The Secret to Building a Strong High-Yield Portfolio

Written By
Paul Tracy
Updated January 16, 2021

On average, they're yielding 7.1%. That's more than 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. Of the 34 securities, 31 are showing positive returns. The best performer has gained 118.9%, yet still yields 5.2%.

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 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 assets classes few investors know about. A case in point is Canadian real estate investment trusts (REITs). These REITs deliver exceptional yields (some as high as 12%), but many stateside investors have never heard of them.

[InvestingAnswers Feature: REITs - Real Estate Investing Minus the Headaches]

Other lesser-known securities I look at are exchange-traded bonds, master limited partnerships (MLPs) 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's a well-known fact that the majority of common stocks simply don't yield much. The S&P 500's average yield is under 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 (NYSE: GE). General Electric's common shares currently yield 2.9%, but you can find preferred shares of GE yielding more than 7.0%. You still benefit from the underlying company's backing, but with 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. 

Rule #3: Look for Securities Trading Below Par Value

Some of my highest returns have come from buying bonds trading below par value. Par value is simply the face value assigned to a 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 -- like during the recent market panic -- 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 (which have since been called). 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 more than 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 bear market, and I'm glad I did. Continuing to hold these would have greatly reduced returns on my portfolio.

[InvestingAnswers Feature: 7 Red Flags That Say It's Time to Sell]

It may sound cliche, 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 don't want a part of it.

These rules should help guide you to higher yields and better returns. 

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