Earn Income of Up to 8% From High-Yield Bonds
With defaults rising, reaching for these returns means serving yourself a big portion of risk.
Issued by firms with below-average credit ratings, these bonds pay much more than investment-grade IOUs. The average “junk” bond now yields 8.4%, according to Merrill Lynch, up from about 5% in mid 2014. Today’s plump yields should help the bonds retain more value should interest rates rise.
Earnings for All
- Bank Accounts: 1%-4%
- Municipal Bonds: 1%-3%
- Investment-Grade Bonds: 3%-5%
- Real-Estate Investment Trusts: 2%-6%
- Foreign Bonds: 3%-6%
- Preferred Stocks: 4%-7%
- Closed-End Funds: 5%-11%
- Master Limited Partnerships: 5%-11%
Risks to your money. Defaults are rising, led by the energy, metals and mining industries. Ratings agency Fitch predicts that high-yield bonds will default at a rate of 6% in 2016, up from 3.5% in 2015. Although that’s well below peak rates of about 10% in a typical market cycle, making money gets harder when defaults are escalating, says Marty Fridson, a veteran high-yield analyst. Moreover, outside of commodity-related bonds, junk looks to be “fairly or richly valued,” he says.
Hire a pro. Treading cautiously makes sense in this environment. Osterweis Strategic Income (OSTIX, 7.6%) has held up relatively well in past downturns and should continue to limit losses if the high-yield market stumbles. Lead manager Carl Kaufman looks for businesses he believes are improving and are candidates for a ratings upgrade. Such discipline keeps him far away from the energy patch. (All prices and returns are as of March 31.)
Vanguard High Yield Corporate (VWEHX, 5.6%), a member of the Kiplinger 25, sticks with debt in rating tiers just below investment grade. Its conservative stance should make it a better bet in a junk slump. For more income, go for iShares 0-5 Year High Yield Corporate Bond ETF (SHYG, $45, 6.6%). It owns bonds maturing in less than five years, limiting its interest-rate risk. Energy-related bonds make up nearly 9% of its assets. That could hurt results if the rally in oil prices falters.