4. High-Yield Bonds
“High-yield” is the relatively modern term for what used to be primarily known as “junk” bonds. Junk bonds receive low ratings from credit agencies regarding their ability to pay off their debts. Since they are by definition riskier investments, they typically pay higher interest rates, thus the term “high-yield.” Particularly in a low interest-rate environment, these higher-than-average yields can entice investors to take on added risk in an attempt to earn a higher return.
Why High-Yield Bonds Are Toxic
High-yield bonds by their very definition are high-risk investments. Companies with low credit ratings are just like people with low credit ratings — they’re more likely to default or go bankrupt. If you own a high-yield bond of a company that goes bankrupt, you’ll likely lose your entire investment. It’s hard for individual investors to get all the detailed information necessary to understand what’s really going on at a company, so choosing a high-yield bond that will survive is a challenge. Buying high-yield bonds via a mutual fund is a way to lessen this risk, but it doesn’t entirely eliminate it.
