High Yield Notes

High yield notes are easy to find. Discovering ones that have an established history with minimal risk can be another matter. Find out which notes are yielding the highest rates and at what risk here.

High-Yield Notes: Don’t Forget to Do Your Homework

If you’ve been hearing a lot about high-yield notes lately, that’s because these securities have been getting a lot of attention over the last year or so as investors look for alternatives to traditional investments whose interest rates aren’t great right now. For example, you might hear about things like notes from GM with a 12% APY, or Microsoft notes with an 8% yield. Just seeing figures like these is enough to make novice investors drool, but unfortunately these high-yield notes are not all they’re cracked up to be. While no one’s saying categorically that you should not invest in them, it is important that you do your homework beforehand.

How high-yield notes work

Most of these notes fit into the category of reverse convertible notes (RCNs). RCNs are complicated, but I’ll try to put them in simple terms: Basically, they promise fixed income payments that depend upon certain events taking place. In other words, when you read the fine print of an RCN, you’ll see that the company has outlined various things that have to happen in order for the quoted interest to be paid in full.

Furthermore, these high-yield notes may actually cause you to lose some of your initial investment. In fact, with RCNs you’re exposed to multiple risks—there’s the risk that usually comes with debt instruments, and then there’s the risk associated with the underlying asset. Needless to say, before becoming involved with these instruments, you might want to ask yourself whether you have a stomach for this level of risk. And even if you do, it’s probably a good idea to confine these investments to a small out-of-the-way corner of your portfolio.

What to know before you buy

Obviously, the first thing you  need to know before buying one of these high-yield notes is the condition of the company. Companies generally don’t put out these kinds of instruments unless they’re expecting some form of shock to their system in the near future, and this is generally not a good sign. In all likelihood, the company is using these instruments to raise money to brace themselves against the shock. Do you really want your funds to be used for this purpose?

Another thing to know is what is embedded in the note that you’re considering buying. Most come with a slew of embedded options that make even the most advanced investors’ heads spin. Basically, if you’re not very familiar with the nature of all these details, then you’re pretty much trusting the company to tell you what’s what, and this isn’t always the most investor-friendly policy.

Finally, it’s also important to be aware of the basic built-in costs of the investment. For one thing, there are probably going to be fees paid up front—which can be up to 10 percent of the total cost—and there may also be costs associated with ending the transaction at certain times. Be sure to read the fine print of when the note expires and whether you can withdraw your funds without fees.