Junk bonds are yielding an average of more than 5%, compared
with just above 3% for investment-grade corporate bonds and around 2% for a
10-year U.S. Treasury note. Junk bonds have been on a roller-coaster ride the
past two months, with prices sagging and then bouncing back.
For the year ended July 2, high-yield-bond funds attracted
some $3.2 billion, according to Lipper. Then investors got nervous and yanked a
record $7 billion out of junk-bond funds in the week ended Aug. 13, according
to Bank of America Merrill Lynch Global Research. More high-yield bond-fund
money headed for the exits in that one week than had come in for most of the
year. Then for the week ended Aug. 20, more than $2 billion flowed back into
junk funds.
As long as you recognize that junk bonds have a higher risk
of not paying off in lean economic times and may be currently overpriced
relative to other corporate bonds, they make sense in a well-rounded income
portfolio. Yet there's no need to load up on them. Experts generally advise
putting no more than 5% of an income portfolio into junk bonds.
Holding both investment-grade and junk-bond funds is a
better idea and makes it less likely you'll be thrown off a cliff if junk bonds
lose favor for an extended period. Keep in mind that bond funds can lose value
if rates rise—the longer the maturity, the greater the downside hit.
The SPDR Barclays High Yield Bond exchange-traded
fund, which holds a $9.3 billion portfolio of lower-quality corporate bonds, is
up 5% this year through Sept. 3, beating the total U.S. investment by nearly
one-half a percentage point, according to investment-research firm Morningstar.
The fund yields 5% and charges 0.40% in annual expenses.
Try to avoid timing the market, which can make you
vulnerable to market turns. That means not being sucked into overinvesting in
long-term U.S. Treasury bonds, which are more sensitive to interest-rate
changes than junk bonds, but have seen prices rise this year due to a slight
dip in rates and a global flight to high-quality government bonds.
An all-purpose bond ETF can serve as a simple way to get
broad diversification. The $21 billion Vanguard Total Bond Market ETF,
which invests in intermediate-maturity corporate, mortgage and Treasury bonds,
samples most of the U.S. bond market except for Treasury inflation-protected
securities and junk bonds. The ETF is yielding 2% and is up 4.5% this year
through Sept. 3. The fund charges 0.08% in annual expenses.
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