As recently as March 5, 2019, Kiplinger published an article focused on the risks of “high-yield” or “junk” bonds. Its headline did not mince words: “Junk Bond Funds Don’t Belong in Long-Term Portfolios . . . Safety-Minded Investors Can’t Overlook the Risk that Comes Along with Them.”
Before reading further, it is critical to understand two simple concepts: (1) the terms “high yield bonds” and “junk bonds” are synonyms in the securities industry. The terms refer to the same type of security: a bond with a low-credit rating. In simple English, they are high-risk bonds. But, many financial advisors avoid using the term “junk bond” when discussing prospective investments with clients, often instead directing the focus of their recommendation to the words “high-yield bonds”; and, (2) junk bonds pay higher rates of interest than high-quality bonds, but that higher rate of interest means that there is greater risk to losing some, or all, of your principal.
With the broad decline in interest rates over the past decade, the higher interest rates paid by junk bonds have made for an easy sales pitch in recent years by financial advisors to elderly investors since seniors often depend on the income generated by their investments to pay important living expenses. The net result has been a massive accumulation of junk bonds by senior citizen investors. But many investors lack the necessary expertise or time to assess the risks of investments selected and recommended to them by their brokers. Often, elderly investors do not even realize that their portfolio owns junk bonds and is, thus, exposed to their inherent high risks. In this post, we have provided 4 questions you can pose to your broker or financial advisor to help you determine whether your retirement funds are exposed to junk bonds and, if so, to what extent is that exposure?
The easiest way to determine whether your account is holding junk bonds may be to ask your broker or financial advisor directly. But please note that there is an important caveat to this. No matter your circumstances, neither the Law Offices of Montgomery G. Griffin nor any other law firm can say what is legally advisable for you to do without being consulted and fully apprised of the facts of your situation. If you have a securities account under the guidance of a broker or financial advisor and are concerned that the account might have underperformed due to unsuitable investments and/or inadequately explained junk bond holdings, you should first consider contacting an attorney who specializes in analyzing brokerage accounts and arbitrating investment mismanagement issues against brokers and financial advisors, such as the Law Offices of Montgomery G. Griffin. Choosing instead to inquire with your broker or advisor without representation can have undesirable consequences. For example, your broker may dissuade you from pursuing meritorious claims stemming from his or her unsuitable junk bond recommendations. After all, if your broker or financial advisor defrauded you once (when recommending the purchase of an unsuitable investment, such as a junk bond), he or she is liable to do so again. In addition, you may unwittingly impair your legal rights, such as by squandering valuable time to file a claim before a legal deadline to do so. To receive legal advice on your situation, you must consult an attorney.
If you nonetheless simply wish to inquire with your broker or financial advisor to understand whether you hold junk bonds, below is a list of questions you might consider asking. To retain a record of your correspondence, you may consider making this inquiry to your financial advisor in writing, such as through e-mail.
- Am I invested in any junk bonds? This is the simplest and most direct question that might be asked. Any broker or financial advisor should be able to review your portfolio and determine whether you in fact are invested in any junk bonds. But it is a general question, and general questions beget general answers that may (intentionally or unintentionally) obscure important truths. For instance, a broker or financial advisor may cleverly inform you that none of the bonds in your account are individual junk bonds but fail to mention that you hold a bond fund (a fund that holds a portfolio of bonds) that does hold certain individual junk bonds. For that reason, asking the more specific questions below may be necessary.
- What are the S&P credit ratings of the bonds I am invested in? This is a more specific question with certain advantages. When a bond is issued, credit rating services, such as Standard & Poor’s, analyze the bond and assign it a letter grade credit rating (for example, AAA or AA or A or BBB, etc.) that indicate the agency’s assessment of the credit risk of the bond. In essence, the rating conveys the risk that the issuer of the bond will eventually default and fail to pay interest on the bond or, worse yet, fail to return your principal when the bond matures). Note that sometimes your monthly account statements reflect these credit ratings next to your bond holdings, allowing you to check the ratings yourself without inquiring with your broker or advisor.
Another advantage of this question is that even if you are holding only bonds with credit ratings above “junk” status (so-called “investment grade” bonds), it can be good to know whether their ratings are relatively low and therefore almost junk status. The lowest investment grade ratings are Baa and BBB-. Such “almost-junk” bonds could behave very much like junk bonds (indeed, they may even get downgraded to a “junk” rating) and incur significant losses in an economic downturn despite their technical investment-grade status.
- Am I invested in any mutual funds that are holding bonds? In addition to advising clients to hold individual bonds directly, financial advisors often construct portfolios where the client holds bonds indirectly by investing in a mutual fund that invests in bonds, such as bond funds (i.e., funds dedicated to holding a portfolio of bonds). Bond funds can have advantages, but they also can have unique risks and drawbacks. Some bond funds hold junk bonds, others do not. In addition, bond funds may (a) have “sales loads” (often high commissions or fees paid upon purchase) and (b) employ leverage, which will increase the fund’s losses during a period of poor performance. Bond funds can have complicated structures and strategies, making it even more important that your broker or advisor spend time fully explaining to you any risks and drawbacks pertinent to any bond funds you hold.
- If I am invested in any mutual funds that invest in bonds, do any of them hold junk bonds? What credit ratings are the bonds they invest in? These questions can be very difficult for investors to determine on their own. Obtaining the accurate and complete answers may require poring through lengthy prospectuses or other paperwork, but that does not make the answers any less important, and your advisor or broker should be capable of performing this work. If you invest in a fund that holds junk bonds, then you still have exposure to the risks of those junk bonds.
If you fear that you own high yield, “junk” bonds and your broker or financial advisor did not inform you of the high risks often associated with those securities, you should consider consulting an attorney. To contact the Law Offices of Montgomery G. Griffin, click on the contact link below.