Slow Down When You See "High Yield" |
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Junk Bonds
Generally, bonds are lumped into two broad categories—investment grade and non-investment grade. Bonds that are rated BBB, bbb, Baa or higher are generally considered investment grade. Bonds that are rated BB, bb, Ba or lower are non-investment grade. Non-investment grade bonds are also referred to as high yield or junk bonds. Junk bonds are considered riskier investments because the issuer's general financial condition is less sound. This means the entity issuing the bond—a corporation, for instance—may not be able to pay the interest and principal to bondholders when they are due.
Junk bonds typically offer a higher yield than investment-grade bonds, but the higher yield comes with increased risk—specifically, the risk that the bond's issuer may default
Many investors heavily weigh the rating of a particular bond in determining if it is an appropriate and suitable investment. Although credit ratings are an important indicator of creditworthiness, you should also consider that the value of the bond might change depending upon changes in the company's business and profitability. Some credit rating agencies issue outlooks and other statements to warn you if they are considering upgrading or downgrading a credit rating. In the worst scenario, holders of bonds could suffer significant losses, including the loss of their entire investment. Finally, some bonds are not rated. In such cases, you may find it difficult to assess the overall creditworthiness of the issuer of the bond.
| Don't Reach Do not make your investment decision based solely on a bond's yield. This is referred to as "reaching for yield," and is one of the most common mistakes bond investors make. It is especially common during periods when interest rates are low and/or stock market performance is lackluster. The high return on the bond you are "reaching for" is usually an indicator of increased investor risk. Rather, take a more comprehensive look at your investment. In addition to looking beyond yield to such things as a bond's credit rating, liquidity and the creditworthiness of the issuer, evaluate your tolerance for risk, when you will need the money and how you plan to use the money you are investing. For more information about the dangers of yield reaching, see FINRA’s Investor Alert The Grass Isn’t Always Greener—Chasing Return in a Challenging Investment Environment. |
Distressed Debt
Believe it or not, there is a market for distressed and even defaulted debt. This is a playing field for sophisticated bond investors who are seeking—often through painstaking research, or with the intent to assume increased investment risk—to find a few diamonds in this very rough environment characterized by bankruptcies and steep debt downgrades.
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