High yield mutual funds may be an effective way to build a diverse investment portfolio. These mutual funds typically invest in high yield, or junk bonds. In many ways, a junk bond is the same as a regular bond. Junk bonds are an IOU from a corporation or organization that states the amount it will pay you back (principal), the date it will pay you back (maturity date) and the interest (coupon) it will pay you on the borrowed money.
The difference is that junk bonds are riskier. Companies with poor credit ratings have to pay higher interest rates than those with good credit ratings. Therefore, junk bonds pay investors better interest rates than investment grade bonds. These bonds pay high yields to bondholders because their credit ratings are less than perfect, making it difficult to get capital inexpensively.
High yield mutual funds invest in two types of junk bonds: fallen angels and rising stars. Fallen angels are bonds that were once investment grade but fell when their issuers' credit ratings dropped. Rising stars are mutual funds whose issuers' credit ratings are rising and may become investment quality.
High-yield mutual funds have typically produced larger returns than CDs, government bonds and highly-rated corporate issues. Including high yield mutual funds in a balanced portfolio has risks, but could raise its overall value.
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