# High-Yield Bond: Definition, Types, and How to Invest

## What Are High-Yield Bonds?

High-yield bonds, often referred to as [junk bonds](https://www.investopedia.com/terms/j/junkbond.asp), are debt securities issued by corporations that offer higher interest rates due to their lower credit ratings compared to [investment-grade](https://www.investopedia.com/terms/i/investmentgrade.asp) bonds. While they have the potential to provide attractive yields, these bonds also involve greater risks, including a higher likelihood of default. Typically, high-yield bonds are issued by startups or capital-intensive firms with substantial debt ratios. Some high-yield bonds are known as "[fallen angels](https://www.investopedia.com/terms/f/fallenangel.asp)," as they once held higher credit ratings before being downgraded.

### Key Takeaways

*   High-yield bonds, also known as junk bonds, offer higher returns than investment-grade bonds but come with increased risk due to lower credit ratings, including the risk of default.
*   They are typically issued by startups or companies with high debt ratios and can be divided into subcategories, including "fallen angels," which are bonds that have lost higher credit ratings.
*   High-yield bonds face several risks such as default, higher volatility, interest rate changes, and liquidity constraints, making them a less stable investment compared to investment-grade bonds.
*   Retail investors are often advised to invest in high-yield bond funds, like ETFs or mutual funds, to diversify and mitigate default risk rather than holding individual high-yield bonds.
*   When market interest rates rise, the value of high-yield bonds can decrease; however, these bonds may also benefit during economic expansions, which can lower their default risk.

![High-Yield Bond: Debt securities that pay higher interest rates because they are deemed more likely to default.](https://www.investopedia.com/thmb/ZrG4h88OT6w3rNx_KW2BZlI2uBI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/high_yield_bond.asp-final-f5f6ae6f8d464ac6b58f2fe562ab1f54.png)

*— Investopedia / NoNo Flores*

## Deep Dive into High-Yield Bonds

A high-yield bond, or junk bond, is a corporate bond that represents debt issued by a firm with the promise to pay [interest](https://www.investopedia.com/terms/i/interest.asp) and return the principal at [maturity](https://www.investopedia.com/terms/m/maturity.asp). Junk bonds are issued by companies with poorer credit quality.

Bonds are characterized by their credit quality and fall into one of two bond categories: investment grade and non-investment grade. Non-investment-grade bonds, or high-yield bonds, carry lower [credit ratings](https://www.investopedia.com/terms/c/creditrating.asp) from the leading credit agencies.

A bond is non-investment grade if its rating is below BB+ by [Standard & Poor’s](https://www.investopedia.com/terms/s/sp.asp) and [Fitch](https://www.investopedia.com/terms/f/fitch-ratings.asp), or Ba1 or below from [Moody’s](https://www.investopedia.com/terms/m/moodys.asp). Bonds with ratings above these levels are considered investment grade. Credit ratings can be as low as D (in default), and most bonds with C ratings or lower carry a high risk of [default](https://www.investopedia.com/terms/d/default2.asp).

High-yield bonds are typically broken down into two subcategories:

*   **Fallen angels**—A bond that has been downgraded by a major rating agency and is headed toward junk-bond status because of the issuing company’s poor credit quality.
*   **Rising stars**—A bond with a rating that has increased because of the issuing company’s improving credit quality. A [rising star](https://www.investopedia.com/articles/markets/070816/fallen-angel-bonds-and-rising-stars-risks-and-opportunities.asp) may still be a junk bond, but it’s headed toward being investment quality.

## Benefits of Choosing High-Yield Bonds

Investors choose high-yield bonds for their potential for higher [returns](https://www.investopedia.com/terms/r/return.asp). High-yield bonds offer higher returns than investment-grade bonds, unless they default. Typically, the riskier the bond, the higher the yield. [Modern portfolio theory](https://www.investopedia.com/terms/m/modernportfoliotheory.asp) states that investors must be compensated for higher [risk](https://www.investopedia.com/terms/f/financialrisk.asp) with higher expected returns.

## Risks and Downsides of High-Yield Bonds

High-yield bonds can lead to higher gains than [investment-grade bonds](https://www.investopedia.com/ask/answers/06/highyieldlowyieldbonds.asp), but they also come with risks like default, volatility, interest rates, and liquidity issues.

### Understanding Default Risk

Default is itself the most significant risk for high-yield bond investors. The primary way of dealing with default risk is diversification, but that limits strategies and increases fees for investors.

With investment-grade bonds, you can buy directly from companies or governments and hold them. Holding individual bonds lets you build [bond ladders](https://www.investopedia.com/terms/b/bondladder.asp) to manage [interest rate risk](https://www.investopedia.com/terms/i/interestraterisk.asp). Investors can often avoid the fees related to funds by holding individual bonds. However, the possibility of default makes individual bonds riskier than investing in bond funds.

> **Important**
>
> Small investors may want to avoid buying individual high-yield bonds directly because of high default risk. High-yield bond exchange-traded funds (ETFs) and mutual funds are usually better choices for retail investors interested in this asset class because their diversity helps reduce risk.

