How to Avoid Junk Bonds

The name says it all: why buy junk? The problem is: how do you know what's junk and what's not? Here are some steps you should follow in order to avoid junk bonds.

Difficulty: Easy

Instructions

Avoid Junk Bonds Using Standard & Poor's Index

1. Go to the Standard & Poor's Web site.

2. From the menu on the left, under Credit Ratings, select "Find a Rating."

3. From the drop-down menu, select "Credit Ratings Search."

4. Under "Quick Search," select "Search by: Organization Name." In the blank box, enter the name of the company you are investigating, and hit "Submit."

5. From the search results, select the name of the company for which you are looking.

6. Under "Organization Ratings," find a rating consisting of one to four letters.

7. If the rating is in the range from AAA to BBB, the company is considered to be offering investment grade bonds. If the rating is lower than BBB (i.e., BB to C), the bond is considered a junk bond.

Avoid Junk Bonds Using Moody's

8. Go to the Moody's Web site.

9. In the top right corner of the home page, in the Quick Search, select "Search by: Issuer Name." In the blank box, enter the name of the company you are investigating, and hit "Go."

10. From the search results, select the name of the company for which you are looking.

11. Scroll down to "Market Implied Ratings."

12. Look at the rating for "Bond - Implied."

13. If the rating is in the range from Aaa to Baa, the company is considered to be offering investment grade bonds. If the rating is lower than Baa (i.e., Ba to C), the bond is considered a junk bond.

Tips & Warnings

• You will have to register to access either the Standard & Poor's or Moody's ratings. Registration is free.
• You should avoid junk bonds because they hold a higher risk of default. That is, the issuing company is more likely to go into bankruptcy than the issuing company of a bond with a higher rating. Although junk bonds pay higher returns, those returns are outweighed by the higher risk. If the company goes into default, you will get no returns at all.