Bonds are rated according to their risk of default by independent credit rating agencies such as Moody's, Standard & Poor's and Fitch. Those with lower ratings have higher risks associated with them that investors should consider. Due to increased risks, these bonds typically carry higher coupon rates. Issuers, such as consumers with less-than-perfect credit, must pay more for loans. While investing in lower-rated bonds carries more risk when buying these junk bonds, do not completely write them off. There are opportunities among lower-rated bonds that can still prove to begood investments; you just have to know what to look for when investing.
Key Takeaways
- High-yield, or "junk" bonds are those debt securities issued by companies with less certain prospects and a greater probability of default.
- These bonds are inherently more risky than bonds issued by more credit-worthy companies, but with greater risk also comes greater potential for return.
- Identifying junk bond opportunities can boost a portfolio's performance, and diversification through high-yield bond ETFs can cushion any one poor performer.
Junk Bond Opportunities
Identifying goodopportunities among junk bondscan be difficult for the average investor. For this reason, the best way to invest in lower-rated bonds is through a high-yield mutual fund, closed-end fund(CEF) or exchange-traded fund (ETF). Investing this way gives your portfolio better diversification across several issues of high-yield bonds. Also, holding shares of a high-yield fund gives you access to professional money management. These mutual fund managers have more knowledge and time to research each bond issue held within the portfolio than an average investor.
Furthermore, investing through a mutual fund, CEF or ETF allows for the use of leveraging techniques, bulk discounts and some bond issues that are only accessible to institutional investors like a fund.CEFsonly issue a specified number of shares, and then the portfolio trades in the secondary market. If you can find a CEF trading at a discount to its net asset value, or NAV, you stand to profit not only from the high income payments but also from some growth on your principal investment. A few notable high-yieldETFsare theSPDRBarclays High Yield Bond (JNK) andiSharesiBoxx$ High Yield Corporate Bond (HYG).If you are set on choosing individual high-yield bonds to purchase for your portfolio, recognize that the necessary due diligence on your part will increase. Consider first selecting issues from companies deemed "fallen angels," those companies that are historically reputable but have temporary financial problems.
Other Considerations
By choosing to invest in bonds from these companies, you are likely to find deep discounts and high yields but can rest assured that the chances of the company defaulting on the debt are not as likely as current ratings may reflect in the market. Peruse the company's financial statements and sentiment toward the company's stock. If the stock is still valuable, the bond issue is likely to be fine too.
Follow interest rate patterns and changes; you profit from owning high-yield bonds in a rising interest rate environment as prices increase as yields align with new issues at prevailing higher rates.
What The Experts Have to Say:
Advisor Insight
Donald P. Gould
Gould Asset Management, Claremont, CA
High yield bonds are not intrinsically good or bad investments. Generally, a high yield bond is defined as a bond with a credit rating below investment grade; for example, below S&P’s BBB. The bonds' higher yield is compensation for the greater risk associated with a lower credit rating.
High yield bond performance is more highly correlated with stock market performance than is the case with higher-quality bonds. When the economy weakens, profits tend to decline and so does the ability of high yield bond issuers (generally) to make interest and principal payments. This leads to declining prices on high yield bonds. Declining profits also tend to depress stock prices, so you can see how economic news, good or bad, could cause stocks and high yield bonds to move in the same direction.
FAQs
High yield bonds are not intrinsically good or bad investments. Generally, a high yield bond is defined as a bond with a credit rating below investment grade; for example, below S&P's BBB. The bonds' higher yield is compensation for the greater risk associated with a lower credit rating.
Are bonds a good investment right now? ›
High-quality bond investments remain attractive. With yields on investment-grade-rated1 bonds still near 15-year highs,2 we believe investors should continue to consider intermediate- and longer-term bonds to lock in those high yields.
What are the problems with high yield bonds? ›
A high-yield corporate bond is a type of corporate bond that offers a higher rate of interest because of its higher risk of default. When companies with a greater estimated default risk issue bonds, they may be unable to obtain an investment-grade bond credit rating.
Are high yield bonds better investments than low yield bonds? ›
The low-yield bond is better for the investor who wants a virtually risk-free asset, or one who is hedging a mixed portfolio by keeping a portion of it in a low-risk asset. The high-yield bond is better for the investor who is willing to accept a degree of risk in return for a higher return.
Is it good to have a high-yield? ›
When choosing between placing your money in a high-yield savings account or investing, the best decision for you depends on your goals. High-yield savings accounts are good for short-term savings, like emergency funds, while investing can be better for long-term goals, like retirement.
Are high-yield funds risky? ›
But high-yield mutual funds and ETFs also come with risks. For instance, if a number of investors want to cash out their shares, the fund might have to sell assets to raise money for redemptions. The fund might have to sell bonds at a loss, causing its price to fall.
Can you lose money on bonds if held to maturity? ›
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
Are bonds still a good investment in 2024? ›
Positive Signals for Future Returns
At the beginning of 2024, bond yields, the rate of return they generate for investors, were near post-financial crisis highs1—and for fixed-income, yields have historically served as a good proxy for future returns.
What's better now, stocks or bonds? ›
With risk comes reward.
Bonds are safer for a reason⎯ you can expect a lower return on your investment. Stocks, on the other hand, typically combine a certain amount of unpredictability in the short-term, with the potential for a better return on your investment.
What happens to high yield bonds when interest rates go up? ›
When interest rates rise, prices of existing bonds tend to fall, even though the coupon rates remain constant, and yields go up. Conversely, when interest rates fall, prices of existing bonds tend to rise, their coupon remains constant – and yields go down.
Meketa Investment Group recommends that most diversified long-term pools consider allocating to high yield bonds, and if they do so, between five and ten percent of total assets in favorable markets, and maintaining a toehold investment even in adverse environments to permit rapid re-allocation should valuations shift.
Does high-yield mean high risk? ›
High yield or lower-rated bonds and municipal bonds carry greater credit risk, and are subject to greater price volatility. The taxable-equivalent yield shown is based on the highest individual marginal federal tax rate of 37%, plus the 3.8% Medicare tax on investment income.
Is it good to invest in high-yield bonds? ›
High-yield, or "junk" bonds are those debt securities issued by companies with less certain prospects and a greater probability of default. These bonds are inherently more risky than bonds issued by more credit-worthy companies, but with greater risk also comes greater potential for return.
Why are high bond yields a problem? ›
Rising interest rates affect bond prices because they often raise yields. In turn, rising yields can trigger a short-term drop in the value of your existing bonds. That's because investors will want to buy the bonds that offer a higher yield.
What are the cons of bonds? ›
Cons of Buying Bonds
- Values Drop When Interest Rates Rise. You can buy bonds when they're first issued or purchase existing bonds from bondholders on the secondary market. ...
- Yields Might Not Keep Up With Inflation. ...
- Some Bonds Can Be Called Early.
Looking at the asset class's historical performance leads us to believe that high yield is poised to produce a positive return in 2024, albeit not as robust as that experienced in 2023. We believe that the economy is not rolling over and that a recession is likely to be at least six months away.
What is the interest rate on a high yield bond? ›
Basic Info. US High Yield B Effective Yield is at 7.72%, compared to 7.60% the previous market day and 8.84% last year. This is lower than the long term average of 8.49%.
