In the investment world, equity stocks -- with their infinitely variable proportions of risk and return -- are the charismatic rock stars, while bonds and other dowdy debt instruments play a supporting role. Bonds have a well-deserved place on the safe, conservative side of your investment strategy, but surprisingly, they also have a wild side. Bonds from new or struggling companies are risky and offer higher returns than investment-grade bonds, and class C bonds are the riskiest of all.
A Quick Primer
Reduced to its fundamentals, a bond is an IOU. When you invest your money in a company or government, the bond is that issuer's promise to pay your money back at a contracted rate of interest. The likelihood of the issuer making good on that promise is key to the system working as it should, and major organizations such as Moody's and Standard & Poor's have time-tested criteria for evaluating an issuer's solvency. Bonds rated below S&P's BBB or Moody's Baa are considered to be "high-yield" bonds in the industry, colloquially called "junk bonds."
Bad and Worse
The C class has three broad categories of bonds. The CCC category is the best of them. Although the criteria vary slightly between agencies, these are companies teetering on the edge of being unable to pay their bills. They need a "home run" in the form of a substantial new customer, government assistance or a general economic upturn if they're going to survive. Class CC bond issues are even more endangered, and the company might even already be in default. Still, there's at least an outside chance of recovering some portion of the debt. Class C issues have already stopped paying, and there's little likelihood of making back your money.
Risk and Reward
The riskier a debt instrument is, the greater the interest it pays. That means nervy investors sometimes seek out these substandard debt offerings in the hope of mining a high return. You might feel that the issuing company is sound enough to recover from its short-term challenges, or at least to last long enough for your bond to mature. Alternatively, you might gamble that their purchase price is so low that you'll make a profit if investors recover even a modest payout from the wreckage. In either case, this isn't an investment to make with your retirement money. Like the roulette wheel in Las Vegas, this is where you put the extra dollars you can afford to lose.
Spread the Risk
Unless you're content to roll the dice and trust to luck, earning a positive return on class C bonds requires a deep understanding of the issuer's business. If you can't draw on that kind of expertise but would like to have some money in speculative high-yield bonds, a mutual find might be your best option. Instead of you picking individual issues for yourself, the fund's managers selectively choose high-yield bonds that show promise of making good on their commitments. In exchange for a modest management fee, you'll benefit both from that technical expertise and from a pool of fellow investors to share the risk.
- Financial Industry Regulatory Authority: Smart Bond Investing—Types of Bonds
- Moody's Investors Service: Rating Symbols and Definitions
- Standard & Poor's: Standard & Poor's Ratings Definitions
- Securities Industry and Financial Markets Association: What Are High-Yield Bonds?
- Investor Protection Trust: A Primer for Investing in Bonds
- AndreyPopov/iStock/Getty Images