29 Dec Junk bonds vs. high-yield bonds

Q. Is there a difference between high-yield bonds and junk bonds, or is it just in the name?
— Investor

A. It’s all about name-calling.

The term “junk bonds” is effectively a slang term for “high-yield bonds.”

The term “high-yield bonds” is really a euphemism for bonds that have to pay high rates of income because of their low ratings and potentially high default rate, said Stephen Craffen of Stonegate Wealth Management in Oakland.

He said junk bonds are usually those that have a rating of below BBB from S&P and below Baa from Moody’s.

Most people invest in high-yield bonds through a mutual fund or exchange traded fund (ETF), Craffen said.

“It is imperative that you be well-diversified if you are considering high-yield bonds as an investment since their default rate has reached high levels during times of economic stress,” he said. “In 2009 and 2010, they exceeded 10 percent. It certainly can take a lot of income from the bonds to compensate for that.”

Craffen said he’s not a huge fans of high-yield bonds because of their behavior during recessions. They act like a stock, he said, because their prospects are so heavily dependent on the strength of the issuing company.

“These tend to be companies that might be small or for various reasons do not have ready access to credit markets without paying a lot for credit. Or they could be companies experiencing difficulty whose debt has been downgraded,” Craffen said.

During a recession, Craffen said, bonds should be the safe part of a portfolio and not one that acts like another stock investment but without the potential upside that stock has in the long term.

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This post was first published in December 2016.