is usually not because of conditions but due to poor managers. The markets are a relatively flat playing area, so all asset managers start from the same position. Yet most fail while others excel. It is a fact that most mutual, future and hedge funds produce poor returns.
So what can you do to ensure that your investment constantly yield high returns? You are taking the risk with your money. How do you protect your investment and receive the rewards you would expect from your risk?
First of all check the consistency of performance of the investment. Any investment can have a period o high performance in a bull market. A short burst of high yields might be down to a specific market issue, a spike in one sector or generally strong trend. To take out the short term success factor look at the investment over a three to five year period. If yields are consistent and if they performed well in market downturns then these are the sort of vehicles worth your time. They will show that steady management has kept these investments returning good yields over a long period.
A second area to look at is fees. Make sure when you are reviewing yields
that you look at fees and how they may impact returns. Fees can quickly add up and they can serious reduce your returns. And remember it’s you taking the risk.
Managers who get paid a portion of the fees could be in a conflict of interest between generating revenue for the fund or institution and what’s best for you. Mangers in this situation are more likely to trade in order to create more commissions for themselves and that might not be best for the investment.
Thirdly look at the performance of the manager. Look at his or her performance with all funds they have managed. Some asset managers will show off their best performing account but it is incumbent upon you to look at all their investments. And again look over a longer period of time. If the fund manager has been successful with a number of investment vehicles over three to five years through a number of market conditions then they are worthy of your confidence.
The best managers will use long term disciplined techniques that liquidate losers quickly and ride profitable trends. If you are risking your money in high yielding investments that are designed to produce higher returns then the method of is crucial. You have to have confidence in the manger that that will stick with their system or manage their way out of losing periods.
Drawdowns are important to look at too. Drawdowns are the peak-to-trough decline during a specific period of an investment or fund. It is usually quoted as the percentage between the peak and the trough. A drawdown is from the time a retrenchment begins to when a new high is reached (because you won't know the depth of the trough until the new high is reached). It is important to look at your investment in terms of drawdown as well as profit and look at the performance in terms of the severity and length of any drawdown. For example, if an asset manager produces gains of 60 percent with a 50 percent drawdown and another does 40 percent with a 15 percent drawdown, the latter is probably the better from a risk over reward point of view.
Another thing to consider is the length of a drawdown from peak to valley. If you jumped in at a particularly low period for the investment, how long would it take for you to reach a new high in equity?
As with so many investments research is key. But the higher risk of high yield investments means you have more things to consider and must research more and deeper into the investment and the manger. If you follow the above you can go some way to minimizing your risks and maximizing your profits.
Jay Northco is the editor of http://www.Cramerwatch.org a website that pits Wall Street Guru and host of Mad Money, Jim Cramer against a stock-picking monkey.
