Few terms in investing are as misleading as junk bonds. The name suggests something worthless, but the reality is a multi-trillion-dollar asset class that pension funds, insurance companies, and institutional investors have held for decades.
These are corporate bonds issued by companies with lower credit ratings, ones that pay higher coupon rates because they have to. The trade-off is straightforward: more income in exchange for more risk. And for investors who know what they are looking at, that is exactly the point.
Questions to ask about junk bonds
→ What are junk bonds?
→ Are junk bonds riskier than other bonds?
→ Do junk bonds pay more than regular bonds?
→ Why would anyone invest in junk bonds?
This is a marketing communication and in no way should be viewed as investment research, investment advice, or recommendation to invest. The value of your investment can go up as well as down. Past performance of financial instruments does not guarantee future returns. Investing in financial instruments involves risk; before investing, consider your knowledge, experience, financial situation, and investment objectives.
In this guide to junk bonds
- What junk bonds are
- Investment grade vs high yield bonds
- Bond credit ratings explained
- When high-yield bonds make sense in a portfolio
- Why investors buy junk bonds
- Risks to understand before investing
What are junk bonds?
Before the 1970s, bonds rated below investment grade were mostly “fallen angels,” companies that had been downgraded after financial deterioration. There was no real market for new issuance at these lower ratings.
That changed when investment banker Michael Milken popularized the idea that companies without investment-grade ratings could issue new debt at higher coupon rates and still attract buyers. The term junk bonds emerged as shorthand for this new category of lower-rated corporate debt, and it stuck, even as the market matured into one of the largest segments of global fixed income.¹
¹ Britannica, “Michael Milken,” britannica.com/money/Michael-R-Milken
Defining bonds
For a foundational overview of bond mechanics, including coupons, maturity, and face value:
Investment grade vs high yield bonds
The line between investment grade and high yield is drawn by the credit rating agencies. Bonds rated BBB- or above by S&P and Fitch, or Baa3 or above by Moody’s, are classified as investment grade. Everything below that threshold falls into high-yield territory.
The distinction is more than a label, though, shaping how these bonds behave, who holds them, and what role they play in a portfolio.
|
Investment-grade bonds |
High-yield bonds |
|
|
Credit rating |
BBB-/Baa3 and above |
BB+/Ba1 and below |
|
Yield |
Lower |
Higher |
|
Default risk |
Lower |
Higher |
|
Price volatility |
Lower, more rate-sensitive |
Higher, more credit-sensitive |
|
Typical issuers |
Governments, large corporations, utilities |
Mid-sized companies, leveraged firms, growth-stage businesses |
|
Investor profile |
Capital preservation, steady income |
Income generation, higher return potential |
Yield and return
The yield premium on high-yield bonds vs investment grade reflects the additional credit risk investors take on. This spread fluctuates with market conditions, widening during periods of economic stress and tightening when credit conditions improve.
Risk profile
- Investment-grade bonds are more sensitive to interest rate movements.
- High-yield bonds respond more to changes in the issuer’s financial health and economic conditions.
- During recessions, default rates on high-yield corporate bonds rise more sharply than on investment-grade debt.
Suitability
Neither category is inherently better. Investment-grade bonds might be suitable for investors prioritizing capital preservation and stability. High-yield bonds might be suitable for investors willing to accept more risk for higher income potential. Many portfolios include both, allocated according to the investor’s objectives and risk tolerance.
Ratings as the starting point
Explore bond returns, maturity, and risk factors in more detail:
Bond credit ratings explained
The previous section mentioned BBB- and Baa3 as the dividing line between investment grade and junk bonds. Those ratings come from 3 independent agencies, each with its own scale, and the full picture of bond credit ratings goes well beyond a single threshold.
