Junk Bond Funds

Junk bond funds are mutual funds that invest in junk or high-yield bonds. Why are these bonds referred to as junk? Because these types of bonds are issued by corporations considered high risk. This means that bond rating services such as Standard & Poor's and Moody's Investors Service have assigned them a low rating in terms of the company's ability to meet its obligations.

So why would anyone invest in these kinds of investment vehicles? The answer lies in their alternative name, high-yield bonds. To offset the risk involved, these bonds offer higher interest rates than other corporate bonds and are sold at a discount.

Is the higher interest rate paid worth the risk? The answer is that it depends. The risk may be worth it if a company looks promising, but is too young to have an established a record, as opposed to having a bad history. On the other hand, if the company issuing the junk bond has poor growth, low profits or a lot of debt, chances are good that the risk is one you shouldn't take. Just keep in mind that in a worst-case scenario the company could go bankrupt and default on its obligations, causing you to lose your investment.

© 2024 Wolters Kluwer. All Rights Reserved.