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Should I invest in junk bonds?

03/03/2024

Different investment types come with varying levels of risk attached to them. On the whole, bonds are often seen as one of the safer investments…but this isn’t always the case, as the existence of junk bonds shows.

But what exactly are junk bonds, and does their name suggest you should avoid them?

 

What are junk bonds? 

A junk bond – which can also be called a high-yield bond or a speculative-grade bond – is a type of corporate bond. Like other corporate bonds, they involve investing in debt: purchasing a junk bond means that you are lending money to the bond issuer on the promise that you will be paid back with interest when the bond matures. Whether the issuer can actually deliver on this promise is another matter. 

This is where bond rating agencies come in. Every bond is given a letter rating by these agencies: BBB or higher is classed as “investment-grade”, meaning the agency believes it’s likely that investors will see a return. Anything lower than BBB is a junk bond. Lower ratings suggest that a company is less likely to be able to repay its debts: these ratings are generally issued to companies that have seen recent financial difficulties, or that are brand new. 

 

Are junk bonds worth investing in?

Because of the high risk of default, junk bonds can pay significantly higher rates of interest than investment-grade bonds. The chance to receive a steady income stream with high interest rates can prove attractive to some investors. 

While a riskier investment than investment-grade bonds, investing in junk bonds comes with a lower risk of losing money than investing in stocks. During times of economic uncertainty, stock prices are more volatile than junk bond prices. 

However, there is a risk that the issuer can file for bankruptcy so investors could see a significant loss in value. In the years before they mature, junk bond prices fluctuate, meaning they may be unsuitable for those who prefer shorter-term investments.

The minimum investment amount is also relatively high compared with other investment types, which some may find prohibitive. Instead, some choose to buy shares in junk bond index or mutual funds to make junk bond investment more affordable and to spread the risk.

 

“Stable Rise Limited is not authorised or registered by the Financial Conduct Authority. The marketing materials are not intended to provide financial advice nor promote any individual financial products.”

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