Don't Use High Yield Bonds to Diversify out of Stocks

Morningstar has released a study showing that high yield bonds and high yield bond mutual funds are too correlated with stocks.

To diversify out of stocks, Morningstar recommends high-quality bonds, such as those that you would find in a typical intermediate bond fund. Stay clear of "junk bonds" and junk bond funds if your goal is to diversify.

On the other hand, Morningstar also finds that high yield bonds and high yield bond funds, unlike their high-quality counterparts, hold up better when interest rates rise. The report states that the reason for this is that junk bonds and junk bond funds have higher dividends that soften the blow of rising interest rates.

Source: MorningstarAdvisor.com, October 28 2002