Bond Market Look: High-Yield vs. Investment-Grade Bonds

In this guide, explore key factors for high-yield versus investment-grade bonds. Learn the importance of credit, research, and market condition in bond selection. cut: Investment-grade and high-yield bonds, including corporate, municipal, and Treasury bonds
3 min read
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Key Takeaways

  • Understand the different types of investment-grade bonds
  • High-yield corporate bonds come with their share of risks
  • Analyze the risk and return trade-offs between investing in high-yield corporate bonds versus government bonds

Investors looking to add bonds to their portfolios face a trade-off: The safest government bonds typically pay very low yields, while higher-yielding corporate bonds are more prone to default.

As a rule, high-yield corporate bonds come with more risk. On the other end of the spectrum are U.S. Treasury bonds, which are generally considered to be one of the safest investments around.

So how can investors decide which bonds to add to their portfolios?

Types of investment bonds: Factors to consider 

Three popular types of bonds include corporate, municipal, and U.S. Treasury. Of the three, high-yield corporate bonds generally represent the most aggressive investment and Treasury bonds the least aggressive.

The difference in the credit quality of the bond issuers certainly plays a role, but other factors can influence bond yields as well. A company issuing high-yield corporate bonds typically won’t have as strong a track record or as strong financials as a firm that can issue an investment-grade corporate bond. Investment-grade bonds are rated “BBB” or better as designated by Standard & Poor’s.

During times of uncertainty, the difference in investment-grade bonds versus lower-rated bonds becomes increasingly obvious, which is why it’s important for investors to do their own research when considering which bonds to add to their portfolio.

In addition to prevailing interest rates, the yields for a municipal bond depend on the financial condition of the issuing authority and whether the bonds are insured. With various exceptions, interest paid on municipal obligations is generally not subject to federal taxes. U.S. Treasury bonds, besides being considered safest from default, aren’t taxable at the state or local level. As previously mentioned, corporations issue bonds, and their yields depend on the company’s perceived financial strength.

During times of market and economic uncertainty, investment-grade bonds can quickly be downgraded, and their value can fall dramatically, which is why it’s important to know what you’re buying.

But it’s difficult to know for sure which corporations or municipalities can weather a prospective financial storm and come out in good shape.

High-yield bonds come with added risk

Aggressive investments, such as high-yield bonds, aren’t for everyone. But during low-interest rate environments, their yields can look lofty.

Still, chasing yield is never a good idea without understanding that it comes with added risk. Look at the rating and read the ratings agency reports, and if you do go down the credit scale to obtain yield, understand the risk you’re taking. 

Be a Bond Wizard

Whether you’re just starting to learn about fixed income or a seasoned expert, the Bond Wizard can help your strategy.

  • Log in to your TD Ameritrade account.
  • Select Research & Ideas > Bonds & CDs
  • Select the Bond Wizard from the left menu.
Investments in fixed income products are subject to liquidity (or market) risk, interest rate risk (bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall), financial (or credit) risk, inflation (or purchasing power) risk and special tax liabilities. May be worth less than the original cost upon redemption.

Key Takeaways

  • Understand the different types of investment-grade bonds
  • High-yield corporate bonds come with their share of risks
  • Analyze the risk and return trade-offs between investing in high-yield corporate bonds versus government bonds

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