Bond Funds: The Worst Investment You Can Possibly Make

At our 14th Annual Investment U Conference at the beautiful Grand Del Mar in San Diego last week, I discussed a number of attractive investment opportunities available right now.

But I also warned them about one of the worst investments you can make. Take a minute now to make sure you don’t have it in your portfolio right now.

As I mentioned in a recent Investment U column, we’re at the tail end of the biggest 30-year rally in bonds the nation has ever seen. Three decades ago, Fed Chairman Paul Volcker pushed the prime rate up to 21.5% to squelch inflation. Long-term Treasury yields reached 16%. From that pinnacle, long-term yields have plummeted to 3.1% today. Bond prices have soared accordingly.

But the financial crisis is over and the economy is beginning to show a pulse. Higher inflation may be just around the curve. And as yields move up, bond prices move down. And perhaps way down.

Just about the worst thing you can own when interest rates are moving up is a leveraged bond fund. When a fund manager borrows short term at low rates in order to buy additional long-term fixed-income investments for his fund, it’s the equivalent of buying stocks on margin. It works fine while bond prices are flat or rising. But when bond prices fall – as they will when interest rates rise – these shareholders take a shellacking. If you’re not sure whether the bond funds you own are leveraged, don’t guess. Call the funds and ask.

And if you owned a leveraged closed-end fund, don’t even call. Just get out, especially if the fund is trading at a premium to its net asset value (NAV).

Recall that closed-end funds are not like Fidelity or Vanguard mutual funds. Like ETFs, they trade on an exchange and can be bought and sold throughout the day (not simply redeemed at the closing price like open-end mutual funds).

However, closed-end funds can see their prices fluctuate well above or below their net asset values (NAV). When a fund trades above its NAV, it is said to be trading at a premium. And when it trades below the NAV, it is trading at a discount.

There is no easier (or more obvious) buy or sell signal than to buy these funds when they trade at big discounts and sell them when they go to a premium.

If those premiums are huge – as many are in the fixed-income sector right now – they are ticking time bombs that you definitely don’t want in your portfolio. Here are just a few that are particularly dangerous right now:

And then there is the biggest stink bomb of them all: PIMCO High Income Fund (NYSE: PHK), currently trading at a 60.4% premium to its net asset value. Over 60%! That is completely nuts. These shareholders are clearly asleep – and overdue for a rude awakening.

Even if your closed-end funds aren’t on this list, don’t be complacent. Call your mutual fund and ask if the manager is using leverage. Or visit a free website like www.cefconnect.com and check out the relationship of your closed-end funds to their net asset values.

It may well be the most important three minutes you spend on your portfolio this year.

Good Investing,

Alexander Green

The Ultimate Alternative Investment?

The Ultimate Alternative Investment?
by Alexander Green, Investment U Chief Investment Strategist
Friday, February 10, 2012: Issue #1706

Last week I spoke at an investment conference at Rancho Santana, a charming resort community on the Pacific coast of Nicaragua, near the town of San Juan del Sur.

Set on more than two miles of coastline with rolling hills and dramatic cliffs, the reserve attracts expats, investors, surfers and nature lovers from all over the world. They like the idea of owning a piece of – or at least visiting – one of the most spectacular stretches of coastal land in the world.

Some are attracted because the property is so inexpensive. It’s hard to believe you can buy a stunning home site directly on the Pacific Ocean for less than $175,000.

And it’s not just the property that’s inexpensive. One evening 14 of us rode into town to have dinner at a favorite local restaurant, Yolanda’s. The proprietor served up heaping helpings of local lobster, fresh vegetables, black beans and rice, plantains and plenty of Corona beer. When I picked up the tab, I was shocked. The cost was less than $9 a person.

Some investors here are banking on increased foreign investment and commercial development. The International Monetary Fund estimates that Nicaragua’s economic growth hit 4% last year… and is on the verge of accelerating.

Exports jumped 23% last year. Tourism is up. MSN Money ranked Nicaragua at the top of their list of “Ten Exotic Retirement Spots for 2011,” telling readers “[Now] is the time to put this country at the top of your super-cheap overseas retirement list.” CNN Money calls it “the next Costa Rica.” Indeed, Rancho Santana is just 50 miles north of the Costa Rican border.

Good things are happening locally, too. A local business leader plans to invest $300 million next door in a world-class marina, golf and spa resort called Guacalito. Due to open in Spring 2013, it’s located just 30 minutes from Rancho Santana and is already bringing increased investment and improved infrastructure to the region. And an international airport is planned for the Tola area, located less than a half hour away.

Other investors are putting money to work here for privacy reasons. They want to diversify their portfolios beyond the prying hands of angry ex-spouses or potential litigants.

