What is a junk bond?

According to Msnbc:

CHICAGO — A sideways stock market has investors searching for other places to make a decent return on their money. And junk bonds, for better or worse, are starting to look like gems to many.

The appeal is easy to understand.

Junk bonds, known more politely as high-yield bonds, are bonds with very low credit ratings that corporations pay more interest on so they can attract investors. As of last week, they were yielding 8.34 percent, down from 9 percent earlier in July.

That number is mighty enticing at a time when the Standard & Poor’s 500 index is up just 1 percent for 2010 and down 22 percent from a decade ago. And a murky economic outlook hampers prospects of a strong rebound any time soon.

Virtually nowhere else can you get 8 percent back on your money these days. The going rate for a 10-year U.S. Treasury note last week was 3.05 percent, low by historical standards. It’s not much better for investment-grade, or more highly rated, corporate bonds: 3.8 percent, as measured by the Barclay’s Capital U.S. Credit Bond Index.

Return-starved investors have noticed. High-yield mutual funds have seen nearly $3 billion in inflows over the past three weeks, according to Lipper FMI, a unit of Thomson Reuters.

But investor beware: They’re called junk for a reason. Bonds below investment grade, or those with S&P ratings below BBB and Moody’s ratings below Baa, are much likelier to default.

Has anyone ever owned junk bonds? I have and they did quite well. They were part of a mutual fund I had in a retirement program. They made all sorts of money. I rolled that acount over a while back and I don’t know how that bond fund is doing now. My great risk-taking was when times were good and not a great deal of money was involved.

Are these junk bonds worth the risk? It seems like all of us have taken a huge risk just having a 401k. I honestly have thought about just jumping off the merry-go-round.

Who knows where some good rates of return are outside the stock market? I have a retirement account that guarantees me 4.5%. I used to laugh at it. Now I am not so sure.

2 Thoughts to “Junk bonds: Savvy investment or fool’s gold?”

  1. IVAN

    Investing is a risk vs. reward proposition. The events of the last few years have made people alot more conscious of risk and changed their expectations of reward. Unless you have a bunch of money to gamble with, chances are you will take a more conservative approach to investing until the US economy turns around. Junk bonds are just another instrument designed to seperate people from their money. If you have extra “play money” then by all means give it a shot. If you are relying on your investments to live on the rest of your life, then I’d be VERY cautious.

  2. Thanks for your input, Ivan. I would probably not have those mutual funds today…if I still had that portfolio. They sure made good money back in the day though.

    One good way to help offset a laggard stock market is to buy stocks with good dividends.

    I am not sure how that works with a 401k or 403b plan though.

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