How to Invest in Junk Bonds

Junk bonds, also known as high yield bonds, are debt certificates issued by financially insecure companies. Because the companies are not blue chips they must pay higher interest to bondholders. Junk bonds are the same as regular bonds except they pay investors a higher return for taking more risk. In order to successfully invest in junk bonds you must have financial knowledge and a significant amount of capital for diversification.

Difficulty: Challenging

Instructions

1. Learn about the high yield market. Study the financial figures of individual companies to determine why their debt is considered to be junk. A good place to look for information are the bond rating announcements and reports put out by Moody's and Standard & Poor's.

2. Assess your financial situation. Determine how much money you can invest in the high yield market. Junk bonds should make up a small fraction of your portfolio, but you must have enough money to buy them from six or more companies.

3. Buy junk bonds for short-term gain when the high yield market is depressed. Sell them once the market recovers. If the market continues to fall, invest more money in order to dollar cost average. Like most short-term strategies, this method is high-risk.

4. Invest in junk bonds for the long-term by holding a group of them for 10 years. With time your gains make up for your losses.

5. Buy shares in high yield bond funds. These provide diversification with only a small amount of capital and expert management. For example, the Vanguard High-Yield Corporate fund has a low expense ratio and consistent returns. This fund charges a fee if you exit the fund less than a year before buying in. Other funds have two year minimums.

Tips & Warnings

• Typically, bonds that are rated at or below Ba by Moody's or BB by Standard & Poor's are considered junk. Higher rated bonds are considered investment grade.