### Navigating High Volatility

Historically, high-yield bond prices have been significantly more [volatile](https://www.investopedia.com/terms/v/volatility.asp) than their investment-grade counterparts. [The volatility of the high-yield bond market](https://www.investopedia.com/articles/investing/022616/history-high-yield-bond-meltdowns.asp) is similar to the volatility of the stock market, unlike the investment-grade bond market, which has much lower volatility.

### Managing Interest Rate Risk

All bonds face interest rate risk. This is the risk that market interest rates will rise and cause the prices of a bond to decrease. The price of bonds move in the opposite direction to the price of market interest rates.

The longer a bond’s term, the higher the interest rate risk because there is more time for interest rates to change.

### Tackling Liquidity Risk

[Liquid assets](https://www.investopedia.com/terms/l/liquidasset.asp) are ones that you can sell easily for cash. When bonds are traded frequently, they have higher liquidity. [Liquidity](https://www.investopedia.com/terms/l/liquidity.asp) risk is the risk that you won’t be able to sell an asset at the time and for the price that reflects the true value of the bonds.

High-yield bonds generally have higher liquidity risk than investment-grade bonds. Even high-yield bond [mutual funds](https://www.investopedia.com/terms/m/mutualfund.asp) and [exchange-traded funds (ETFs)](https://www.investopedia.com/terms/e/etf.asp) carry liquidity risk.  

## Comparing Investment-Grade with Non-Investment-Grade Bonds

You can typically classify bonds into investment-grade and non-investment-grade. Bonds are rated by three major ratings agencies: Moody’s, Standard & Poor’s, and Fitch.

When a bond is rated Baa3 or higher by Moody’s or BBB- or higher by Standard & Poor’s or Fitch, it is considered investment grade. Bonds rated Ba1 or lower by Moody’s or BB+ or lower by Standard & Poor’s or Fitch are considered non-investment grade.

You’ll want to have a higher [risk tolerance](https://www.investopedia.com/terms/r/risktolerance.asp) for investing in non-investment-grade bonds.

## Investing in High-Yield Bonds: A Comprehensive Guide

You can invest in high-yield bonds in several ways:

*   You can buy high-yield corporate bonds directly from [broker-dealers](https://www.investopedia.com/terms/b/broker-dealer.asp).
*   You can buy into a mutual fund or ETF that holds high-yield bonds.

With the latter strategy, you buy shares of a fund that is managed by a [fund manager](https://www.investopedia.com/terms/f/fundmanager.asp) who chooses which bonds to include.

When researching your choices in high-yield bonds, you can read primary documents like the bond’s [prospectus](https://www.investopedia.com/terms/p/prospectus.asp), which provides information about the financial health of the company issuing the bond. It also includes the company’s plans for using the proceeds of the bond, along with the bond terms and risks involved.  

## The Effect on High-Yield Bonds When Interest Rates Rise

When [interest rates](https://www.investopedia.com/terms/i/interestrate.asp) go up, high-yield bond values can drop since newer bonds offer better returns. However, rising interest rates can also help high-yield bonds because interest rates tend to increase when the economy expands, so the corporations issuing the bonds can benefit from increased spending. This means that these bonds would have a lower risk of default.

## What is a non-investment-grade bond?

A non-investment-grade bond is a bond that pays higher yields but also carries more risk and a lower credit rating than an investment-grade bond. Non-investment-grade bonds are also called high-yield bonds or junk bonds.

## Are BBB bonds investment grade?

Bonds that have a BBB rating from either Standard & Poor’s or Fitch are considered investment-grade bonds, although they are the lowest tiers of investment-grade bonds. Non-investment-grade bonds are rated BB+ through CC. (Moody’s uses a different [rating system](https://www.investopedia.com/ask/answers/09/bond-rating.asp).)

## The Bottom Line

Like with any investment, high-yield bonds have risks and rewards to consider. For investors with a high risk tolerance, high-yield bonds may fit their investing goals. These bonds can offer more attractive yields, but they carry more risk and a lower credit rating than investment-grade bonds.

Factor in your individual financial situation, including your income, net worth, investment goals, and risk tolerance, when deciding whether high-yield bonds are right for you.

> **Article Sources**
>
> 1.  Investor.gov, U.S. Securities and Exchange Commission. “[High-Yield Bond (or Junk Bond)](https://www.investor.gov/introduction-investing/investing-basics/glossary/high-yield-bond-or-junk-bond).”
>     
> 2.  Fidelity Investments. “[Bond Ratings](https://www.fidelity.com/learning-center/investment-products/fixed-income-bonds/bond-ratings).”
>     
> 3.  Vanguard, Institutional Investors. “[Crossovers, Fallen Angels, and Rising Stars](https://institutional.vanguard.com/insights-and-research/perspective/crossovers-fallen-angels-and-rising-stars.html).”
>     
> 4.  U.S. Securities and Exchange Commission. “[What Are High-Yield Corporate Bonds?](https://www.sec.gov/files/ib_high-yield.pdf)”
>     
> 5.  AllianceBernstein. “[Rising Rates: Good or Bad for High Yield?](https://www.alliancebernstein.com/corporate/en/insights/investment-insights/rising-rates-good-or-bad-for-high-yield.html)”