If you’re an investor then the odds are that you have more than a few bonds in your portfolio. But while there are plenty of different options out there, one of the most misunderstood types of commodities are junk bonds. Their name certainly suggests that they’re hardly worth your effort, but in some cases you may very well be able to benefit from them. In any case, knowing the basics of junk bonds is important for anyone who invests their money. Good, bad, or ugly, they’re out there in abundance and there’s even a chance that you already own a couple of them.
At their most basic level junk bonds work just like regular bonds. They’re basically a loan you’re giving to a company. They include information on the principal amount the company will repay you, the date that they’ll pay it to you – known as the maturity date, and the amount of interest that they’ll repay. You pay the principal to the company and they issue the bonds. When the maturity date arrives, they’ll repay you the principal plus the agreed upon interest rate. It’s a good way for companies to raise capital and a great way for investors to diversify their portfolio.
But where junk bonds differ from traditional ones are in their interest rates and their risks. Traditional bonds are usually called investment grade bonds. The risk of these companies defaulting on the bonds is usually very low and they’re normally issued by respected, established companies with solid financial information and a good history. They also carry a relatively low interest rate, meaning you won’t get much of a return on your investment. Junk bonds, on the other hand, are issued from less established companies. The risk of defaulting on repayment is higher, but if the company holds to its word then you’ll receive a much higher return.
Interest rates are normally four to five percent higher on junk bonds than they are with regular ones. Since the risks are greater, the rewards need to be as well in order to attract bond buyers. There are plenty of investors who are willing to add a few junk bonds to their portfolio, and the different bonds are rated to help show the level of risk associated with them. Be sure that you take care to invest in them only when a return of four to six percent more than treasury standards exists, otherwise you’re really just taking a risk that is unnecessary.
Usually, it’s the wealthiest investors who buy junk bonds. But today a number of average investors do still add them to their portfolio, especially with the help of a financial advisor or investment broker. If you do, take care to do all of the needed research on each bond you purchase. Bond funds are often the best course of action and allow you to utilize the services of pros who really concentrate on nothing but researching the various junk bonds available. If you don’t mind taking the risks, these bonds could provide you with some serious rewards.