Independent agencies, such as Standard & Poor's and Moody's Investors Service, rate the likelihood that corporate or municipal bond issuers will meet a bond's interest payments and repay your principal at maturity. They base their decisions on the issuer's past track record, its revenues or profits, the state of the economy, the industry and sector, and a host of other factors. U.S. Treasurys are not rated — they're considered absolutely safe, since they're backed by the full faith and credit of the federal government.
The various ratings systems have slight differences, but generally include 10 categories, ranging from a high of AAA (or Aaa) to a low of D. The lower the rating, the higher the interest rate the issuer usually pays on the bond in order to attract investors, but the greater the risk of default. The top three or four ratings are considered investment grade, and pose virtually no risk of default.
You'll need to be willing to take on a lot of risk if you plan to invest in very low-rated bonds. Otherwise known as junk bonds or high-yielding bonds, these are highly speculative investments.
However, as you build your bond portfolio, you may want to offset your low-yielding Treasurys with higher-yielding corporate bonds. If your bond portfolio is otherwise well diversified, you might even consider putting a small portion of your bond portfolio into something quite speculative.
Don Kittell
