Introduction to High Yield Mutual Funds and Money Market Funds
September 03 2010
The word "yield" is a general term in the world of finance meaning rate of return.
The yield of the mutual fund is the percent gain in value or income of a share of that fund for over some specified period of time. It is also
known as the "performance" or sometimes the "historic rate of return".
For example, if a fund or any security has a value of $100 per share at the beginning of 2009, and then rises in value to $110 per share at the beginning of 2010, we would say that it had a 10% yield because it rose $10 from an initial value of $100 ($10/$100 = 10%).
Higher yields are better for investors because it makes them more money but are often associated with securities that have low credit ratings. The historic rate of return is usually calculated for time periods of year-to-date, one year, three year, and five year returns. Some funds also have ten year return rates. There is a limit to how far back in history one can go, as mutual funds have a birthdate known as the "date of inception" or "incept date". Investors searching for a high yield mutual fund at the best mutual fund companies should be aware that in general, a historic rate of return is no guarantee of future rate of return. A mutual fund may do exceedingly well by having a high rate of return in one year (or over a few years), but the next year things may sour badly and the fund performs much worse. There are multiple reasons for this.
What Affects Mutual Fund Yields
One reason why the performance of the mutual fund can fluctuate so wildly is that the component stocks
in general fluctuate in value. In a bad year, the portfolio (or the groups of stocks) of the mutual fund
may all perform poorly individually, which leads to the mutual fund performing poorly also. Another reason
is that the fund manager who is responsible for choosing the component stocks, when to buy and sell, may
make a poor decision that results in lower yields. He or she may have pulled out of good stocks, entered
new ones, but finds that the research indicating this action does not pan out. Finally, some mutual funds
rely upon the state of powerful external forces, such as the Federal Bank's mandated bank lending rate.
Should the state of these external forces change for the worse of the fund, the fund may find itself losing
value rapidly. Many high yield mutual funds do not have good credit ratings which is one reason for why their
values are so volatile. Another overlooked factor is that load funds have higher fees which eats into the yield
whereas no load index funds have lower fees that affect an investor positively in the long run.
Identifying Strong Funds
That being said, some investors will seek to maximize their revenue with high yield mutual funds by
trying to identify strongly performing funds at the best mutual fund companies. This is not unreasonable. The thinking is that despite the
volatility and random nature of stocks, there may be certain combinations that prove winning over time
or in a window of time. These combinations may be randomly derived or selected through the skill of the
fund manager. At the very least, one should be able to filter out such high yield mutual funds
by looking at the strong performers. In other words, the high yield mutual funds are made of two
groups: a subset of true, strong mutual funds and a subset of ones that performed well due to chance.
These funds will help diversify your portfolio risk profile.
The First Step of Analysis
It remains up to the skill of the investor to discern among the high yield mutual funds to which class
each fund belongs. Therefore, identifying the high yield mutual fund is merely the first step in
analysis of what constitutes a good mutual fund. Asking for advice from a financial broker or advisor
may be helpful if there is no conflict of interest. Use the financial advisor or contact the
company directly to get a fund prospectus that will help you evaluate it. Websites like Morningstar.com,
LipperWeb.com and Finance.Yahoo.com offer valuable, up-to-date as well as historical information on
tens of thousands of high yield mutual funds.
Caveat Emptor
The investor should always be aware that historic rates of return are not predictive of the future. In
fact, high yield mutual funds may actually indicate greater risk. It's a generally accepted tenet
that in order to achieve stratospheric gains, a fund must sacrifice stability at the cost of increasing
risk. So while the chance for great gains is higher, the chance for great losses is correspondingly increased.