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Buying stocks? Never again!

I have three extraordinary stories to share with you today – true stories.

If you take these opportunities seriously, I have no doubt you can become a wealthy and successful investor over the next decade – or maybe sooner. And I know you’ll never buy a stock again. In fact, most of the time you’ll own something that’s literally safer than cash.

These three stories are about a kind of investing that’s far safer than stocks and still routinely makes investors much more than 100 percent a year. It won’t surprise you to learn that Wall Street does almost nothing to educate the public about these opportunities. Nor do any of the discount brokers. But lest you think these investments are only for professionals, we’ll start with a letter I received recently from a reader, someone who is a part-time investor and, probably just like you, reads investment newsletters with a healthy amount of skepticism:

I write in response to your request to hear from all of your readers… [Last January] Porter delayed the January 2009 PSIA report and promised readers something big. I expected some small-cap, geographically remote company that you were investigating and needed more time. Imagine my surprise when the letter came out and your much-vaunted recommendation was “Long Corporate Bonds/Short Government Bonds.”

“Well,” I thought to myself, “at least my money back guarantee hasn’t expired yet.” But, your macro analysis on interest rates was one of the best I had ever read, and I had been reading them for 20 years. But 50 percent gain on a long corporates/short Treasuries trade in one year? Forgive me my skepticism. So I inched into the trade gradually and never committed near the 10 percent of portfolio you recommended.

I feel safe in reporting results close to one year after I started the trade…

My capital commitment was $88,000 on the long, and I will call it $19,000 of margin requirement on the short calls for total capital of $107,000. The total [gain] comes out to $83,607. Total return is 78.13 percent. Average holding period is 9 months… Annualized the return on my trading of it was 104 percent.

When Brett Favre started playing with the New York Jets last year he was amazed at rookie tight end Dustin Keller’s ability to get open, catch and run. He asked him, “Why couldn’t I have met you 18 years ago?” Now I know how Favre felt. – Paid-up subscriber RL

While RL used a bit of leverage and the options market to short government bonds (by selling calls), on the “long” side of his big trade from last year, all he did was simply buy a big position in high-quality corporate bonds, via a diversified bond fund. Anyone could make this trade with the click of a mouse.

Normally, buying bonds involves knowing a little bit about what you’re doing, calling a knowledgeable broker, and being patient about the price you pay for a given bond. Most investors won’t do any of these things, which means there is less competition for truly excellent investments.

As you may already know, bonds are vastly safer than stocks for two simple reasons…

First, bonds represent a legal claim on a company’s assets. As a bondholder, a company has a legal obligation to repay the bond in full. Common stocks, on the other hand, are only entitled to whatever share of the profits the board of directors chooses to distribute via dividends. If the company goes bust, common stockholders typically get nothing.

Second, while stocks are typically valued by earnings, bonds are valued (and misvalued) by the likelihood they will continue paying timely interest. That means, from time to time, you can buy bonds that literally trade for much less than the value of their underlying collateral.

In the fall of 2008, the bond market collapsed as investment banks and hedge funds all tried to liquidate their bond holdings at the same time. As a result, you could buy a legal claim – a bond – for far less than the value of the collateral underlying that claim. And in January of last year, we told readers to buy Rite Aid bonds in our “S&A 16” model portfolio. This week, our editor in chief, Brian Hunt, sent me a note about that recommendation…

Last year produced the biggest return we’ve ever registered in the history of the S&A 16. Mike Williams’ Rite Aid bond was placed in the portfolio at a price of $286. As things got “less bad” in corporate bonds, this position advanced to its current price of $915. And as Mike predicted, Rite Aid was more than able to cover its interest payments, which amounted to $68.76 in yield. Total gain on our buy price was 244 percent. A special congratulations to Mike Williams is in order.

My bet is 90 percent of our readers have never bought a corporate bond, don’t really understand how they work, or why they’re frequently far superior to stocks – both in terms of risk and the potential for total returns. We can only lead the horse to water.

I asked Mike Williams – our in-house bond analyst and the editor of our bond-centric publication, True Income, about his performance last year. Mike has been analyzing bonds professionally since the year I was born (1972). This experience gives him a perspective on bond investing most people simply don’t have – and never will. Says Mike about his best picks:

The picks I like the best are not always the best performers. To me the “best” is the best return for the lowest risk. Over the last year, there were three of these “no-brainers”: ILFC, Janus and Sears… ILFC (the jet aircraft leasing giant) are brilliant operators, hugely profitable, absolute masterful debt management, well-established investment-grade credit whose only fault was poor choice of a corporate parent. For that we buy an investment-grade, two-year bond at an impossible 31 percent discount.

Janus (the fund management company) is such a simple business it is nearly impossible to screw up… And I personally knew the guys at InTech, a new acquisition that Janus was cross selling very successfully. I knew Janus would benefit from a stock market recovery. It had a cash hoard of $400 million and generated more cash every day. A BB-plus credit trading at another impossible 35 percent discount.

Sears was similar. After months of punk retail sales, investors wanted nothing to do with the sector. But Sears was not going to go away. It had lots of cash, lots of valuable real estate, and lots of time. This bond offered us 9.2 percent in cash and was, in my opinion, an underrated BB credit trading at a 27 percent discount. Lampert (Sears’ largest shareholder) had been buying back both stock and debt.

This bond ran up to $970. We sold it and bought a longer-dated Sears bond for $605. That increases our effective annual cash yield to 15 percent, which we will collect until 2017. Same credit, more money for longer.

If I had the power to grant all of my readers one gift, I’d probably choose an understanding and an appreciation of the bond market.

I am more and more convinced part-time investors should keep nearly all of their investment dollars in short-duration corporate bonds trading at a discount to collateral value. It’s the only sure way I know to earn substantial returns without putting capital at risk.

If you don’t know anything about bonds yet, treat yourself this year to a subscription to our bond letter – True Income. Let a veteran professional bond investor show you the ropes. And as always, if you’re not 100 percent satisfied – if you don’t walk away with profits and a good understanding of how to buy bonds – we’ll refund your money.

Horse, meet water.

Good investing.