The Risks of Investing in High-Yielding Debt

High-yield bonds (popularly known as “junk bonds”) are corporate debt securities that pay higher interest rates because of the low credit rating of the issuer (indicating a higher default risk). 

Credit ratings are broadly classified into investment-grade rating and below-investment-grade rating.

Investment Grade

  • Rated BBB- or above
  • Lower Yields
  • Lower Default Risk

Below Investment Grade

  • Rated BB+ or below
  • Higher Yields
  • Higher Default Risk

In most cases, the risk outweighs the benefit of a high yield on the bond. The risk of default, depending on the economic and industry conditions, is dynamic.

A Few Examples of High-Profile Defaults

Over 2015-20, a number of high-profile companies defaulted on their bonds, leading to large losses for investors in these securities. The image below includes some of the most notable examples:

While junk bonds are risky, it’s not synonymous with avoiding them in all cases. Very shrewd investors with a diverse portfolio of issuers, liquidity of the paper, and adequate resources usually benefit from the higher yield.

However, for the vast majority of investors, we would recommend the following: