In recent years, the demand for high-yield investments has increased due to lowering U.S. Treasury prices and other low-risk investments. Fixed-income investments include municipal bonds, corporate bonds, government bonds, and Treasury bonds that offer returns on a fixed schedule. They are often classified into low, medium, and high-yield offerings, each carrying a higher level of risk.
Duration and Risks
There are two characteristics to look for in the bond market to find the highest yield: duration and risks. Long-term bonds tend to offer higher returns than short-term bonds. This is because there is more that can go wrong over ten, twenty, or thirty years compared to the shorter time frame of short-term bonds, hence long-term investors want higher compensation for the additional risk they are taking on.
Note: High yield always comes with higher risks. If you are a new investor, make sure to understand your risk tolerance to avoid losing your capital.
Investment-Grade Corporate Bonds
Investment-grade corporate bonds are considered a less risky way to increase yield. This is especially true if they focus on high-quality and short-term issues. For example, from 1997 to 2020, the yields on investment-grade corporate bonds were higher than the yields on U.S. Treasuries.
The trade-off for these high yields is a higher level of risk compared to U.S. Treasuries. Two main factors affect corporate bonds: interest rate risk (the impact of price movements on prices) and credit risk.
Over time, investors have paid for this risk: In July 2021, the investment-grade corporate bond index within the S&P 500 Investment Grade Bonds had a 10-year annualized yield of 4.8%. This outperformed the 3.15% yield of the broader investment-grade bond market, as measured by the S&P U.S. Aggregate Bond Index.
The performance of the Bloomberg U.S. Investment-Grade Corporate Bond Index over more than 10 years was even better, producing an average annual yield of 8.43%.
High-Yield Bonds
High-yield bonds are considered one of the riskiest areas in the bond market, with their volatility often close to what one would expect from equities. Nonetheless, high-yield bonds are one of the most popular ways to invest among those needing to boost their investment income.
From 2011 to 2021, high-yield bonds had an average yield advantage of 3.98% over U.S. Treasuries. As of June 30, 2021, the average annual yield over ten years for the Credit Suisse High Yield Index was 6.09%. Compare that to U.S. Treasuries, which averaged 2.11% in the same year.
The yield on high-yield bonds is over 2% better than the investment-grade bond market. Although high yields have declined compared to the stock market, they still represent an important part of the income portfolio – as long as you can handle the risks.
Note: The yields on high-yield bonds have shown a steady increase over the past ten years, as indicated by the average annual yield of the S&P 500 at 13.02%.
Senior Bank Loans
Senior bank loans were previously a somewhat obscure asset class. However, in the search for high-yield options, these assets have gained notoriety over time. Senior loans, also known as leveraged loans, are loans made by banks to companies that they then pool and sell to investors. Because most of these senior loans are made to companies rated below investment grade, they tend to offer higher yields than standard investment-grade corporate bonds.
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At the same time, senior loans can offer a return about 2% lower than high-yield bonds. Funds that invest in these types of loans tend to be less volatile than those focusing on high-yield bonds.
One of the most interesting aspects of bank loans is that they carry variable rates. This means the rate will be reset from time to time, rather than staying at a fixed level. This feature can somewhat protect against rising interest rates. You can expect funds that invest in senior bank loans to offer yields of around 2% or 3% above long-term U.S. Treasury funds.
Note: Senior loans carry higher risks than bonds.
Foreign Corporate Bonds and Foreign High-Yield Bonds
Until recently, the options available for investing in corporate bonds and high-yield bonds issued by companies outside the United States were very limited. However, the current demand for high-yield investments has led to the emergence of numerous mutual funds and exchange-traded funds in this area.
The yields are high: These types of funds will offer returns ranging from 3% to 6% above U.S. government bond funds. But if you choose to invest in exchange-traded funds outside the U.S., be cautious. When global markets face broad economic concerns, or when major events occur, these funds may not always be stable and carry a high risk of loss.
However, if you have a long-term time frame and can handle more risks than most people, you may want to consider this new and emerging category to increase your income and enhance your portfolio.
High-Yield Municipal Bonds
If you belong to a higher tax bracket, you have the option of investing in high-yield municipal bonds. These are bonds issued by government entities with a low credit rating. Funds that invest in this area can offer yields ranging from 1.5% to 2.5% above funds focused on investment-grade tax-based municipal bonds.
While the volatility is higher in this part of the market, those investing for the long term have been compensated for the higher risks they take. The performance of high-yield municipal bonds has outperformed investment-grade bonds over the past decade.
Finding Yield Outside the Bond Market
If you’re looking for investments outside the bond market while still getting high yields (and higher risks), there are several ways to do so, including:
- Convertible bonds
- Dividend-paying stocks
- Utility stocks
- Real estate funds
- Master limited partnerships
- Preferred stocks
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and maintain the accuracy, reliability, and quality of our content.
Federal Reserve Bank of San Francisco. “What is the yield curve and how can it be read?”
Federal Reserve Bank of St. Louis. “Yield on Baa-rated investment-grade corporate bonds as rated by Moody’s compared to the yield on 10-year fixed-maturity Treasury bonds (BAA10Y).”
Standard & Poor’s 500 Dow Jones Indices. “S&P 500 Index of Investment-Grade Corporate Bonds.”
Standard & Poor’s 500 Dow Jones Indices. “S&P U.S. Aggregate Bond Index.”
Vanguard. “Vanguard Long-Term Corporate Bond Index Fund Admiral Shares (VLTCX).”
Fidelity. “Portfolio Composition: DHY.”
Federal Reserve Bank of St. Louis. “10-Year Treasury Constant Maturity Rate (DGS10).”
Standard & Poor’s Dow Jones. “Standard & Poor’s 500 Index.”
T. Rowe Price. “Understanding the Current Opportunity in High-Yield Municipal Bonds.”
Source: https://www.thebalancemoney.com/highest-yielding-fixed-income-investments-417030
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