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June 02, 2009


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High Yield bonds are generally riskier bonds. They get higher % returns because the companies that issue them are less credit worthy. They have lower credit ratings so they are a bit more risky. They are also sometimes called "junk bonds".

I'm not sure what "core bonds" are really. That might just be the name of the bond fund. Is it Oppenheimer Core bond? Personally I'd stay away from that one. They had particularly bad losses for a bond fund and are being sued over it. Something very fishy was going on there.

If you look at the details of the bond fund then it should say more about what kind of bonds it invests in. Its likely government or "investment grade" bonds. Treasury or municipal bonds are generally high rated with low risk and lower yield. An "investment grade" bond is one with a high credit rating and lower yield.

Jim did a good job of covering the core differences between "investment grade" and "high yield" bonds. High yield bonds are a perfectly acceptable investment. You just need to expect much higher volatility than for investment grade corporate or government-backed bonds. If you can ride out the long term you'll care far less about the amount the bonds are worth and the yields will make up for it. If you can't wait for the long term you'll probably want the principal preservation of investment grade bonds.

From an asset allocation perspective High Yield is more corelated to stocks than investment grade/treasury bonds.

High yields are risky corporate bonds.

A "core" bond fund generally has high quality (and relatively low-risk) corporates, U.S. Treasuries, and perhaps some high-quality mortgage-backed securities like GNMAs. This is the case with the excellent Vanguard Total Bond Index (VBMFX). Another fine core bond holding is Harbor Bond (HABDX). This fund is managed by bond guru, Bill Gross.

The risk/return profile of a high yield bond fund is low compared to that of a good core bond fund. In other words, a high yield bond fund is probably not worth the added risk. The standard deviation of Vanguard's Hi-Yield Fund (VWEHX) is 14.11, about three times the average of VBMFX and HABDX. The diversification benefits of high yield bonds (one of the attractive qualities of bonds) are minimized, in part, because they are more closely correlated with the stock market than other bonds. In addition, high yields generate a lot of taxes.

Finally, the 10-year tax-adjusted return of the Vanguard high yield fund was 0.47% compared with 4.58% for HABDX and 3.62% for VBMFX.

The occasional outperformance of high yields probably isn't worth chasing.

Stay away from high yield (junk bonds). The only bonds worth trusting in these times are short term Treasury Bonds .

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