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How to understand high yield/junk bonds

What about buying individual High Yield Bonds?

In general, it is not prudent for the average investor to buy high yield bonds individually.  The risk of repayment can be enormous. The key to buying into this market is typically diversification.  The majority of retail investors will not likely have the capital to broadly diversify this portion of their portfolio across hundreds of holdings.   Furthermore, the likelihood that the average investor has completed the necessary financial analysis in each individual company’s financials is also improbable.   Most investors will be served far better by capturing exposure to these areas through mutual funds and ETF’s.

When should you buy High Yield Bonds?

The purpose of buying into this area of the market is that it serves as a potential hedge against interest rate risk.   Should an investor have a fixed income portfolio of treasuries, government agencies and good quality corporate bonds, they will be exposed to the negative/inverse correlation when rates rise over time.   As a result, having a small portion of your fixed income portfolio allocated to this area of the market will offset a portion of that risk, while simultaneously paying a higher income.   Such a holding simply balances the risk associated with the better quality debt holdings.  It is important to note that these positions are typically a much smaller percentage of the overall holdings than that of traditional fixed income.  In cases where a portion of your portfolio is exposed to stocks or stock funds, it should also be noted that high yield bonds may correlate closely with them as well.  The correct percentage exposure in an individual’s portfolio is going to be specific to that person’s financial goals and time frame. The same can be said of any asset class, as each situation must be addressed in a unique manner.

Joe Favorito

Joseph Favorito is a Certified Financial Planner™ who began his career in the financial services field in 1997. Over the past two decades Joseph has worked for several New York stock exchange members. In 2011 he founded Landmark Wealth Management, LLC , a Long Island-based Securities Exchange Commission registered investment advisory firm.