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Tips on investing in high-yield bond funds

- Alan Lavine and Gail Liberman

You'd like to earn an 7 percent to 8 percent yield, right?

That's about what you can earn on a high-yield bond fund. But before considering this high-risk investment, be sure you know what you're getting into.

High-yield bond funds invest in bonds issued by companies with poor credit ratings. The issuers are rated below BBB by Standard & Poor's and below Bbb by Moody's.

These pay high yields because otherwise, nobody would invest in them. They're too risky. Anytime you risk your principal, you need to get compensated accordingly!

In the 1990s, high-yield bond funds registered double- digit losses when the economy went into a recession. The same thing could happen again.

That's why it's so important to make high-yield yield bond funds just a small part of your bond holdings. Your other bond-type investments might include money funds, high-quality bonds, U.S. Treasury bonds and bank CDs.

If you decide to invest in a high-yield bond fund, here's what to consider:

  • Make sure the bond fund manager invests in companies with good quality assets, such as real estate, plants and equipment, and future products.

  • Call the fund manager and ask how much the investor typically gets compensated if a bond in the fund defaults. You want to invest in bonds that can pay back investors close to $1 for $1 if there's a default.

  • A company that issues a bond should be able to survive five years of poor business conditions.

  • The rates on high-yield bonds should yield about 2 percent to 3 percent more than Treasury bonds. Otherwise, why take the risk when you can invest in bonds guaranteed by Uncle Sam?

  • The high-yield bond fund should own a large number of issuers in a large number of industries. So if a few bonds default, the overall holdings won't suffer.

  • Go to www.Morningstar.com and review the track record of the bond fund. Seek a four-star or five-star rating by Morningstar Inc., Chicago. That rating means the fund delivers the best return with the least amount of risk in its category.

  • Also check the fund's fees and expenses. Your goal: A no-load mutual fund that charges no commissions. Make sure the fund's expense ratio is in line with the average bond fund expense ratio--around 1 percent.


    Spouses Gail Liberman and Alan Lavine are syndicated columnists. Their latest book is "Rags to Retirement (Alpha Books)." You can e-mail them at MWliblav@aol.com.

    To read more columns, please visit the column archive.

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