This is the time when many people ask whether they should be buying junk bonds. Why? Because they envision turning such junk into gold. What's in back of this?
First of all, the stock market is still in flux (or is that an understatement?) and interest rates are at extremely low levels (another understatement?). As a result, investors are looking high and low for better returns and therefore, are casting an eye over what are known as high-yield corporate bonds….or junk bonds.
Secondly, keep in mind that because they have low credit ratings, junk bonds do offer much higher interest rates than, let's say, Treasury bonds. For example, a benchmark junk-bond index compiled recently by Merrill Lynch shows that such bonds have a yield of around 10.5 percent compared with a measly four percent return on a 10-year Treasury note.
Thirdly, many experts (and I use that term advisedly) are even proclaiming that now is a good time to own junk bonds because unlike regular bonds, junk-bond prices tend to rise along with the stock market as corporate balance sheets get stronger. We see this already. Junk bonds have started climbing.
Now don't forget that junk bonds have a reason why they are called that. Along with high yields, they do carry a much higher risk. For instance, as the economy floundered last year and companies were struggling to stay afloat, 21 percent of the world's junk bonds were in default, on a dollar-volume basis, according to Moody's Investor Services. That's almost a quarter of all junk bonds.
So, what to do? If you don’t want to get really trashed, keep three basic points in view: First, never buy individual bonds. Most experts will agree that if you need or want to buy junk bonds, then buy mutual funds that own a kettle of different junk bonds. Who are they? Consider Pioneer High Yield A, Neuberger Berman High Inc. Bond Inv., Columbia High-Yield Z, and WM High Yield A.
Next, consider plunking less than 20 percent of your bond portfolio in junk. Why? Volatility and high risk.
Finally, you have to keep a constant vigil on your portfolio. Remember that junk prices can fall quickly as default concerns increase. This is especially true in a soft economy.
If you don't have a pretty thick skin coupled with a high-risk tolerance, you should probably steer clear of investing in junk bonds. Your heart may not be able to take it. However, my friends at Morgan Stanley say that with today's economy expected to improve (it can go only one way, right?) this may be a good time to buy selected high-yield bonds. The current spread between junk bond yields and Treasury yields are what is called "generous" by historical standards.
Want to know more about the investment style of a junk-bond mutual fund? Log on to www.morningstar.com. They offer a composite peek at the credit ratings of junk bonds held in various funds.
But, no matter what, caveat emptor here.
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