A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

Should You Be a Bond-Market
Junkie?
Is the bond market immune to the maxim that investment
risk and reward are related? Not at all! During most periods,
so-called junk bonds (lower credit quality, higher-yielding
bonds) have given investors a net rate of return two
percentage points higher than the rate that could be earned on
“investment-grade” bonds with high-quality credit ratings. In
2010 investment-grade bonds yielded about 6 percent,
whereas “junk” bonds often yielded 8 percent. Thus, even if
2 percent of the lower-grade bonds defaulted on their interest
and principal payments and produced a total loss, a

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diversified portfolio of low-quality bonds would still produce
net returns comparable to those available from a high-quality
bond portfolio. Thus, many investment advisers have
recommended well-diversified portfolios of high-yield bonds
as sensible investments.
There is, however, another school of thought that advises
investors to “just say no” to junk bonds. Most junk bonds
have been issued as a result of a massive wave of corporate
mergers, acquisitions, and leveraged (mainly debt-financed)
buyouts. The junk-bond naysayers point out that lower
credit bonds are most likely to be serviced in full only during
good times in the economy. But watch out if the economy
falters.
So what’s a thoughtful investor to do? The answer
depends in part on how well you sleep at night when you
assume substantial investment risk. High-yield or junk-bond
portfolios are not for insomniacs. Even with diversification,
there is substantial risk in these investments. Moreover, they
are not for investors who depend solely on interest payments
as their major source of income. And they are certainly not
for any investors who do not adequately diversify their
holdings. However, at least historically, the gross-yield

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premium from junk bonds has more than compensated for
actual default experience.