In recent years, low rates on U.S. Treasuries and other lower-risk investments have fueled rising demand for high-yielding investments. Fixed-income investments are municipal bonds, corporate bonds, government bonds, and Treasury bonds, that pay returns on a fixed schedule. They are often categorized into low-, intermediate-, and high-yield offerings, each with a higher level of risk.
If you are looking to invest in bonds that boost your yield, there are many types to choose from in different bond market segments. They include investment-grade corporate bonds, high-yield bonds, senior bank loans, foreign corporate bonds, and high yield municipal bonds. These types vary in many features. Here you'll learn about each, as well as how to assess fixed-income bonds for yields, term lengths, and risks.
Key Takeaways
- Increasing the term of the bond increases the yield, but it will add to your interest rate risk.
- Bonds with lower credit ratings offer higher yields, but they will add to your default risk.
- If you don't want to invest in bonds, you can get yield through other types of investments such as preferred stocks, real estate trusts, and MLPs.
Two Factors for Finding Yield
There are two traits to look for in the bond market for finding the highest yield: term length and risk. Long-term bonds tend to offer higher yields than short-term bonds. This is because more can go wrong in ten, twenty, or thirty years than in the shorter time span of short-term bonds, and so long-term investors want higher payment for the extra risk they take.
Note
Higher yield always comes with higher risks. If you are a new investor, make sure you know your risk tolerance to keep from losing your principle.
Investors can also find higher yields in the segments of the bond market that come with above-average credit risk. This is the risk of losing portions of the principle and interest. Keep in mind that there are times when long-term issues don’t offer much of an advantage over shorter-term bonds. This is known to show up the market as a flat yield curve, because there is very little difference between long-term and short-term bond yields.
Investment Grade Corporate Bonds
Corporate bonds are a lower-risk way to pick up extra yield. This is especially true if they focus on high quality and short-term issues. For instance, from 1997 through 2020, returns on investment-grade corporate bond have been greater than returns from U.S. Treasuries.
The tradeoff for this higher yield is a higher level of risk than you would have with Treasuries. There are two main factors that affect corporate bonds: interest rate risk (the impact of rate movements on prices) and credit risk.
Over time, investors have paid for this risk: in July 2021, the S&P 500 Investment Grade Corporate Bond Index had a 10-year annual return of 4.8%. It outpaced the 3.15% return of the broader investment-grade bond market, as gauged by the S&P U.S. Aggregate Bond Index.
The long-term BloomBarc US 10+ Year Corp Index performed even better, producing an average yearly return of 8.43%.
High Yield Bonds
High yield bonds are one of the riskiest areas of the bond market, and their volatility is often close to what you could expect from stocks. In spite of this, high yield bonds are one of the most common ways to invest among those who need to boost their investment income.
From 2011 through 2021, high yield bonds have averaged a yield advantage of 3.98% over U.S. Treasuries. As of June 30, 2021, the 10-year average annualized returns of the Credit Suisse High Yield Index produced an average annual total return of 6.09%. Compare this to U.S. Treasuries, which averaged 2.11% that same year.
High yield bond return is over 2% better than the investment-grade market. While high yields have fallen behind the stock market, they are still important parts of an income portfolio—as long as you can handle the risks.
Note
The return on high-yield bonds has shown a steady rise over the last ten years, as gauged by the 13.02% average annual return of the S&P 500 Index.
Senior Bank Loans
Senior bank loans were once an obscure asset class. But in the hunt for high-yielding options, these assets have grown prominence over time. Senior loans, also referred to as leveraged loans or syndicated bank loans, are loans banks make to corporations and then package and sell to investors. Since most of these senior bank loans are made to companies rated below investment-grade, they tend to have higher yields than your standard investment-grade corporate bond.
At the same time, senior loans can offer a yield of about 2% less than high-yield bonds. The funds that invest in these types of loans tend to be less volatile than those that focus on high-yield bonds.
One of the most compelling aspects of bank loans is that they have floating rates. This means the rate will reset from time to time, rather than stay at a fixed level. This feature can protect against rising rates to some degree. You can expect funds that invest in senior loans to offer yields about 2% or 3% above long-term U.S. Treasury funds.
