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
Despite those risks, performance has been positive lately. High-yield bonds have generally outperformed high-quality investments like U.S. Treasuries, investment-grade corporate bonds, and the overall US Aggregate Index this year, but that pace of outperformance may be difficult to replicate going forward.
Are high-yield bonds a good investment right now? ›
High-yield bonds and preferred securities can be considered by long-term investors who can ride out some volatility, but we wouldn't suggest large or overweight positions in either given the low yield advantage they offer relative to high-quality investments. Many preferred securities do offer tax advantages, however.
What is the downside of high-yield bonds? ›
What are the risks? Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market.
Should you have high-yield bonds in your portfolio? ›
To be sure, high-yield bonds aren't the only fixed income investments that can offer attractive yields and reliable income. However, high-yield bonds also offer a unique advantage that other bonds don't. Their returns are not strongly affected by changes in interest rates.
Is it good to buy bonds when yields are high? ›
Because bond prices typically rise when interest rates fall, the best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but about to come down.
What happens to high yield bonds in a recession? ›
During recessions, as the gray columns below indicate, or during periods of general market volatility, high-yield spreads tend to rise sharply. That can be painful for high-yield bond investors because rising spreads pull down the prices of high-yield bonds relative to Treasuries.
What is the safest high-yield investment right now? ›
Overview: Best low-risk investments in 2024
- High-yield savings accounts. ...
- Money market funds. ...
- Short-term certificates of deposit. ...
- Series I savings bonds. ...
- Treasury bills, notes, bonds and TIPS. ...
- Corporate bonds. ...
- Dividend-paying stocks. ...
- Preferred stocks.
The Bottom Line. Interest rates and bond prices have an inverse relationship. When interest rates go up, the prices of bonds go down, and when interest rates go down, the prices of bonds go up.
What is the largest risk associated 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.
Which government bond gives the highest return? ›
List of the 10 Best Government Bonds
| Bond Issuer | Coupon Rate | Credit Rating |
|---|
| Tamil Nadu Generation and Distribution Corporation Limited | 9.72% | A |
| Karnataka State Financial Corporation | 9.24% | AA- |
| West Bengal State Electricity Distribution Company Ltd | 9.34% | A- |
| Indel Money Limited | 0% | BBB |
6 more rowsJan 24, 2024
2024 is 'a good time to hold bonds'
Bond funds tend to lose value when interest rates rise, and when inflation ticks up. “The aggressive nature of those interest rate hikes contributed to the aggressive decline of bond values,” Lee said. Rising interest rates tend to lift rates on new bonds.
What is the long term return of high-yield bonds? ›
True to their name, high-yield bonds offer an average yield of about 7.7% as of June 30, 2024. This alone is higher than the 7.4% annual long-term return on the S&P 500 since 2000 (based on Bloomberg data to the end of May 2024).
Should I put my savings in a high-yield? ›
While you can grow your money with a high-yield savings account, it's not the best way to generate long-term wealth for retirement because the yield often doesn't keep up with inflation. As a result, working with a broker or robo-advisor to develop an investment portfolio is better for long-range plans.
Can you lose money on bonds if held to maturity? ›
TAKEAWAYS: Not losing money by holding a bond until maturity is an illusion. The economic impact of market rate changes still impacts investors holding bonds until maturity. A bond index fund provides an investor with greater diversification and less risk.
What bonds have a 10 percent return? ›
Junk Bonds
Junk bonds are high-yield corporate bonds issued by companies with lower credit ratings. Because of their higher risk of default, they offer higher interest rates, potentially providing returns over 10%. During economic growth periods, the risk of default decreases, making junk bonds particularly attractive.
Should you sell bonds when interest rates rise? ›
Most bond investors are in it for the long haul, meaning for the term of the bond, but there are several good reasons for selling bonds before they mature. They include: Selling bonds because interest rates are about to increase, making your existing bonds less valuable.
Is it a good time to buy bonds right now? ›
While it may be a great time to buy, hold, and ladder bonds, the outlook is also bright for investors in funds that manage bonds with an eye to making money as prices rise.
What happens to high yield bonds when interest rates go up? ›
Bonds have an inverse relationship to interest rates. When interest rates rise, bond prices usually fall, and vice-versa. To those unfamiliar with bond trading, the negative correlation between interest rates and bond prices may be counterintuitive.
