The Lurking Dangers of Bond Funds

Underwater…

“Paddle left” was the last thing I heard as our raft flipped violently on the Middle Fork of the Salmon River in Idaho. Before I could take a deep breath, the current pulled me under.

The water was freezing and moving fast. I started getting panicky as my lungs ran out of air. Disoriented, I finally surfaced. The next thing I heard was the reassuring voice of our guide. “Just relax, point your feet down river, we’ll regroup at the next bend.”

The rest of our trip down river was beautiful but uneventful.
“Thanks for saving my head,” I said to the guide as I gave him a generous tip. “I forgot the feet first down river rule.” Actually I forgot everything when the raft flipped. “That's pretty common,” he said. “Unless you've got some history on the river it's hard to keep your wits about you when things get ugly.”
The same thing is true in investing…

Many investors know what they’re supposed to dowhen the going gets tough. They just don’t do it. They don't have a guide to calm them. They don’t have the experience to calm down, get their bearings and keep paddling.
With experience or a guide with experience, investors would know that…

* Market declines are common and natural part of the investment process.

* Since 1900 the Dow Jones Industrial Average has had 312 declines of 5% or more. That’s about three times per year, on average. Market dislocations have always provided great opportunities for buying high quality investments at discounted prices.

For the 10-year period that ended December 31, 2008 the S&P had a 10-year average return of -1.5%. Looking back to every point when the market returned less than 2.5% for 10 years, the market returned an average of 13.3% for the next 10 years. The worst 10-year return was 7.1%, the best 18.6%.

Despite these facts, when markets decline, many investors go to the sidelines. You will get ahead by having the fortitude to buy when others are most fearful. That time is not now. But it will come again.

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Trust your guides…

The analysts of IDE have more than a hundred years of history on the river. And we have designed a new portfolio allocation program that you can use to make money now and in the months and years ahead. It is based on historical facts. It is conservative. And it has proven to be very profitable.

Here are a few examples:

* Our in house options expert is Ted Peroulakis. He will show you how to use a small sliver of your portfolio to generate outsized gains, whether the markets are moving up or down. Ted is on fire, delivering a half-dozen gains over 100% in the last two months, plus several gains in double digits.

* Steve McDonald is showing his readers how to generate long-term stock market returns, plus generous income, without taking stock market risk. Out of more than 60 recommendations, Steve has taken only one loss in a year – 15%.

* Andrew Gordon leads his readers to the safest and strongest income-generating stocks in the market – companies you can hold for years to come, compounding your wealth by thousands of percent. Andy’s most recent winner is a stock that pays a safe 13% yield… and has appreciated 58% since his readers got in less than a year ago.

* Dr. Rusty McDougal has dedicated more than 15 years of his life to precious metals and the field of natural resource exploration. And has it ever paid off! In the last year, 16 out of 17 recommendations are winners… including gains as high as 285% and 276%.

In just a few weeks from today, IDE will release our portfolio allocation program, including ongoing monthly recommendations. It will be free to all members of our flagship newsletter Sound Profits, which will be re-launched at the same time.

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The Wall Street Journal reports that 78% of money market funds are paying 0.1% or less in annualized yield.

Many people rely on money markets for income. But with most funds yielding next to zero, these investors are pouring into other fixed income investments. They assume these investments are safe. But they’re not.

In August alone $40 billion dollars fled the money markets into bond funds – mostly intermediate and long maturity and junk bond funds. Steve McDonald, editor of The Bond Trader says, “These funds are time-delayed land mines that can wipe out those who are unaware. They have exposure to inflation and interest rate risk that slash as much as 30% of the principal.”
Bond funds can be attractive because of the high dividend payments…

Most bonds funds that pay 4% to 6% yields in this interest rate environment do so by applying leverage to long maturity bonds. Both of these factors substantially increase their risk.

The longer a bond’s maturity, the greater it will drop in value when interest rates or inflation go up. As the underlying value of the bonds in a fund drop, the net asset value (NAV) drops as well. That’s your principal disappearing. Leveraging – or borrowing against the portfolio to increase income – only adds to the problem.
In 1994, investors felt safe in “widow and orphan” investments…

That year, many bond and government securities funds lost as much as 30%. Many investors never got those funds back. All because they did not understand the relationship between interest rates, leverage, and the value of the bonds within their funds.

According to The Journal article, the riskiest bonds right now are Treasury notes and bonds, with 10- to 30-year maturities. Steve says, “When interest rates spike – and they will – you have the most to lose in treasuries.”

The safest way to increase your income in this market is to stay in ultra-short maturity bonds (three years or less). Stick to high-quality, investment grade issues. And use no leverage.

Steve offers this combination of quality, short maturities and no leveraging to his subscribers. So far, after 60 recommendations, he is averaging 6% yields plus around 12% annually in capital gains and income.

If you’re interested in long-term stock market returns (over 10% annually), using a strategy that provides the greatest protection against inflation, interest rate increases and market risk, check out The Bond Trader.
Federal Express can provide you with a much better snapshot of the economy than any Ivy League economist…

Last week, the company reported earnings off 53% versus a year ago. Revenues fell 20%. But those figures look backwards. We already know that the last quarter was tough on all businesses.

We want to know what the company sees over the next quarter. The good news is that even though his crystal ball is “misty.” Alan Graf Jr., the CFO of FedEx, sees “year-over-year growth in the U.S. domestic package business.” The company also stated that they see signs of improvement in the global economy.

Heading into the holiday season we obviously expect an increase in the business of package shippers. But FedEx knows that this seasonality will occur. If they are anticipating year-over-year growth, it is an encouraging sign.

Here’s the chart of FedEx over the last year…

At least for the time being, Federal Express is telling us that the economic trend is up-and-to-the-right.


Good Investing,

Bob Irish
Investment Director
Investor's Daily Edge