Moody’s, S&P Global, and Fitch Ratings dominate the global ratings market. Each uses its own scale, but the logic is the same: higher ratings indicate lower expected default risk, and lower ratings indicate higher risk.
|
Rating category |
S&P / Fitch |
Moody’s |
Classification |
|
Highest quality |
AAA |
Aaa |
Investment grade |
|
High quality |
AA+, AA, AA- |
Aa1, Aa2, Aa3 |
Investment grade |
|
Upper medium |
A+, A, A- |
A1, A2, A3 |
Investment grade |
|
Medium |
BBB+, BBB, BBB- |
Baa1, Baa2, Baa3 |
Investment grade |
|
Speculative |
BB+, BB, BB- |
Ba1, Ba2, Ba3 |
High yield |
|
Highly speculative |
B+, B, B- |
B1, B2, B3 |
High yield |
|
Substantial risk |
CCC+, CCC, CCC- |
Caa1, Caa2, Caa3 |
High yield |
|
Near default |
CC, C |
Ca, C |
High yield |
What ratings measure
- A bond credit rating reflects the agency’s assessment of the issuer’s financial strength, cash flow stability, debt levels, and the broader economic environment.
- It is not a recommendation to buy or sell, and it does not guarantee a specific outcome.
- Ratings change over time. An issuer rated BB today could be upgraded to investment grade or downgraded further.
- These transitions affect bond prices, sometimes sharply, as institutional investors with rating-based mandates are forced to buy or sell.
Limitations
Ratings are backward- and forward-looking assessments, but they are not infallible. The 2008 financial crisis exposed significant shortcomings in how structured products were rated.
For individual corporate bonds, ratings remain a useful starting point, but they work alongside other due diligence rather than replacing it.
When high-yield bonds might make sense in a portfolio
There is no universal rule for when to include high-yield bonds in a portfolio. The decision depends on individual objectives, risk tolerance, and time horizon.
|
Investor profile |
Primary objective |
Role of high-yield bonds |
|
Income-focused |
Maximizing regular income from fixed income holdings |
Could serve as a core income source together with other bond types |
|
Growth-oriented |
Building long-term wealth through a mix of asset classes |
Could complement equities and investment-grade bonds |
|
Capital-preservation-focused |
Protecting principal above all else |
Limited role, if any, due to higher default risk |
High-yield bonds compared to equities
High-yield bonds sit between investment-grade bonds and equities on the risk spectrum. Their returns tend to show a stronger correlation with stock markets than investment-grade bonds do, especially when markets are under pressure. During downturns, high-yield corporate bonds can decline in combination with equities instead of acting as a counterweight.
The difference is the income structure. Bonds pay fixed coupons on a defined schedule. Equities may pay dividends, but those payments are discretionary and can be reduced or suspended. For investors who value scheduled income over capital appreciation, high-yield bonds offer something equities do not.
Time horizon matters
Short-term investors face more exposure to price volatility and liquidity risk. Investors with longer time horizons have more room to absorb short-term price swings and benefit from coupon income over the life of the bond.
Why investors buy junk bonds
Despite the risks, junk bonds attract a broad range of investors. The appeal comes down to a few factors that are difficult to replicate with other fixed income instruments.
- Income generation
The primary draw is yield. High-yield bonds pay higher coupons than investment-grade alternatives, making them attractive for investors seeking regular income. In low interest rate environments, the spread between high-yield and investment-grade becomes even more relevant, as traditional fixed income may not generate enough income to meet an investor’s goals.
- Portfolio diversification
Adding high-yield corporate bonds to a portfolio that already includes investment-grade bonds and equities could improve overall diversification. Their return profile differs from both pure equity and pure investment-grade fixed income, which means they could contribute to a more balanced risk-return outcome.
- Short duration opportunities
Many high-yield bonds are issued with shorter maturities than investment-grade corporate or government bonds. Shorter duration reduces interest rate sensitivity, which can be an advantage when rates are rising or volatile.
Risks to understand before investing
High-yield bonds compensate investors for taking on more risk. Understanding those risks is essential before allocating capital.
