If I asked you what mutual fund returned over 9% per year on average over the last 10 years, what would you guess?  If I told you it isnt a stock fund, would you be surprised? If I told you that this same fund had a higher return than the S&P 500 from 1991 2010, would you be shocked?  Not only has this mutual fund outperformed the S&P 500, but it does so with less risk.  This fund is The Fidelity High Income Fund (SPHIX).  From 2000 to 2010 an investment in an S&P 500 index fund returned only 3.6%, while an investment in The Fidelity High Income Fund returned 78.5%.  From 1991 2010, the S&P 500 index fund returned 557% while the Fidelity High Income fund returned 646%.

What does the Fidelity High Income fund invest in?  It invests in lower quality bonds, also known as junk bonds.  Companies that dont have good balance sheets or have unfavorable earnings expectations issue junk bonds.  They are considered lower quality because there is a greater chance that the company will not pay back its bondholders.  Investing in junk bonds is risky business.  That is where the mutual fund manager comes in.  Even in the worst of times, junk bonds default less than 15% of the time, so it is up to the manager to choose from the bonds of the 85% that dont default.

Companies that issue lower quality bonds have a better chance of paying back investors if the economy is growing.  When the economy is doing well, the stock market does well.  Therefore, when the stock market does well, the High Income Bond Fund will do well.  Generally bond funds do the opposite of stock funds.  That is where the High Income fund is unique.  It goes up when the stock market goes up, and goes down when the stock market goes down.  The greatest benefit of the High Income Fund is it is always getting interest payments from the bonds that are owned by the fund.  Therefore if the economy tanks, and the stock market falls, even though the fund will drop, the drop will be mitigated by the interest that is being received from the bonds.

Everyone should own bond funds in their 401k.  It doesnt matter how old or young you are.  We all learned this as a valuable lesson over the last 10 years, where the stock market has gone nowhere. If you want a fund that can provide excellent returns when the economy grows and have some downside protection when the economy is doing poorly, consider a junk bond fund such as Fidelity High Income (SPHIX).