Avoid Stock Slump With Short-Term Bonds

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Posted on Wednesday, October 22nd, 2008 | In Market Commentary

Contributed by: Contrarian Profits (http://contrarianprofits.com) -

The stock markets opened sharply lower again today. Steve McDonald says bonds are a much safer and more profitable alternative right now. Investors should stick to short-term bonds to maintain a flexible portfolio and limit market risk.

This from Investor’s Daily Edge:

It’s 1974 all over again!

Many of you are old enough to remember the market in the 70’s. What a nightmare! The Dow went below 1000, then settled between 700 and 900, and stayed there until almost the mid eighties.

That’s what you call a sideways market. It was years before anyone made any money.

The similarities to our market today are amazing. In the 70’s we had high inflation and a recession, high oil prices, a market in complete turmoil and a government that really didn’t get it

Does anyone remember Jimmy Carter’s request for voluntary price and wage fixing to try to curb double-digit inflation? Unbelievable.

How about 15% mortgages? My first mortgage was 13.75% in 1982.

Today, inflation is just over the horizon, we are in an unofficial recession, and oil prices are coming off new highs. We have a market that forgot which end is up, and the government is doing its usual mule imitation, thick and slow, while stock investors are dying on the vine.

It’s no wonder people are bailing out of the stock market.

There is an alternative to stocks. Bonds are the stealth investment. They’ve been around forever and no one knows anything about them.

Bonds are lesser known than stocks because you can’t pull up a quote for a bond on any computer, there aren’t ten TV programs talking about bonds all day, everyday, and they have a different lingo than stocks.

While the market does a sideways dance for the next few years, bonds can still make long-term stock market returns with none of the headaches of a prolonged stagnant stock market.

Bonds are also more comfortable than stocks. You can have a life without running home to check the markets constantly. With bonds, you pretty much just wait for your interest payments and capital gains to arrive in your account.

Consider this scenario. A telephone company bond, with a current yield of 8.11%, and one that will pay you a capital gain at maturity of another 6% to 7%. That’s a total return of interest and capital gains of 27% (five interest payments totaling $190, plus $65 in capital gains at maturity per bond, divided by the purchase price of the bond of $935.00 equals 27%).

The real beauty of this bond is, it is investment grade, and you only have to hold it for a little over two years. A 27% return while the rest of the market earns zero, or continues to slide.

Short-term bonds are key to a successful bond portfolio, especially in this environment.

The biggest mistake investors make with bonds is locking themselves into long term ones, 10, 20 and 30 years. This is a bad decision for many reasons.

It ties you to a fixed interest rate for too long, exposes you to inflation and market risk, and gives you almost no investment options.

The shorter-term strategy, less than three years, gives you new money every year or so to move into new investments, and allows you to re-invest your principal at higher rates in an inflationary environment. You don’t have to give up return to stay on the short end.

If you’re set on a longer term strategy, to generate more income you can use a ladder strategy that will help keep you balanced and not keep you tied up in just long-term bonds. But, don’t get into only long-term bonds because of the higher interest rate they pay. You will be sorry.

You don’t have to be a victim of a prolonged sideways market. Keep your head above water and look into the alternatives to the stock market. Your financial future is at stake.

Let the other guy go down with the ship. You live to fight another day.