High Income Bonds and Junk Bonds
High-interest, high-risk bonds are often referred to as ‘junk bonds,’ which means that those who invest in them are, in practice, buying the debt of companies with a sub-par credit rating. In today’s world of ultra-low bank interest rates, many investors – especially seniors who invest for income, may be intrigued by the possibility of high returns from junk bonds. While most bank accounts and traditional (i.e. safer) bonds currently advertise rates of around 1 or 2% at the most, some ‘high-yield’ bonds advertise returns of 7% or more. However, many jump into these investments without knowing the risk, and those investors who over-concentrate their portfolio in junk bonds often find themselves experiencing significant financial losses.
Since most companies offering high-interest junk bonds already have a sub-par credit rating (typically BB or below), any further downgrades in a firm’s credit rating can seriously reduce the value of an investor’s bonds. In fact, a 2012 study conducted by Vanguard Mutual Funds determined that most high-risk bond investors do not collect anywhere close to the bond’s projected (or advertised) returns. In addition, Vanguard’s research suggests that adding high-yield bonds to a portfolio does not help with the portfolio’s overall diversification; instead, junk bonds behaved like stocks in a down market instead of holding steady like safer, lower-yield bonds.
It’s not just individual investors who have lost money on these risky investments; historically, several major investment firms have gone under due to an over-concentration in junk bonds. In addition, junk bonds have been the focus of a variety of financial frauds, perhaps most famously the case of “junk bond king” Michael Milken, who spend two years in federal prison for violating U.S. securities laws and whose actions resulted in the bankruptcy and eventual dissolution of his former employer, then investment banking giant Drexel Burnham Lambert.
If junk bonds can cause the fall of major investment banking firms, they are unlikely to be a good fit for many average investors – especially seniors, many of whom rely on their investments for income to satisfy their basic needs. Despite this unsuitability, brokers, financial advisors, and investment firms continue to market high-yield junk bonds to senior investors, and for better or worse, many decide to invest, hoping to earn higher-than-typical returns on what many believe is a relatively safe product.
In one 2011 case, the Oregon Division of Financial and Corporate Securities fined LPL Financial Corporation $100,000 for “failing to adequately supervise one of its brokers,” after former LPL representative Jack Kleck sold “$40,000 of general partnership units and $45,000 in high-yield bonds to an 89-year-old client who Mr. Kleck described as ‘mentally lost’ and ‘confused.’” With cases like this all too common, it’s essential for investors, especially senior citizens and their family members, to be extremely careful about investing in any high-yield junk bonds. Remember to do significant research before deciding to buy any investment, and to consult an experienced securities attorney if you feel that you’ve been defrauded by your broker or financial advisor.
The Silver Law Group can help you determine whether an investment loss is the result of a violation of securities industry rules and regulations. If so, you may be able recover their losses through a FINRA arbitration claim. To assess your individual situation and discover your options, contact us for a free consultation with an experienced elder financial fraud and securities arbitration attorney.