Beware The Promise Of Junk Debt

Until the recent sell-off toward the end of July, yields on high-yield bonds had been hitting record lows. At the end of June 2014, the yield on five-year bonds rated BB—the credit rating just below investment grade—was only 4.3 percent, or about 2.7 percentage points higher than the yield on five-year Treasurys. That puts the yield spread at levels not seen since before the 2008 financial crisis began.

This all matters because with the yields on safe bond investments at low levels, investors are chasing yield wherever they can find it—not just in high-yield bonds, but in other risky investments, such as dividend-paying stocks and REITs.

My colleague and co-author Kevin Grogan takes a look at whether it makes sense to add high-yield bonds to a portfolio. From its inception in January 1979 through June 2014, Vanguard’s High Yield Corporate Fund (VWEHX) returned 8.8 percent per year. By comparison, the Barclays Credit Bond Index Intermediate returned 8.3 percent per year over the same period.

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