How Exactly Do High Yield Bond Funds Work?
High yield bond funds are just like any Mutual Fund or ETF, in that they are an investment vehicle designed to pool together multiple investors assets to invest for the same goal. In this case they are investing assets in lower credit quality bonds referred to as High Yield.
The reason why the yield is higher is because the chance of default is higher. In investing there is always a trade off – the more risk you take, the higher potential return. These companies are paying investors a higher rate to encourage them to accept the higher risk and lend to the company. This increased risk is why diversification is so important. When using a bond fund to invest in high yield bonds, you are able to spread your assets across many different high yield bonds instead of just picking a couple to invest in. If you are using a fund to do this, you might be investing in 100 or 200 different high yield bonds which decreases the impact if one of them defaults.
– Matthew Morzy, CFP® Investment Team Manager
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