Getting started with investing in fixed income can seem a little overwhelming at first. As a bond investor, you've got a wide range of possible choices. First, you could invest in high quality bonds, often issued by federal or state governments. Second, you can purchase highly rated corporate debt. This is fairly low risk. In fact, some corporations are now actually paying lower interest rates than many sovereign (government) bonds. Finally, you could commit some of your capital to high yield bonds.
It's possible to buy individual high yield bonds directly from the issuing company. But such piece meal purchases are beyond the reach of the majority of normal investors. The bond market is ruled by institutional players, who spend their days looking over corporate financials and assembling portfolios with maximum returns and minimum volatility.
Luckily, there are many excellent high yield bond funds and ETFs that you can invest in. They're managed by professional portfolio managers, and offer the great benefit of diversification. For instance, two of the most popular high yield bond ETFs (with ticker symbols JNK and HYG) currently have 223 and 446 different fixed income securities within their portfolios respectively. Likewise for a lot of of the available high yield bond mutual funds: they hold a large selection of individual securities, limiting some of the impact of default and price declines. You can visit Morningstar, Yahoo Finance or any other popular investment websites and easily find good high yield mutual funds.
You need to be a little mindful about when to invest in high yield. One strategy is to keep an eye on the so-called interest "spread" between high yield and high grade securities. High yield bonds usually yield between 4 and six percent more than bonds that are considered less risky. During economic recessions, this spread rises, as investors flee to the safety of government as well as other less risky bonds. Corporations selling high yield bonds then have to pay a high rate of interest to get investors to buy their bonds, so the interest rate difference may be 6% or sometimes even higher. This is often the best time to purchase high yield funds. For example, during the global financial crisis in 2008 and 2009, the high yield spread increased to upwards of seven percent over U.S. Treasuries. High yield bonds have gained a lot in value since then.
You should also be aware that high yield bond prices usually decline during economic recessions. In other words, they behave like the stock market. This means potential investment losses.
Don't allow the bad reputation of high yield bonds stop you from seriously considering them as a valuable source of income for your investment portfolio. But bear in mind that high yield bonds are a lot riskier than many higher grade fixed income securities. With the added yield comes increased risk -- in investing, there's no free lunch.
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