Investment in Unwanted Bonds

What are junk bonds?

Junk bonds, or what is known as “high-yield bonds,” carry a higher risk than investment-grade bonds. Junk bonds can easily be identified when reviewing potential investment bond lists, as they receive credit ratings below BB from rating agencies like Standard & Poor’s (S&P) or Fitch, or a Ba rating or lower from Moody’s.

Why do investors buy junk bonds?

As with any other investment or loan, increased risk leads to higher interest rates. As an investor, you can earn more when investing in junk bonds compared to lower-risk bonds.

If you are willing to take on more risk compared to investment-grade bonds in the fixed income asset class, junk bonds are a logical option to explore.

Junk bonds can enhance the overall return of your portfolio while allowing you to avoid the high volatility of stocks. These bonds typically offer higher returns than investment-grade bonds and can improve if they are upgraded when the company’s performance improves.

Junk bonds generally perform closely with stock performance and are less correlated with other bonds. Unlike stocks, bonds provide fixed interest payments. They are less risky than stocks in some aspects. For example, bondholders are usually paid before stockholders in the event of bankruptcy.

Junk bonds are issued with maturities ranging from four years to over 10 years, with the most common being 10 years. Typically, junk bonds are non-callable for three to five years, meaning the borrower cannot pay off the bond before that time frame.

Advantages and disadvantages of investing in junk bonds

Advantages:

1. Higher investment returns: High-yield bonds usually pay higher interest rates than investment-grade bonds.

2. Less risk than stocks: In the event of a company bankruptcy, bondholders are paid before stockholders.

3. Regular payments: Like most corporate bonds, junk bonds include ongoing “coupon” payments until the bond matures.

4. Portfolio diversification: Investing in a single asset class can be risky. Adding a variety of junk bonds to your portfolio improves diversification if this asset class aligns with your investment goals.

Disadvantages:

1. Higher risk of default: Low credit ratings indicate a higher risk of default or bankruptcy in the issuing company, especially if the economy or business deteriorates.

2. Asset price risk: If the rating of the bond is downgraded, future buyers will demand a higher yield, which pressures the market price of the bond.

How do investors buy junk bonds?

If you are interested in adding junk bonds to your investment account, you have a few ways to get started. The best option for most individual investors is to buy a junk bond fund or exchange-traded fund (ETF). These funds give you exposure to a variety of junk bonds through a single purchase in your brokerage account.

Individual bonds: If you have available cash, you may be able to invest directly in individual bonds using your brokerage account. However, individual bonds do not provide very effective diversification and are not suitable for most investors.

ETF funds: These funds are bought and sold like stocks and give you exposure to many bonds at once. You should pay attention to the fund’s fees, historical performance, and ratings before purchasing.

Mutual funds

Mutual Investment: Mutual bond funds are another way for individual investors to access the bond markets. They are bought and sold in night batches but operate almost the same way as ETF funds.

Conclusion

Junk bonds make up a large portion of the bond market, but that doesn’t mean they should make up a large portion of your portfolio. For many individual investors, junk bonds can be completely bypassed. For others, this type of investment should represent a relatively small part of your portfolio and should be purchased through diversified ETF funds.

Unlike that pile in your basement, you might find junk bonds desirable for your investment portfolio. Just invest cautiously and make sure you understand the risks before hitting the buy button.

Source: https://www.thebalancemoney.com/what-are-junk-bonds-pros-cons-ratings-3305606