- Default risk: The issuer fails to make coupon payments or repay principal at maturity.
- Liquidity risk: High-yield bonds can be harder to sell than investment-grade bonds, particularly during market stress, when bid-ask spreads widen.
- Interest rate sensitivity: Rising rates increase borrowing costs for issuers, which can weaken their financial position and increase default probability.
- Credit spread risk: When the yield gap between high-yield bonds and government bonds widens, prices fall, sometimes rapidly.
- Downgrade risk: A rating downgrade can trigger forced selling by institutional investors, pushing prices down regardless of changes to the issuer’s actual default risk.
High-yield bonds for European retail investors
For much of the bond market’s history, high-yield corporate bonds were largely inaccessible to individual investors. Minimum investment sizes were high, issuance was concentrated in institutional channels, and the infrastructure to access them was not built for retail participation.
Regulated investment platforms have lowered the barriers, making it possible to invest in individual high-yield bonds with smaller amounts and greater transparency than traditional channels allowed.
What to evaluate when choosing a platform
A few factors matter when assessing where to invest in high-yield bonds as a retail investor:
- Credit assessment visibility
Clear information provided by the platform about issuer quality before an investment is made.
- Issuer diversification
The range of companies and industries available.
- Minimum investment
An entry point low enough to allow meaningful diversification spanning multiple bonds.
- Regulatory standing
Regulated by a recognized financial institution.
The infrastructure around high-yield bonds has changed significantly over the past decade. Regulated platforms now offer the kind of transparency, issuer range, and low entry points that were previously reserved for institutional investors. The result is a market that retail investors can access on their own terms.
Mintos is a regulated investment platform licensed by Latvijas Banka that gives retail investors access to high-yield corporate bonds.
✓ Invest your way: Hand-pick individual bonds or, if suitable, let an automated High-Yield Bonds portfolio do the work for you
✓ Fixed income from €50: You could start earning scheduled returns with a low minimum investment
✓ Bonds from 40+ different issuers available: Diversify across industries and companies
✓ Flexible access: Sell on the Secondary Market or request a cash out of your High-Yield Bonds portfolio at any time, subject to demand
Developed by the Mintos Content Team, making investment knowledge accessible for everyday investors across Europe.
Frequently asked questions
What exactly are junk bonds, and why are they called that?
Junk bonds are corporate bonds rated below investment grade by agencies such as S&P, Moody’s, and Fitch. Though the industry now uses “high-yield bonds” as the standard term, the name reflects the higher default risk these bonds carry compared to investment-grade debt, not that they are worthless.
What is the difference between junk bonds and regular bonds?
The mechanics of the bond itself, including coupons, maturity, and face value, work the same way. The difference is credit quality. Investment-grade bonds are issued by companies or governments with strong credit profiles and lower default risk. Junk bonds are issued by companies with lower credit ratings, and the risk is offset with higher coupon rates.
How do I read a bond credit rating?
Bond credit ratings use letter-based scales. S&P and Fitch use AAA as the highest rating, descending through AA, A, BBB (all investment grade), then BB, B, CCC, CC, C (all high yield). Moody’s uses a parallel scale starting from Aaa. Anything rated below BBB- (S&P/Fitch) or Baa3 (Moody’s) is classified as high yield. Each agency also adds modifiers (+ and – for S&P/Fitch, or 1, 2, 3 for Moody’s) to indicate where within a rating tier the bond falls.
What should a first-time investor understand about high-yield bonds before considering them?
High-yield bonds pay higher coupons but carry a meaningfully higher risk of default than investment-grade alternatives. Liquidity can be lower, prices are more sensitive to issuer health than to interest rate movements, and individual defaults can result in permanent capital loss.
What returns can I realistically expect from high-yield bonds?
Returns depend on the bonds held, the economic environment, and whether they are held to maturity. Coupon rates on high-yield corporate bonds are higher than on investment-grade bonds, but those coupons need to be weighed against the possibility of defaults.
