In an era where financial security holds utmost importance, people tend to prefer saving over spending. Saving more money might help you have a decent corpus, but you might be cutting down on your expenses. A better alternative to saving more is to invest that money and multiply it over time. There are several investment options ranging from Fixed Deposits and National Pension systems to the stock market and crypto. Out of many investing options, there is another option that investors are looking for — Junk Bonds.
A junk bond is a new investment option that has emerged quite recently. It functions in a certain way and is mostly issued by the government and various other corporations. It is also known as a high-yield bond which is rated below investment grades by different credit rating agencies. Well, do you want to know the meaning of a junk bond, and how to invest in it?
Then this article is solely dedicated to junk bonds and their significance. This article will help you understand the meaning, purpose, pros, and cons of having a junk bond.
What is a junk bond and what is its significance?
A junk bond or a high-yield bond is an investment option that is rated below the investment grades by different credit agencies. These investment-grade bonds are generally a higher-risk option as compared to several other investment schemes like FDs, mutual funds, etc. These bonds are mostly issued by companies that have poor shape. The quality of the junk bonds might also vary many times, depending upon the company through which you get them.
There is a rating scale according to which different bonds are ranked known as the Standard & Poor’s credit rating scale. There are several markers like AAA, BBB, etc. On that scale, a junk bond is rated below BBB in the rating scale, indicating the highest risk of a company missing an interest payment. However, there are several higher-rated junk bonds that do not default and provide good returns to investors.
How can a new investor start investing in a junk bond?
Investing in a junk bond is an easy process, and you can learn it quite fast. You can buy junk bonds from many brokerage firms that buy and sell individual bonds regularly. If you want better outcomes and a diversified portfolio, then you can also buy junk bonds through a mutual fund or an ETF.
These options are quite preferable for those investors who are eager to invest in junk bonds but lack confidence while selecting their process of investment. Having a diversified portfolio will increase your yield and lower your risk of investment.
What are some of the benefits of investing in a junk bond?
There are several benefits of investing in a junk bond and they are:
- High returns:
As compared to other investment options available in the market, junk bonds provide a better yield to investors. In addition, you can increase the returns even more if you learn the basics properly and prefer a diversified portfolio.
- Constant cash flow:
Most bonds are one of the preferable ways to provide the consistent cash flow required for your portfolio. So, as junk bonds are also not as volatile as stocks, you will maintain a constant cash flow without facing the risk of losing all the money.
As junk bonds perform differently among different financial conditions, they diversify your investment portfolio more than stocks.
What are some of the disadvantages of investing in a junk bond?
Unfortunately, there are many downsides to investing in junk bonds, especially for new investors.
- Risk of defaulting:
As you already know that junk bonds are mostly issued by companies that do not have substantial financing stability, and there is a risk of default associated with it. In comparison to various other investment-grade bonds, junk bonds are the ones that have the highest risk of default.
- Issue of liquidity:
Though junk bonds are tradable, you may not be able to trade them as frequently as investment-grade bonds. So, in case you had a financial crunch or a crisis, it will be harder on your part to immediately sell them off. In some cases, you might have to compromise on a lower rate than the actual market price.
- Higher risk of investing in individual junk bonds:
Investing in individual junk bonds possess a higher risk than investing in a collection of junk bonds. You should even consider buying a well-diversified collective junk bond to increase the returns and minimise the risk factors.
The Bottom Line:
Junk bonds have become a bit popular in recent times because they provide high returns to investors. Furthermore, they also provide a constant cash flow benefit to the investors to maintain the steadiness of their portfolio. They also diversify your investment portfolio more than that stocks. However, investing in junk bonds also has many risks involved with it, which you must be aware of before jumping into the process. You should be aware of all the downsides and conduct sample research before buying any junk bonds.
You should prefer choosing a company that has a strong financial footing and ensures no default during the interest payment. You can discuss investing in junk bonds with your financial advisor and then reach a consensus before investing in it. In case you have come this far, it means you are a keen reader of topics like finance and investment. If that’s the case, you should visit Piramal Finance to find highly engaging content on topics like loans, investment schemes, etc.