But for most, it’s the sheer beauty of the place. The New York Times points out that, “The beaches are among the finest in the Americas, and among the least developed.” Gaze out from atop one of the many bluffs on this 2,700-acre reserve and you’ll see what the coast of California looked like a hundred years ago, pristine and largely undeveloped.

Residential lots are selling quickly. Over 50 homes have been built and 24 more are under construction. It’s not hard to see why. The terrain is such that home sites can capture views of the ocean, the nearby valley and lovely sunsets. Labor costs are significantly lower here. And a master association and various sub-associations exist so that owners are assured that high and consistent standards of quality are maintained.

Is oceanfront property in Nicaragua the ultimate alternative investment? That’s for you to decide. But if you’d like to learn more, feel free to visit the website or, better yet, sign up for a property tour.

The cost is $500 per person ($600 per couple) and includes all transportation, breakfast and three nights in oceanfront accommodations at Rancho Santana. This is a great trip for those wanting to come down and investigate investment, second home or retirement opportunities. (Contact Bryan McMandon.)

In the interest of full disclosure, Rancho Santana is being developed, in part, by colleagues of mine at Agora Publishing. However, I am not compensated in any way (directly or indirectly) for any sales at the development. I just think it’s a beautiful place and an interesting investment.

And whether you decide to invest or not, I know you’d enjoy the experience.

Good Investing,

Alexander Green

The Best Investment You Can Make In Four Minutes

The Best Investment You Can Make In Four Minutes

by Alexander Green, Investment U Chief Investment Strategist
Monday, February 6, 2012: Issue #1702

What if you could reach total financial independence in just four minutes a day?

If that sounds unrealistic, stay tuned. Because in the weeks ahead, our panel of experts at Investment U is going to show you exactly how it’s done.  Best of all, it won’t cost you a dime. After all, this service is free.

It’s a shame, really, that the average person graduates from high school and still doesn’t truly understand compound interest, or adjustable-rate mortgages or what a 401(k) is. Far fewer still know how to navigate the world’s treacherous but lucrative financial markets.

Since financial literacy and advanced money management skills aren’t taught in school, many men and women follow a predictable path when it comes to investing.

First, realizing they don’t know enough to risk their saving without potentially making huge mistakes, they turn to a stockbroker, insurance agent or mutual fund salesman for advice.

Not good.  Many people in the financial industry are peddling advice that is pedestrian, self-serving, far too expensive or all three.  Expect to hear these folks tell you, for example, that full-load mutual funds, whole life insurance and high-cost variable annuities are the best things since night baseball.

After a few years, the typical customer realizes that he’s dealing not with a fiduciary but a salesman – and a primary reason he’s not doing well is that his broker is doing too well.

That’s when many investors make their next predictable move. They transfer their account to a discount broker like E-Trade or Charles Schwab.

And while a discounter is a whole lot cheaper than a full-service broker, it quickly becomes apparent that the customer isn’t a professional money manager himself and – truth be told – really doesn’t know that much about what he’s doing.

The typical discount customer ends up with a few winners and a few losers, but doesn’t know when to sell them or why. At the end of the year, he looks at his statement and sees he isn’t much closer to his financial goals – if, indeed, he ever took the time to set any.

This brings many investors (older, wiser and generally poorer) to the conclusion that they do need qualified help, just not from a salesman in a transaction-based relationship.

Eventually, hundreds of thousands of investors turn to Investment U, the free, Web-based source for men and women seeking to achieve and maintain total financial freedom.

Proven Principles Don’t Change

We do something virtually no one else does. Investment U provides daily commentary and analysis about today’s fast-moving financial markets, but always with the objective of tying our advice to timeless investment principles.

Economies expand and contract. Currencies rise and fall. Governments come and go. Markets zig and zag. But proven investment principles don’t change.

Yet the sad fact is that most investors have never learned them. They’re trying to ace Trigonometry without having mastered Algebra 1. Why don’t you have the crucial knowledge you need?  Because schools don’t teach it and telling the unvarnished truth isn’t conducive to selling high-priced financial products.

As Vanguard founder John Bogle likes to say, “It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.”

We don’t have conflicts like that here. We don’t charge commissions or fees. We don’t want to “capture your assets.”

Yes, Investment U offers premium services to subscribers. (We couldn’t support a free e-letter forever if we didn’t.) But there is never any obligation to buy and any purchase comes with a free-trial period and a money-back guarantee.

So stick with us. In the weeks ahead, we are going to reveal big dividend plays, high-yield bonds, undervalued currencies, ultra-cheap commodities, risk-reduction techniques, and proven strategies to prevent losses, protect gains and navigate today’s volatile investment environment.

Best of all, we’re going to do all this with a single goal in mind: To show you the shortest, most direct route to total financial independence.

