3 Popular Options Explained
Unfortunately, unless you are one of the lucky few born into it, money very rarely comes for free. And even for those who are, history has shown how quickly vast fortunes can be squandered by those who do not take care of them. To a greater or lesser extent, the vast majority of us have to work hard for our money. And when we have managed to build a surplus that extends beyond the fixed costs of our chosen lifestyle, that money has to also be put to hard work if it is to amount to anything more than keeping abreast of inflation. Once an investor has amassed a healthy level of investment capital they can begin to split that up into different levels of risk and yield categories.
There is no set formula as to how an investor should diversify their portfolio in terms of risk. There is in most cases a close correlation between potential returns and widely accepted risk level. This very much depends upon the risk appetite of the individual investor and what they are prepared to accept as their best and worst case scenario. A model conservative investment portfolio would typically allocate 15% to 20% to higher risk asset classes while a very aggressive one, 80% or more. Carefully consider what you are prepared to potentially lose in the pursuit of greater gains when deciding on your own portfolio’s weighting.
It is important to do your homework when it comes to higher risk high yield investments. Question every detail and ensure that you are confident that you fully understand the factors that mean a high yield investment can generate its returns and what factors could mean those returns not being realised. Here’s a list of three popular high yield alternative finance options with medium to higher risk profiles for the appropriate section of your investment portfolio:
- High Yield Corporate Bonds
Bonds are relatively simple to understand. They are in essence the financial instrument equivalent of an IOU. Companies seeking to raise capital issue debt in the form of bonds with investors buying that debt from them in return for a regular, fixed income payment and the original loan being returned at the point of the bond’s maturity. This period can vary significantly but is most commonly between 6 and 10 years.
The risk lies in the possibility that the company that has issued the bonds will not be in a position to meet the interest payments and/or redeem the bonds when they have reached maturity. High yield bonds are a bet on the issuer remaining liquid enough to meet the obligation of the debt issued.
- Private Equity
While bonds are investors buying debt from a company private equity is investors buying a stake in the company itself, owning part of it. Private equity buys either a stake in or the full acquisition of privately held companies that are not listed on the stock exchange. The difference is you don’t subsequently have a liquid exchange and a market price at which you can subsequently sell those shares when you want. Private equity invests in the full range of companies from early stage start-ups to large international corporations with turnovers in the billions. This means that within private equity there is a vast range of risk profiles you can choose from should you choose to go down this route.
- Peer-to-peer Lending
The increased restrictions on bank lending to individuals and small companies, as well as the march of the digital age into the investment world, has seen the rise of P2P lending as an alternative finance investment option. P2P lending works in basically the same way as the tradition banking sector where loans are made at interest rates which reflect the relative risk profile of the borrower. The P2P platform will assess the prospective borrower’s assets and cash flow and in the context of their loan request assign repayment terms and an interest rate. The loan request must then be taken up by the private investors who use the platform. Taking one such loan in its entirety would clearly be very high risk. However, the idea is that each investor takes a fraction of the loan and builds a portfolio of loans with varying risk levels meaning that the portfolio can absorb a level of loan defaults while still realising a healthy overall profit.