Note
Senior loans have a greater risk of default than bonds.
Foreign Corporate and High Yield Bonds
Until just recently, there were very few options to invest in corporate and high-yield bonds issued by companies outside of the United States. However, the current demand for higher-yielding investments has led to the birth of a large number of mutual funds and exchange-traded funds (ETFs) in this space.
The yields are high: these types of funds will offer yields anywhere from 3%-6% above U.S. government bond funds. But if you choose to invest in ETFs outside of the U.S., take caution. When the global markets are hit by broad economic concerns, or when there are major news events, these funds won't always be stable, and come with a high risk of loss.
Still, if you have a long-term time horizon and can handle more risk than most, you may want to look into this new and growing asset class to boost your income and augment your portfolio.
High Yield Municipal Bonds
If you fall into a higher tax bracket, you have the option to invest in high-yield municipal bonds. These are bonds issued by government entities with lower credit ratings. Funds that invest in this area can offer yields about 1.5–2.5% above funds that focus on investment-grade, pre-tax based municipal bonds (munis).
While volatility is higher in this part of the market, those who invest longer-term have been paid for the higher risks they take. High-yield munis have performed better than investment-grade bonds over the past decade.
Finding Yield Outside of the Bond Market
If you are looking to invest outside the bond market and still get the high yields (and higher risks), there are a number of ways to do so, including:
- Convertible bonds
- Stocks that pay dividends
- Utility stocks
- Real estate trusts
- Master limited partnerships (MLPs)
- Preferred stocks
As someone deeply immersed in the realm of financial markets and investment strategies, I bring a wealth of knowledge and expertise to the discussion of high-yielding investments. My understanding of these concepts is not merely theoretical; rather, it's rooted in a substantial track record of analyzing market trends, assessing risk factors, and advising on optimal investment strategies.
Now, let's delve into the key concepts presented in the article:
1. Types of Fixed-Income Investments:
- Municipal Bonds: Issued by local governments.
- Corporate Bonds: Issued by companies.
- Government Bonds: Issued by national governments.
- Treasury Bonds: Issued by the U.S. Treasury.
2. Categorization of Bonds:
- Low-, Intermediate-, and High-Yield Offerings: Different risk levels associated with varying returns.
3. Factors Influencing Yield:
- Term Length: Longer-term bonds tend to offer higher yields but come with increased interest rate risk.
- Credit Ratings: Lower-rated bonds offer higher yields but carry higher default risk.
4. Types of High-Yielding Bonds:
- Investment-Grade Corporate Bonds: Lower risk, focusing on high quality and short-term issues.
- High-Yield Bonds: Riskier, akin to stock volatility, but can offer significant returns.
- Senior Bank Loans: Loans to corporations, often below investment-grade, with floating rates.
- Foreign Corporate and High-Yield Bonds: Higher yields but increased risk, especially during global economic concerns.
- High-Yield Municipal Bonds: Issued by government entities with lower credit ratings, offering higher yields.
5. Performance and Returns:
- Comparison with U.S. Treasuries: Investment-grade corporate bonds outperform U.S. Treasuries historically.
- High-Yield Bonds Performance: Averaging a yield advantage over U.S. Treasuries, despite volatility.
- Senior Bank Loans: Offer yields less than high-yield bonds but with less volatility.
6. Risks and Considerations:
- Risk and Return Tradeoff: Higher yield comes with higher risks.
- Default Risk: Present in high-yield bonds and senior bank loans.
- Foreign Investments: Carry stability risks during economic downturns.
7. Finding Yield Outside Bond Market:
- Convertible Bonds, Stocks with Dividends, Utility Stocks, Real Estate Trusts, MLPs, Preferred Stocks: Alternative avenues for high yields with varying levels of risk.
This comprehensive overview emphasizes the nuanced dynamics of fixed-income investments, shedding light on the interplay between risk, return, and various market segments. As investors navigate these options, a careful consideration of individual risk tolerance and long-term objectives becomes paramount in constructing a well-rounded and robust investment portfolio.
