About seven or eight years ago at one of our Oxford Club meetings, we had a discussion about options and how to play them…

One of our Members stood up at the end of the presentation and delivered one of the best comments I’ve heard…

“I’ll tell you the best way to pick options. Do all your research. Decide if you want to play a put or a call. Pick the expiration and strike price you think will work best. Check all your numbers again, and then do the exact opposite of what you think will work.”

[ad#Google Adsense 336×280-IA]She was only half-joking…

The crowd loved it – I laughed too.

But the truth was she hit the nail right on the head, and not just for options.

For the past 22 years I have worked almost exclusively with small investors, and I have always been amazed at how consistently they do the wrong thing, at the wrong time; the exact opposite of what they should be doing.

Look at the mess that is just now beginning to unravel in the bond market…

The Illusion of Safety

For the past few years the small investor has been pouring money into long-maturity, leveraged bond funds, and, as usual, at exactly the wrong time with record-high prices.

In fact, the word “pouring” doesn’t do justice to what has been going on. Record amounts of money have been pumped into bonds and managed bond products at the lowest interest rates of our lifetimes.

And the bad news about these long bonds and funds is just now starting to show up in quarterly statements. Most will ignore the early warnings signs of a sell-off for a few more months. They will ignore these signs because these investments are supposed to be safe. Right?

Nothing could be further from the truth, especially in this market. The long-maturity bonds and managed bond products that the average guy has been loading up on are some of the riskiest investments there are. Between now and 2015 to 2017 they are virtually guaranteed to lose money.

Bond funds will see the biggest losses…

Sacrificing Quality and Maturity

When you buy into a bond fund you give up all control over the two most important factors there are in bond investing: maturity and quality. Quality is always important, but, in this market, if you ignore the maturity factor, it will cost you a fortune.

In order to attract new investors, almost all bond funds own only very long maturity bonds. They pay the highest returns, which draws in new money from the uninformed, but they also drop the most in value when rates move up.

Funds buy these, the most volatile bonds, because the average guy suffers from a disease known at “rate pigitis.” They only look at yield when they are deciding which bonds or bond funds to own. So, fund managers accommodate them by dangling very high rates in front of them, and they always snap them up.

Funds play the little guy like a fiddle!

The result is the mess we now have in the bond market. Mountains of money in investments that are supposed to be safe, which means they are not supposed to lose money.

The bad news is, not only will these lose money, but they will lose it at the fastest pace of all bond investments.

How to Avoid the Traps

The saddest of this mess is that it is completely avoidable.

You can own bonds in this market and you can make a lot of money, if you avoid the traps. You can do both and significantly limit the downside when the inevitable increase in interest rates finally takes hold.

The solution to what will be a disaster for most people is simple but impossible for most people to implement. It involves turning the mechanical nature of bonds in your favor, being patient and scaling back your expectations a little.

These three requirements eliminate about 90% of all investors.

The secret to success in this market is to buy the exact opposite of what almost all bond buyers own: ultra-short maturity bonds.

Owning ultra-short individual bonds gives you control over how much your bonds will drop in value when this 30-year bond bull market finally turns around.

The shorter the maturity, the less they drop. Less than seven years is ideal, but as the edge of this bull market in bonds approaches, the shorter the better. Five or less is even better.

Limiting the downside in your bonds is how you avoid panic selling, which is how all the money will be lost. It’s a head game, but one that works.

Earn a Safe, Double-Digit Return

Here’s a bond that not only offers a great annual return, but has a maturity that is short enough to hold its value when the big selling in bonds really takes hold.

First Data Corp. has a bond that pays a coupon of 11.25%, is selling for about 101.5 ($1,015 per bond), and matures in March of 2016. Its CUSIP is 319963AV6.

The annual yield to maturity is about 10.58%. You receive $112.50 per bond per year in two equal payments in March and September each year.

This bond will pay a huge return for this market, and its three-year maturity should see almost no price fluctuation compared to bonds with longer maturities.

Yes, it is that simple!

This could be your last opportunity to get out of long-maturity bonds and bond funds before the sky really starts to fall.

Make the shift now or forever hold your peace.


Steve McDonald


Source: Wealthy Retirement