Why Would You Buy Junk Bonds?

“Convince me why I shouldn’t buy junk bonds.”

It wasn’t a challenge. My colleague Kyle was looking at some of the juicy yields on offer in high-yield bonds and was legitimately wondering why he shouldn’t load up his IRA with them.

I’m not saying he shouldn’t. Junk bond yields really do look ripe for the picking here. But that’s probably not the best use of capital at the moment.

Let me explain.

It was only a few weeks ago that junk bond yields were trading near all-time lows, just barely above 5%. That’s ludicrous, of course, and they call these “junk bonds” for a reason. Companies that issue junk bonds tend to be weaker financially and carry a lot of debt. Most are not at immediate risk of bankruptcy. But they’re definitely not the highest-quality companies or they wouldn’t be issuing junk bonds.

Not to be mean, but if you were willing to accept a yield of 5% for junk bonds, you deserved to lose money.

But what about today? With the massive sell off in risk assets, junk bond yields have soared to over 11%, which is the highest they’ve been in over a decade.

But if you take a longer term view, that’s nowhere near the highs we saw during the 2000-2002 tech bust or the 2008 meltdown. In 2008, junk bond yields hit 22%, roughly double today’s yield.

I know, I know. That was before the days of QE Infinity. The Fed has already said it plans to buy unlimited amounts of government, mortgage and even corporate debt. It’s doubtful the Fed will buy a lot of junk bonds. That would seem like a bridge too far. But if they suck up enough bond supply from other corners of the market, junk bonds should benefit from the increase in overall liquidity.

So, even if defaults rise from here, junk bond might end up being just fine. But is that still the best use of your capital?

Today, you can buy a high-quality, bulletproof REIT like Realty Income (O) at a dividend yield of nearly 7%. Yes, that’s lower than the current yield in junk bonds. But once the dust settles in this virus scare, what would you rather own? A landlord with a massive collection of high-traffic retail properties like pharmacies, convenience stores and gyms… or a portfolio of bonds issued by crappy companies? Which do you think will ultimately provide more income and better stability over the course of your retirement?

Along the same lines, pipeline giants Enterprise Products Partners (EPD) and Kinder Morgan (KMI) sport dividend yields of 12% and 9%, respectively. Yes, they are in the business of moving oil and gas, and yes, that business may be in rough shape if we see a wave of energy bankruptcies sweep America. There is a risk that cash distributions get cut slightly. Some of the weaker players in this space have already cut to conserve cash.

But again… would you rather own a high-quality pipeline operator with decades of experience and massive insider ownership… or a portfolio of bonds issued by crappy companies?

Even Altria Group (MO), the maker of Marlboro cigarettes and other tobacco products, yields around 10%. Would you rather own one of the oldest and most reliable dividend payers in history… or a portfolio of bonds issued by crappy companies?

I could go on all day, and I’m not necessarily suggesting you run out and dump a ton of money into any of these stocks. But my point stands. Given the dividend yields on offer across the market right now, putting together a portfolio of high-quality dividend payers makes a lot more sense than junk bonds. Once this crisis passes – and it will, even if it takes months – the dividend stocks are a lot more likely to provide a solid stream of income in retirement.