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 high-yield bonds a good investment now? ›
Additionally, the quality of high-yield bonds has improved recently, according to Northern Trust. “High yield issuers generally have become larger and more diversified, improving their ability to weather economic adversity.” In 2024, a high-yield bond could potentially be a way to diversify an investor's portfolio.
What is the downside of high-yield bonds? ›
While high-yield bonds do offer the potential for more gains compared to investment-grade bonds, they also carry a number of risks, like default risk, higher volatility, interest rate risk, and liquidity risk.
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.
How much of my portfolio should be in high-yield bonds? ›
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.
Do bonds lose value in a recession? ›
The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets. However, they also come with their own set of risks, including default risk and interest rate risk.
Will bonds do well in 2024? ›
There are indications that interest rates may start to fall in the near future, with widespread anticipation for multiple interest rate cuts in 2024. Falling rates offer the potential for capital appreciation and increased diversification benefits for bond investors.
Do high-yield bonds do well in recession? ›
The big deal with high-yield corporate bonds is that when a recession hits, the companies issuing these are the first to go. However, some companies that don't have an investment-grade rating on their bonds are recession-resistant because they boom at such times.
Why is rising Treasury yield bad? ›
A rising yield indicates falling demand for Treasury bonds, which means investors prefer higher-risk, higher-reward investments, while falling yield suggests the opposite.
What happens to high-yield bonds when rates rise? ›
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.
Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.
Are high-yield bonds guaranteed? ›
THE GUARANTORS High-yield bonds are frequently guaranteed by most, if not all, of the Issuer's domes- tic Restricted Subsidiaries (“Upstream Guarantees”), and in secured offerings, such Guarantors also typically provide asset security for the bonds.
What are the best bonds to buy right now? ›
9 of the Best Bond ETFs to Buy Now
| Bond ETF | Expense Ratio | Yield to maturity |
|---|
| Vanguard Total Bond Market ETF (ticker: BND) | 0.03% | 5.3% |
| BlackRock Ultra Short-Term Bond ETF (ICSH) | 0.08% | 5.5% |
| SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB) | 0.04% | 5.3% |
| iShares 20+ Year Treasury Bond ETF (TLT) | 0.15% | 4.6% |
5 more rowsJun 5, 2024
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.
At what age should you get out of the stock market? ›
There are no set ages to get into or to get out of the stock market. While older clients may want to reduce their investing risk as they age, this doesn't necessarily mean they should be totally out of the stock market.
Is it a good time to buy bonds now? ›
Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.
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.
Is it good to buy bonds when yields are high? ›
Rising yields can create capital losses in the short term, but can set the stage for higher future returns. When interest rates are rising, you can purchase new bonds at higher yields. Over time the portfolio earns more income than it would have if interest rates had remained lower.
Should you sell bonds when interest rates rise? ›
If bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
