By Harry Prabandham · Updated September 28, 2026
Investing & Markets
High-Yield Bonds: Higher Income, Higher Default Risk
High-yield (junk) bonds are rated below investment grade and pay more interest to compensate for greater default risk. They often fall with stocks.
High-Yield Bonds: Higher Income, Higher Default Risk
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What are high-yield bonds?
- High-yield bonds are corporate bonds rated below investment grade: below BBB- at S&P and Fitch, or below Baa3 at Moody's.
- Issuers pay higher interest because the market sees a greater risk they will miss payments.
- Issuers are often highly leveraged companies, younger businesses, or former investment-grade companies that were downgraded.
- They are also called junk bonds; the label reflects credit risk, not whether a bond is a poor fit for every portfolio.
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Full Guide
What are high-yield bonds?
- High-yield bonds are corporate bonds rated below investment grade: below BBB- at S&P and Fitch, or below Baa3 at Moody's.
- Issuers pay higher interest because the market sees a greater risk they will miss payments.
- Issuers are often highly leveraged companies, younger businesses, or former investment-grade companies that were downgraded.
- They are also called junk bonds; the label reflects credit risk, not whether a bond is a poor fit for every portfolio.
What is a credit spread?
- The spread is the extra yield a high-yield bond pays over a Treasury with a similar maturity.
- Spreads widen when investors worry about the economy or defaults, and prices fall as they widen.
- Spreads can widen sharply in a recession or liquidity crunch even if Treasury yields are stable or falling.
- A wide spread signals the market's concern; it is not a forecast of future return.
What happens if a high-yield issuer defaults?
- Default means missing interest or principal payments, which often leads to a restructuring or bankruptcy.
- Bondholders typically recover only part of face value, and recovery depends on seniority, collateral, and the company's assets.
- Default rates rise during recessions, so losses tend to cluster in the same periods stock prices fall.
- Lower-rated tiers, such as CCC, carry much higher default risk than BB-rated bonds.
Do high-yield bonds behave more like stocks or bonds?
- Their prices depend heavily on the issuer's business health, so they often move with stocks during market stress.
- That means they may not offset stock losses the way high-quality government bonds have tended to.
- They usually have shorter duration than long investment-grade bonds, making them less sensitive to rate changes but more sensitive to credit conditions.
- Many high-yield bonds are callable, which limits price gains when rates fall or the issuer's credit improves.
How are high-yield bonds held and taxed?
- Most individual investors use mutual funds or ETFs because diversification across many issuers limits the damage from any single default.
- Individual high-yield bonds can be hard to trade, and bid-ask spreads can widen sharply in a sell-off.
- Interest is taxed as ordinary income, which is one reason some investors place these holdings in tax-deferred accounts.
- Fund investors should check expense ratios, credit-quality mix, and how the fund has handled redemptions in stressed markets.
Key takeaways
- High-yield bonds pay more because the issuers are more likely to default.
- Returns depend more on credit conditions than on Treasury rates, and they often fall alongside stocks.
- Diversification across issuers and awareness of liquidity risk are central.
- Sizing any allocation depends on your income needs, tax situation, and tolerance for stock-like drawdowns.
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