Investors may find high-yield bond funds appealing since they pay greater interest rates than investment-grade bonds. However, high-yield bonds have a higher default rate than investment-grade bonds, making them a riskier addition to your portfolio.
However, if you want to profit from the higher interest payouts of high-yield bonds while mitigating some of the risks through diversification, you can invest in a basket of high-yield bond funds included in exchange-traded funds (ETFs) by Deciding Between Long-Term and Short-Term Treasury Bonds.
When shopping for high-yield bond funds, make sure to seek for more than simply the greatest yields. There are additional factors to consider when selecting the finest funds to buy.
High-Yield Bonds Overview
High-yield bonds, often known as junk bonds, are bonds that pay higher yields due to poor relative credit ratings of the entities issuing the bonds, as the credit ratings of the businesses producing the bonds are below investment grade. As a result of the risk of default on the side of the organization issuing the bond, a bond may earn a lower credit rating.
As a result of the increased relative risk, the corporations issuing these bonds will pay higher interest rates to compensate investors for assuming the risk of purchasing the bonds, giving rise to the term “high yield.”
This is comparable to a personal credit score, where borrowers with low credit scores typically pay greater interest rates on loans or credit card balances than borrowers with strong or exceptional credit scores. The same is true for bond-issuing companies and US Treasury Bonds, which can include corporations, publicly owned utilities, and municipal and federal governments.
Choosing the Best High-Yield Bond Funds
There are a few considerations to make during the research and analysis phase before purchasing high-yield bonds, and here are some of the essential elements or criteria for selecting the finest high-yield bond funds.
1. Account type
If you have a taxable account, you should consider investing in a high-yield municipal bond fund, which will provide income that is tax-free at the federal level. Taxable income, on the other hand, is not a factor in tax-deferred accounts because the income is not taxable to the investor while the high-yield bond fund is retained in the account.
2. Tax Bracket
Tax-free bond funds are especially beneficial for investors in higher tax brackets, where minimizing taxable income is likely a higher priority than for investors in lower tax brackets, and you can calculate the tax-equivalent yield, also known as the tax effective yield, to measure the benefit of using tax-free bond funds.
3. Risk Tolerance
High-yield bond funds can have stock-like returns, which implies that they can perform better on average than traditional bond funds, but their drops can be more severe. If you are not comfortable with price volatility, high-yield bond funds may not be the ideal option; instead, try a bond index fund such as the Vanguard Total Bond Market Index.
4. Other Portfolio Holdings
Although high-yield bond funds have a higher market risk than conventional bond funds, they may fit well with a diversified portfolio of mutual funds. If you already have a bond index fund and a variety of stock funds, a high-yield bond fund could be a good complement that adds diversification to your portfolio.
Best High-Yield Bond Funds to Invest In
Because there is no such thing as a one-size-fits-all high-yield bond fund, we have selected some of the top high-yield bond funds that might be a good addition to a diversified portfolio.
1. Vanguard High-Yield Tax-Exempt
If you are looking for high-yield bond funds while minimizing taxable income at a low cost, Vanguard High-Yield Tax-Exempt may be the best choice for you. Vanguard High-Yield Tax-Exempt’s portfolio includes over 2,000 municipal bonds that are tax-free at the federal level.
2. Vanguard Long-Term Investment Grade Bond
Along with high yields, expect increased market risk when compared to the typical bond fund, but Vanguard Long-Term Investment Grade Bond has an excellent balance of high yield and lower relative risk when compared to the junkiest of bonds. Long-term bonds typically pay greater yields than short- and intermediate-term bonds, and the average credit risk for bonds in Vanguard Long-Term Investment Grade Bond is just below investment-grade credit quality.
Furthermore, interest rate risk is higher than in bond funds that hold bonds with shorter average duration, and prices may fall in a rising interest rate environment, but long-term performance is likely to outperform shorter duration bond funds.
3. T. Rowe Price Corporate Income
T. Rowe Price Corporate Income is another top bond fund that provides a respectable return while not taking on too much credit risk. As an intermediate-term bond fund, it does not carry as much interest rate risk as long-term bond funds.
4. Fidelity Short Duration High Income
Investors seeking high yields but low interest rate risk can choose Fidelity Short Duration. The high income produces its own market risk, but the trade-off is a high yield (2.72%), and the short-term average duration decreases interest rate risk, which is especially noticeable in a rising interest rate environment.
5. Vanguard Long-Term Corporate Bond Index
VLTCX should be on your shortlist for an addition to your portfolio if you love low-cost index funds and want high yields. Although this fund is only available in Vanguard’s Admiral shares, requiring a $3,000 minimum investment to get started, the fund’s low expense ratio of just 0.07% and the current yield of 3.08% make it deserving of consideration.
As the current fixed-income climate illustrates, high-yield bond funds are not ideal, and they, like any other asset class, have risks. strong-yield bonds have their own set of downsides, including a relatively strong connection with stocks. High yield bonds are also more likely to default due to issuers’ huge debt burdens and/or business risk. These bond funds are among the largest and best in terms of high-yield corporate debt exposure.
1. What are the potential benefits of investing in high-yield bond funds?
Investing in high-yield bond funds can provide higher income potential compared to traditional fixed-income investments. They can diversify a portfolio and potentially enhance overall returns. However, it’s important to note that they also carry higher default risk and may be more volatile than investment-grade bond funds.
2. What are the risks associated with high-yield bond funds?
High-yield bond funds come with a higher risk of default, as the underlying bonds are issued by companies with weaker financials. Additionally, these funds can be sensitive to changes in interest rates and economic conditions. They may experience greater price fluctuations and potentially generate losses during market downturns.
3. How can I find the best high-yield bond funds?
To find the high-yield bond funds, consider factors such as historical performance, expense ratios, management team expertise, fund size, and the fund’s investment strategy. Conduct thorough research, review fund prospectuses, and consult with financial advisors to make informed decisions.
4. Are high-yield bond funds suitable for all investors?
High-yield bond funds may not be suitable for conservative investors seeking capital preservation. They are better suited for investors willing to accept higher risk in exchange for potentially higher yields. Before investing in these funds, investors should carefully consider their risk tolerance and investment objectives.
5. How do I evaluate the performance of high-yield bond funds?
Evaluate the performance of high-yield bond funds by analyzing their historical returns, comparing them to relevant benchmarks, and considering their risk-adjusted performance. Look at long-term track records and consistency in generating income over various market conditions.