The only commitment it requires from you is four minutes a day. That’s how long it takes the average reader to finish our daily column.

The service is free. But the knowledge is priceless.

Good Investing,

Alexander Green

Is Your Investment Advisor Capitalizing on Your Fear?

Is Your Investment Advisor Capitalizing on Your Fear?

by Alexander Green, Investment U Chief Investment Strategist

Monday, January 16, 2012: Issue #1687

Make no mistake. Investors are petrified right now. And they’re telling their investment advisors about it.

The question is: “What is he or she doing in response?” If the answer is adjusting your asset allocation, focusing on your long-term investment goals, or doing a bit of handholding, you probably have a good one.

But if they’re preying on your emotional state with unsuitable investments or all-or-nothing advice, beware.

The story is as old as equity investing itself. When times are good, investors get complacent, take too much risk and generally regret it. When times are bad, investors become anxiety-ridden, take too little risk and generally regret it. Seasoned advisors know this and try to keep you on the right track. But less knowledgeable or less scrupulous advisors may try to take advantage of your worries.

For instance, your investment advisor may recommend that you load up on variable annuities in this uncertain environment. Not a good idea. Some annuities are right for some people. They offer tax-deferred compounding (like an IRA) and a principal guarantee. But the typical annuity is ridiculously expensive, offers mediocre insurance coverage, restricts your investment choices to so-so mutual funds, lacks liquidity and comes with enormous surrender penalties.

Too many investors learn these things about annuities after they’ve plunked for one. Hence, you’ll often hear investors complain that they are “stuck in an annuity” for several years. Investigate these insurance contracts before you invest. On the whole they are oversold, frequently misrepresented and completely inappropriate for many folks.

Another sign that you have a misguided (or unethical) investment advisor is if he suggests that you abandon proven investment principles. For example, if your investment plan is based on a broker’s economic forecast or market timing advice, good luck. You’re going to need it.

No one can accurately predict the economy with any consistency. And it wouldn’t really matter if they could. Stocks routinely rally during the bad times and sell-off during the good ones. If your investment advisor doesn’t know this, you shouldn’t be using her. If she does and is still trying to convince you to flee the market, that’s even worse.

Also beware investment advisors who are paid on a transaction basis and therefore have an incentive for you to trade more frequently. Some brokers today are telling their clients that the old rules no longer apply, that you need to jump in and out of the market and from stock to stock. For a commission-based broker, this can be entirely self-serving advice. And it is almost certain to end badly… at least for the client.

I know it’s tough to buy – or just hang in there – when the outlook is dark. But look back at history. The market was a screaming “Buy” after the crash of ’87, the bear market of 1990, the tech wreck of 1994, the Asian Contagion of 1997, the 2000 to 2002 bear market, and even during the depths of the financial crisis in 2008.

If you’re using an advisor who insists that “this time it’s different,” you might reasonably examine his experience, his ethics and his disciplinary history. And seek out more-qualified advice.

Good Investing,

Alexander Green

Will You Fall Prey to “Headline Risk”?

Will You Fall Prey to “Headline Risk”?

by Alexander Green, Investment U Chief Wealth Strategist
Friday, September 2, 2011: Issue #1592

In the last couple of months, millions of investors have done a 180. It happens all the time. And – just as in the past – they will surely come to regret it.

The story is as old as equities themselves. When the market is an uptrend, investors focus on opportunity and considerations of risk go out the window. When the market is in the tank, they focus on risk and forget about opportunity.

This is the very opposite of what you should be doing.

During my 16-year career as an investment advisor and portfolio manager, I used to show new clients a 200-year chart of the stock market and ask them to identify the best buying opportunities.

Invariably, they pointed to the periods when the market had cratered.

I asked if they would be willing to step up and take advantage of such opportunities in the future. Most nodded vigorously and assured me that they would.

Few actually did.

Why? Because you can never imagine the news backdrop that will accompany a major stock market decline.

When the market recovered – as it always does – these same investors kick themselves for not scooping up bargains when stocks were cheap. Yet when the market declined again, they would generally react the very same way.

Nothing could be simpler than to say, “buy low, sell high.” But pulling the trigger when times are tough isn’t easy.

How to Avoid Headline Risk

It’s easy to fall prey to “Headline Risk.” Here’s what I mean…

On August 9, national newspaper and television headlines shouted that the Dow had plunged 634 points the previous day. That was not an insubstantial drop. It amounted to a 5.5 percent decline in the index.

Yet few sources reminded investors that the Dow was still up 66 percent (excluding dividends) from the market lows 2 ½ years ago. Or that the drop wasn’t even in the top 50 for largest daily percentage losses.

