The Basics And Better Way To Invest In High Yield Bonds In Today’s Business World
Thu, May 9, 2013
High Yield Investment Program
These bonds, often referred to as “junk bonds,” are issued by companies which are a greater credit risk than so-called “investment grade” bond issuers.
The difference between the two types of bonds is based on the creditworthiness and the likelihood the bondholder will be paid back with interest.
What Are High-Yield Bonds?
The definition of a high yield bonds is really simple. A high yield bonds is a bond which is usually issued by a smaller company that may be growing, have high costs, or any other type of business situation which limits its ability to pay off the bond when it matures. As a result, the bond issuing company has to pay a higher rate of interest to attract the capital for the bond. Hence the term us high yield bonds
How Do Credit Ratings Affect Yield?
An investment grade bond is more commonly issued by a company that may not even really need the money. For example, both McDonald’s (NYSE:MCD) and Wal-Mart (NYSE:WMT) both have issued bonds outstanding. Both of them are exceptional credit risks and the borrowings are only to cover cash gaps or to maximum capital allocation often through the tax advantages of issuing bonds. These companies have established businesses and regular cash flows and the risk of them missing an interest payment or not paying the money back when its due is extremely low.
The difference is that a big company with consistent cash flows can borrow money today and pay as little as 2% or 3% interest on their debt.
A less creditworthy company will have to issue us high yield bonds and pay two, three, or more times the amount of interest.
That’s the basics of high-yield bonds and their difference with investment grade bonds.
Here’s where investors come into it.
As with most investment sectors, junk bonds aren’t necessarily good or bad investment. What matters more is when an Investor buys Best high Yield Bonds. And that’s where the investment opportunity with high-yield bonds is created.
Let me explain.
Since high-yield bonds are issued by risky companies, they have gotten a bad reputation over the years.
But what has really given them a bad reputation is same thing that has happened to many other classes of investments.
That reason is many people have lost money in them.
Investors haven’t lost money in junk bonds because they’re “bad investments.” They’ve lost money in them because they’ve invested in them at the wrong time.
The chart below shows the SPDR Barclays High Yield Bond ETF (NYSE:JNK):
Notice the volume in the bottom of the chart.
When high-yield bonds had collapsed during the financial crisis, volume was very low. Most investors perceived them to be “risky” at the time and wanted “safety.”
Since then, the economy has slightly improved and the ability of high-yield bond issuers to make interest payments and pay them back when they’re due has improved. Interest in high-yield bonds and the price of them has improved right along with the economy.
So that’s the main reason high-yield bonds have such a bad reputation. Investors buy them at the wrong time so they are considered bad.
However, Contrarian Investors know that the best time to buy something is when no one else wants it. So even “bad investments” like high-yield bonds can be extremely lucrative. And anyone who bough high-yield bonds during the credit crisis would have nearly doubled their money and would be collecting a current annual yield of nearly 7%.
Now the good part. How does an investor make money in high-yield bonds?
How Individual Investors Can Buy and Profit in High-Yield Bonds
The thing about the bond market most investors don’t ever understand is that’s where Wall Street really makes its money.
The bond market is five times larger than the stock market. And it also attracts the most capable analysts and fund managers in the world.
As a result, bond investing from government bonds to high-yield bonds was once and still continues to be really an insider’s game.
Wall Street analysts have the access and time to properly analyze bonds. And individual investors are better off focusing on the trends and buying baskets of bonds through funds and ETFs.
Individual investors looking for the invest in high yield bonds in should use the advantages of diversification and wait for the periods of economic and financial market stability when bonds can fall greatly in price.
Right now, that’s not one those good times to buy high-yield bonds. That’s because they are only paying an average of 7% as a group. And if the next financial crisis is even five years away, the value of the bonds can easily be cut in half as they were in 2008. That means the 7% annual yield would total 35% of yield in that time while they could lose 50% of their value when the market turns.
The numbers just don’t work to make a winning investment.
Frankly, risking $1 to make 70 cents is not going to make any investor a successful one over the long run. And that’s the situation potential high-yield bond investors face right now.
The best way to invest in high-yield bonds is to buy them when the opportunities come. The only other way for individual investors to buy high-yield bonds will likely cost them more money than it ever makes them over the long run.
Executive Editor, Contrarian Insights
The Group of Big Investors in United States.
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