High-Yield Bonds: What You Need to Know Before Investing | American Funds

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High-Yield Bonds: What You Need to Know Before Investing 

High-yield bonds can play an important role in a well-diversified investment portfolio.

High-yield bonds are issued by companies with a relatively high degree of credit risk, but that doesn’t mean they should always be avoided. Depending on your appetite for risk, these bonds can offer potentially attractive returns, as well as significant diversification benefits.

Investor appetite for high-yield bonds has grown substantially over the past few years. Total existing debt in the U.S. high-yield market stands at about $1.3 trillion. High-yield bonds are rated below BBB by Standard & Poor’s and below Baa by Moody’s. Lower rated bonds may carry more risk.

Potential Benefits

  • For investors willing to assume the increased risk, high-yield bonds offer greater income opportunity than many other types of fixed-income securities and hold the possibility of material price appreciation.
  • Beyond the return potential, high-yield bonds can also help diversify your fixed-income portfolio, as they tend to be more correlated with the U.S. equity market. The combination of a higher yield and price appreciation has at times given high-yield bonds equity-like returns.

Potential Risks

  • The higher yield offered by these bonds reflects an elevated risk that the issuing company may not be able to make interest or principal payments; the historical average default rate is between 4% and 5%, according to Moody’s. In addition to default risk, the day-to-day price volatility and valuation of high-yield bonds is typically more volatile than investment-grade bonds.
  • Besides a company’s own financial challenges, broader, and at times unpredictable, dynamics in the U.S. economy or a company’s industry can drive default risk.
  • High-yield bonds also may be more difficult to sell on the open market, particularly if investors are worried about rising default risk. Trading may not occur as often in the high-yield bond market as it does in the broader bond market or on major stock exchanges.

Reasons to Consider

  • Investors willing to accept the higher risk of loss associated with high-yield bonds may wish to consider investing in them because of the higher total return potential and the benefits provided by broad diversification among asset classes.
  • In addition, high-yield bonds are generally less sensitive to rising interest rates than other types of fixed-income securities, such as Treasury bonds or mortgage-backed securities.
  • Investing in high-yield bonds may not be appropriate for those with a low risk tolerance or a relatively short time horizon.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

Bond ratings, which typically range from AAA/Aaa (highest) to D (lowest), are assigned by credit rating agencies such as Standard & Poor's, Moody's and/or Fitch, as an indication of an issuer's creditworthiness.