Cash and debt

Q. Is it best to invest in companies with lots of cash and no debt? — M.T., New Orleans

A.

Not necessarily. Lots of cash is generally good for a company as it can, for example, permit it to invest in growth or pay dividends to shareholders. Companies with ample cash can take advantage of opportunities that come along. But having much more cash than can be put to good use is not optimal, so some companies aim to have low cash balances, planning to borrow funds when needed. This strategy is less attractive when interest rates are high, though.

Meanwhile, it’s generally OK for a company to have a manageable amount of debt — especially at low interest rates. If it’s borrowing at a relatively low rate while getting great results from the money, that’s an effective strategy.

Q. What’s a “high-yield” stock? — S.C., Elkhart, Indiana

A. There’s no official definition, but it’s generally one with a dividend yield topping (or significantly topping) some benchmark, such as the 10-year U.S. Treasury note — which recently yielded 3.7%.

A stock’s dividend yield is the current annual dividend amount divided by the stock’s current price. So if the Home Surgery Kits Co. (ticker: OUCHH) is trading at $100 per share while paying $1 per share in dividends each quarter (for a total of $4 per year), its dividend yield would be $4 divided by $100, resulting in 0.04, or 4%.

Don’t invest in any high-yield stock without researching it first. As a stock price falls, its yield rises, and vice versa — so one ultra-high yield might reflect a company in trouble while another might reflect a healthy company with lots of cash to spare.

Beware of leveraged ETFs

Exchange-traded funds — which are like mutual funds in many ways, but which trade like stocks — can be great investments for most of us. Many are index funds, often with very low fees. There’s a kind of ETF that most investors should avoid, though: leveraged ETFs.

A leveraged ETF often tracks a certain market index or industry as a traditional index fund might — but with a twist. It employs leverage (a fancy word for debt) in order to amplify gains. It may also use options, futures or other derivatives. A typical leveraged ETF might aim to deliver double or triple the return of an index it tracks — and its name might reflect that via the inclusion of a “2x” or “3x” in its name. (Some just use terms such as “ultra” in their names.) For example, if the Dow Jones Industrial Average rises by 2% one day, the UltraPro Dow30 ETF will appreciate by 6% (less fees).

There are even “inverse” leveraged ETFs: A 2x inverse leveraged S&P 500 ETF, for example, will aim to give investors twice the opposite return of the S&P 500. So if the S&P 500 drops 1% on a certain day, the ETF would go up by 2% (less fees).

This may sound good, but there are several major cautions. Remember that while a leveraged ETF can amplify gains, perhaps doubling or tripling them, it will also amplify losses. So a 3x leveraged ETF can deliver a 10% blow if the index it tracks falls by 3.3%.

Even worse, as these ETFs are focused on daily returns, they’re not meant to be longterm investments. Indeed, holding them for days, weeks or months can deliver big losses — and they can even fall in value when expected to rise. This is problematic, as it goes against the rather effective investing strategy of buying shares of terrific businesses (or simply buying into low-fee, broad-market index funds) and hanging on for many years, if not decades.

Unless you have an appetite for risk, steer clear of these ETFs.