Junk Bonds: Savvy Investment or Fool's Gold?

By Dave Carpenter, AP Personal Finance Writer

CHICAGO (AP) — A sideways stock market has investors searching for other places to make a decent return on their money. And junk bonds, for better or worse, are starting to look like gems to many.

The appeal is easy to understand.

Junk bonds, known more politely as high-yield bonds, are bonds with very low credit ratings that corporations pay more interest on so they can attract investors. As of last week, they were yielding 8.34%, down from 9% earlier in July.

That number is mighty enticing at a time when the Standard & Poor's 500 index is up just 1% for 2010 and down 22% from a decade ago. And a murky economic outlook hampers prospects of a strong rebound any time soon.

Virtually nowhere else can you get 8% back on your money these days. The going rate for a 10-year U.S. Treasury note last week was 3.05%, low by historical standards. It's not much better for investment-grade, or more highly rated, corporate bonds: 3.8%, as measured by the Barclay's Capital U.S. Credit Bond Index.

Return-starved investors have noticed. High-yield mutual funds have seen nearly $3 billion in inflows over the past three weeks, according to Lipper FMI, a unit of Thomson Reuters.

But investor beware: They're called junk for a reason. Bonds below investment grade, or those with S&P ratings below BBB and Moody's ratings below Baa, are much likelier to default.

Not only that, junk bonds act more like stocks than other bonds do. That's because their prices are closely tied to the corporations that issue them and their ability to service debts.

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