Last week, The Wall Street Journal ran an article that contradicted every negative piece it has published about the bond market since 2009.
The article essentially said a rising interest rate market is not the end of bonds or the fixed-rate Armageddon the money press has predicted.
I couldn’t agree more.
You see, just because interest rates are primed to rise, that doesn’t mean investors should simply avoid bonds.[ad#Google Adsense 336×280-IA]Despite the lowest interest rates in a lifetime, my bond strategy includes a mechanism that has earned as much as 17% a year since 2009.
Part of the secret to my success is I’ve recommended high-yield corporate bonds to my subscribers.
The other half of our success has to do with the way I recommend structuring your bond portfolio.
Ladder Your Way to Success
To make money in a rising interest rate market you have to use a modified bond ladder called a staggered ladder.
Despite its suddenly rosy outlook for bonds, the Journal article missed this adjustment altogether. It’s a huge oversight.
For as long as I have been in the money business, a bond ladder has been the preferred tool to limit risk and take advantage of rate changes. And it has always worked very well.
Here’s how a traditional ladder is set up.
Let’s say you buy a bond with a two- or three-year maturity, another with five- to eight-year maturity and another with a 10- to 12-year maturity. (You could go out as far as 30-year maturities.)
The thinking in a traditional bond ladder was to buy many bonds, 10 to 15 for a good-sized portfolio, with different maturities. By buying bonds with various maturities, you had bonds maturing every few years to buy into rising rates.
In the past, as bonds matured it is possible you could have also bought into lower rates.
But interest rates are at almost 0% now. In this market, there isn’t anywhere to go but up.
So when rates do move up (as they did last summer), we won’t have a few years to wait for bonds to mature to take advantage of lower prices and bigger returns.
Last year, for example, the yield on the 10-year Treasury shot up to 3% from 1.66%, an 84% increase in just a few months. It then corrected to the 2.46% range. Since then, it has drifted around from 2.6% to about 2.8%.
What does that mean?
It’s what I call the slingshot effect. Rates have been so low for so long, the natural tendency is for any rate change to be exaggerated, up or down.
When rates move again, what the slingshot effect has taught us is that rates will run up at a faster rate than ever before.
To make this pay off you have to have money available more often than every two to three years. So, instead of a ladder with multiple years between each maturity, make the simple change to a staggered ladder with one year or, ideally, less than a one-year maturity between each bond.
A staggered bond portfolio of ultra-short maturity high-yield bonds of less than seven years will give you a solid, almost bulletproof portfolio with yields exceeding 6% to 17% a year.
While the returns are great, the important part of this strategy is to have cash available every year to buy into what are guaranteed to be higher yields in the future.
The result is lower bond prices, higher yields to maturity and more income.
The Only Place to Be
In the current market, high-yield corporate bonds are experiencing a 98% success rate. That means 98 out of 100 of them are paying exactly as promised. I think this is the best investment opportunity, ever.
Most of us have been swinging for the fences with our investments for years. That was fine when we were 35 and had what seemed like infinity to save for retirement. But, for most of us, the end is now in sight and it’s time to get realistic about returns and risk for the secure portion of our money.
As we age we have to transition to less aggressive investments that more accurately reflect our decreasing risk tolerance. We just don’t have as long to make up for big losses in more aggressive positions.
For most of us that means more bonds and fewer stocks. But you better use the right structure and bonds or get ready for the consequences.
Buying corporate bonds with maturities of less than seven years in a staggered portfolio with at least one bond maturing a year is the only way to play this bond market now and the market for at least the next 10 years.
But it doesn’t matter whether you are in corporates, Treasurys or municipal bonds. Short and staggered is the order of the day.
— Steve McDonald[ad#IPM-article]
Source: Wealthy Retirement