Not Your Grandma’s Bonds: Understanding Junk Bonds, High-Yield Bonds and Other Debt Investments

When many investors hear the word “bond,” the next word to come to mind is “stable” or ”boring.” Many people associate bonds with the Treasurys and high-grade securities popular among retirees. And indeed, these aren’t very exciting. They’re conservative debt investments designed to hold a stable value and provide a modest yield.

But as a whole, bonds don’t deserve their drab reputation.

There are big profits to be found in junk bonds and muni bonds – if you know where to look.

These are quite literally not your grandma’s bonds – they’re more risky than a typical Treasury or savings bond.

But with the right know-how, investing in high-yield bonds can be quite rewarding.

Below, we’re looking at two lucrative kinds of debt investments.

Each has its risks… and also its upsides.

Muni Bonds
Governments tend to be trustworthy borrowers. And the U.S. government is often too trustworthy to create good debt investment opportunities. Due to their extremely high-credit worthiness, the feds can borrow money at very low interest. That’s why their bonds are so boring for investors.

The same can’t be said about municipal government debts, or “muni bonds.” They’re issued by local governments like cities and counties to finance the construction of schools, roads, airports and other public projects.

Unlike the federal government, municipal governments do sometimes default on their debt. Detroit, for example, declared bankruptcy in 2013.

Thus, muni bonds do carry some risk. As a result, they pay a much higher interest rate than Treasury bonds. Today, many yield between 3% and 4%. What’s more, the income generated by muni bonds is federally tax-exempt. Depending on your state laws, it may even be completely tax-free.

If you don’t want to go through the trouble of picking your own munis, there are ETFs that can give you good exposure. The iShares National Muni Bond ETF (NYSE: MUB) has held its value pretty well this year.

The fund took a relatively large 4% dive after the election of Donald Trump, but it’s quickly recovering. It’s also worth noting that bond yields shot up after Trump’s win. His fiscal stimulus rhetoric has strengthened the case for a series of interest rate hikes in the next year.

Bond prices have an inverse relationship with yields. So while this rising interest rate environment might look like bad news for munis, it actually strengthens their income-generating potential.

Junk Bonds
Governments aren’t the only entities that can issue bonds. Corporations can join the debt investment party, too. And some corporate bond issues are very risky borrowers, which means they offer bonds with high interest rates.

Junk bonds are high-yield bonds issued by corporations with low credit ratings. And before we describe them more, we should warn you about something.

Corporate defaults happen quite often. When a company goes bankrupt, it gains the legal right to restructure its debts. And in many cases, that means bailing on some of its bond obligations.

Junk bonds can offer astronomical yields. Today, they hover around a 6% average, which is quite low compared to historical norms. Under different conditions, junk bonds can have double-digit coupon rates. But this is possible only because they come with a significant chance of losing your money.

Investing in the SPDR High-Yield Bond ETF (NYSE: JNK) is a popular way for individual investors to get in on the junk bond action. Despite the recent increase in interest rates, the junk bond fund finished the year with a net gain.

When you look at the bond market as a whole, it becomes clear that the stereotype of “Grandma’s low-yield savings bond” applies to only a small section of it. There’s plenty of profitability to be found in debt investments if you’re willing to take on a little extra risk.

And if you’re interested in learning about the nine-digit codes that can substantially boost your bond returns, check out this presentation from The Oxford Club’s Bond Strategist Steve McDonald.

— Samuel Taube

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Source: Investment U