Similarly, the media made a big deal about the market sell-off the week of August 1 to 5 representing an evaporation of more than $4 trillion in world equity values. That’s a big number. (Unless you’re a Congressman, apparently.) Yet the total value of all stocks worldwide is approximately $55 trillion. And, for the overwhelming majority of investors, these were temporary paper losses.

Where was the context? There wasn’t any. The media needs sensationalism to grab viewers’ attention. Newspapers, magazines and television shows aren’t interested in helping you reach your financial goals. They’re interested in helping their marketing departments sell advertising. Sensationalism does just that.

Understand this and you can inoculate yourself against “Headline Risk.” Scary headlines create strong emotions. But strong emotions are usually the prelude to bad investment decisions.

Flee common stocks – the greatest wealth creator of all time – and where will you go? Into 10-year Treasuries yielding 2 percent? Into money market accounts paying next to nothing? Into gold which has already risen six-fold in the past 10 years? Into residential real estate which is mired in a sea of foreclosures?

High quality stocks are still your best bet to meet your long-term financial goals. National headlines are screaming just the opposite, of course, just as they have during every major buying opportunity of the past 75 years.

The truth is your greatest risk is not market fluctuations. It’s that your money fails to keep up with inflation – or that your investment portfolio kicks the bucket before you do.

Consider that before extravagant headlines prompt you to do something foolish.

Good investing,

Alexander Green

Do Trailing Stops Really Work?

Do Trailing Stops Really Work?

by Alexander Green, Chief Investment Strategist
Monday, June 18, 2011: Issue #1558

Editor’s Note: This week Investment U’s Chief Investment Strategist, Alexander Green, is in Seattle for an annual investment conference. Given his priorities to his subscribers, Investment U will be running one of his classic pieces on trailing stops. We hope you enjoy…

Somebody recently told me over lunch that one of the most controversial aspects of our investment policy is trailing stops.

But they shouldn’t be.

If you don’t have a premeditated sell discipline – and the vast majority of investors don’t – you’re flying by the seat of your pants. And that rarely leads to superior investment performance.

But do trailing stops really work?

Survey Says: Use Trailing Stops

In a word: Yes. Trailing stops protect your profits and your trading capital. And there’s much more than just anecdotal evidence.

In a study published in The Journal of Portfolio Management, Christophe Faugere, Hany A. Shawky and David M. Smith – finance professors at the State University of New York at Albany – researched the performance of money managers who oversee pension funds, endowments and high-net-worth accounts.

Because most institutions work under strict investment guidelines, these academics were able to analyze performance based on differing approaches to selling stocks.

The result? Institutional managers who fared best were those with restrictive rules that didn’t allow much leeway for holding stocks for emotional reasons. Managers who relied on “flexible” sell strategies did far worse.

Count me as unsurprised. Institutional money managers are just as prone to rationalizing as individual investors when they make a mistake. (Hence the old Wall Street chestnut, “What does a broker call a trade gone wrong? A long-term investment.”)

Trailing Stops: Providing Protection… Securing Profits

The culprit is almost always pride, ego, or emotion. Without any kind of sell strategy, emotions come into play. And emotions are almost always wrong.

But by adhering to a disciplined trailing stop strategy, our investment system mows down emotion-driven trading errors like a field full of dandelions.

It cures greed. Eliminates fear. And does away with wishful thinking – as in, “I hope this stock turns around and starts going the right way.”

Of course, trailing stops aren’t the only sell discipline out there. But they’re one of the easiest to implement. They serve two purposes…

• They make sure we never let a small loss become an unacceptable loss.
• They keep us from selling stocks while they’re still trending up.

Maneuver Past the Market Makers With TradeStops.com

The one knock against using trailing stops is that unscrupulous market makers will sometimes take out your stop order right before a stock takes off.

But Richard Smith, President and Founder of TradeStops.com – and a PhD in mathematics – has a service that provides an ingenious solution.

If you visit www.tradestops.com, you can enter the stocks you own, the price you paid and the percentage trailing stop you want to use. There are several valuable benefits…

• If any of your stocks close beneath your selected stop, TradeStops sends a message – to your cell phone, e-mail, or account page – alerting you.
• Some brokerage firms, like Fidelity, offer trailing stop alerts with their accounts. But they generally expire after 30 or 60 days. TradeStops information never expires and even offers a 30-day risk-free trial.
• You can track up to 50 stocks at a time. (And whenever you stop out of one, you can replace it with another.)
• TradeStops is easy to use. It’s specifically designed for technophobes.
• It’s reasonably priced. There are additional services available for dedicated short-term traders who want even more.

It’s important to note that TradeStops notifies you of stops, not your broker. And it doesn’t enter sell orders. But the key is to make sure you have an acknowledged point where you’d be willing to sell any individual stock.

Trailing stops don’t just offer to cut your losses and protect your profits. They guarantee it.

Good investing,

Alexander Green