In a world where government savings accounts minuscule interest rates, investors have been stretching for -- which is to say, going far beyond their comfort zones to take on higher-risk . and
Robust yields can help generate impressive annual payouts, but many investors may be stretching too far to reach them.
It's tempting to go after that kind of yield, but any that promises double-digit payment streams could carry a more risk than you might imagine. Here's how to identify these risky so that you can avoid them by any means necessary.
One way investors pursue such high payouts is through junk bonds, which are offered by companies with uncertain that must provide very high-interest rates to line up demand for their bonds. Of course, for any given a direct correlation between perceived risk and the enticements needed to lure investors compensates for that risk.
So how do you find the line between aggressive and risky?
Well, if you come across a effective yield below 6%, it is likely safe. Understand that bonds, after they are issued, rise and fall in value depending on whether they are perceived to be safe or risky. So if a company initially issued a with an 8% yield, and investors have determined that payments almost surely be made, they buy the . That pushes it up in price, forcing the after-market yield to be lower. That's why you should pay attention in this instance to the current yield (6%) and not the original yield (8%).that an
The converse is also true. A after-market trading, then you should see that as a big flag.that is seen by savvy traders as too risky an after-market yield that is even higher than the "when-issued" yield. So if that that initially offered an 8% yield now an even higher yield in
Of course, investing in the junk bonds of any particular company means that you'll be out of luck if that company runs into deep trouble. That's why many investors prefer to hold a basket of through exchange-traded (ETFs) such as iBoxx $ High Yield (NYSE: HYG) or the Barclays High Yield (NYSE: JNK). Each offers impressive yields while spreading risk around.
The Investing Answer: The investing maxim, "Bulls make, bears make , pigs get slaughtered," surely applies to . It's wise to seek the best yields possible only after you've done your homework.
Remember that you should track the current yield -- and not the "when-issued" yield. If you are looking to buy a newly issued , know that it is quite risky if it is initially offered with a yield in excess of 8%. That kind of payout seems tempting, but it's wiser to take a pass.