Are Junk Bonds Misnamed?
Major agencies slapped the term ‘junk bonds' on them because of the high yield returns they touted and the high default rate that actually happened. This meant that if you put your money in these junk or high yield bonds, chances are that you might not even see your principal again.
Then in the 80s came Michael Milken and he looked long and hard at these bonds and realized that the default rate was not really as bad as it was portrayed to be. Thus the ‘high yield' market came into being. Actually, they had been in existence for quite a while but this was when perhaps they attained a sort of respectability.
People like Milken soon had a system in place to predict what could be termed junk and the ones that weren't and they encouraged these bonds to be issued. So if an investor took a calculated risk, he stood to make millions. So what it all boils down to is that when it comes to high yield bonds, you don't just think ‘risk free' and blindly put your money in. You need to take calculated risks. This means you need to take an informed decision.
The great thing today is the easy availability of research. So it means you do not really have to waste a lot of your time on gathering that. You could also get a rating for the bond from Moody's or Standard & Poor's and they have various standards: AAA/Aaa, AA/Aa, A/A, BBB/Baa), etc.
It really is like you were buying stocks. You need to do a lot of research about the company, its financial status, etc. There are so many sites on the Internet where you could find a lot of helpful information. This could take time but you could find people who are objective and experienced to advise you.
What are the success rates and the failure rates? Well, in the early 90s, the lower rated bonds reaped high 34.5% average returns. This was followed the next year with junk bonds giving better returns. Is this relevant today? It is, because out of the total issues, high yield bonds were a third. In fact these returns look like they are competing with the returns stocks aim for.
When it comes to bonds an over 8% return would be considered good and of course 15 % would probably be manna from heaven. The trick is to do a balanced portfolio with a combination of high risk and low risk, also balancing sure returns with the possibility of killer returns. There has to be a balance of the boring and staid with the gambling, the high flying. It all depends on your potential: how much can you stick your head out when it comes to investing?