Millionaires do not consider high-yield bonds to be one of the best investment strategies in in times of market volatility. What should you know about high-yield bonds?
In times of market volatility, the preferred investment strategies of Millionaires are dividend stocks, insured bank deposits and money market mutual funds, according to an investor survey conducted by Millionaire Corner in June. On the other hand, few Millionaires would invest in high-yield bonds, despite their relatively strong performance in the prevailing low-interest rate environment.
(Click here to learn more about the pros and cons of dividend stocks.)
Why don’t high yield bonds rate highly among the investment strategies Millionaires would use to address market volatility? Learn more about the pros and cons of high yield, or sub-investment-grade bonds.
“With interest rates of Treasury bonds near 40-year lows, higher-coupon-interest payments have been especially valuable during the past few years,” Kathy A. Jones, a fixed-income strategist for the Schwab Center for Financial Research, said in a Schwab Investor Insight. “When reinvested, the compounding of interest income can help reduce volatility in a portfolio.”
The catch? The extra yield comes with added investment risk, according to Jones. “Companies that issue high-yield bonds are, by definition, less credit-worthy than investment-grade companies and are therefore more likely to default.”
Another downside of high-yield bonds? The market for high yield bonds tends to be less liquid than that for other types of bonds, according to Jones.
Strike three? High-yield bonds also tend to be more closely correlated with the stock market than Treasuries and, as a result, can dilute the overall diversification of a portfolio, Jones said. (Diversification and risk are the top two factors Millionaires consider when making investment decisions.)
Few Millionaires appear willing to take on additional investment risk in exchange for the higher yields of sub-investment-grade bonds, according to our June survey. Less than 4 percent of Millionaires said they’d be “most likely” to count high-yield bonds among their investment strategies for volatility. These affluent investors ranked municipal, corporate and Treasury bonds as more viable investment strategies in times of market volatility – though they preferred high yield bonds to foreign bonds with high credit ratings.