The mutual fund industry has done their best to convince investors that the long-term return of the stock market is just over 12%. That is their justification for “buy and hold.” But you can throw that number out the window.
The annualized return of the S&P 500 from 1929 through 2008 is actually 8.9%. And for most active investors the return would be significantly less.

But what if I told you that you can make two to three times the long term stock market average (15% to 30% annual returns)… without taking stock market risk?

Considering the return of the stock market the last couple of years and the fundamentals going forward, I hope you’ll give this your consideration. So how do you beat the market, without putting your money at risk in Wall Street’s casino? Corporate bonds.

Most investors avoid bonds because they think they are boring and the returns are too low. Or they simply don’t understand how they work. This is a big mistake.

Today, I’ll show you how to use high quality corporate bonds (no junk) to generate 15% to 30% annual returns (and more). And I’ll also show you a simple way to determine exactly how much you’ll make when you invest in a bond.

So forget what you have heard about “boring” bonds. I can show you how to build a high octane portfolio, but without the risk and volatility associated with the stock market.

When you invest in a stock, you own a small percentage of the company. But the company makes no promises whatsoever. You have no idea what the price of the stock will be next month or next year. And if the company pays a dividend, there is no guarantee that it will go up in the future or that it will even continue. In terms of financial obligations, shareholders come in just about dead last.

Bondholders are in a more privileged position. When you buy a bond, you have agreed to loan the company your money. For its part, the company is legally bound to return the face value of the bond, plus interest. In other words, you will know (before you invest) exactly what you’re going to be paid.

The only thing that can disrupt your investment is if the company breaks the contract and defaults on the loan. Even in this case, bondholders usually collect something. Often, they receive 100% of what is due, even in bankruptcy. Stockholders, on the other hand, are normally wiped out in bankruptcy.

Now consider that the long term default rate for the most speculative bonds (so called “junk bonds”) is just 4.5%. That means that 95.5% of speculative bond issuers pay exactly what they owe and right on schedule. According to Moody’s, the default rate for investment grade bonds is even slimmer. On a long-term basis more than 99% of these issuers fulfill their obligations to investors.

Think about this for a moment… How would YOUR portfolio look if 99% of your investments made you money? Where would you be today if you made 10% per year on every investment you ever purchased? I expect retirement would be a lot closer… or a lot more comfortable if that were the case.

Now let me show you how to calculate your return on a corporate bond and how to beat the market, hands down, with a far greater level of safety…

If you were to ask an academic how to calculate your return on a bond, they might give you the following formula to calculate yield to maturity:

If you understand that, you can stop reading now. Otherwise, here is a much simpler way to determine your return.

Subtract what you paid for the bond from its face value. The difference is the capital gain you will receive at maturity.
Add the capital gain to the total expected interest payments.

Divide the sum (interest payments + capital gain) by the amount you paid for the bond. This is your “Total Return”
Divide the total return by the number of months to maturity, then multiply by 12. This is your “Annual Return”

Now let me give you an example, using a bond that my colleague Steve McDonald recommended to his subscribers in April.

The bond is issued by Sallie Mae. It matures in October of 2011 and has a coupon of 5.4%. Since corporate bonds are issued with a face value of $1,000, the 5.4% coupon equates to $54 per year in interest.

But Steve’s subscribers didn’t pay face value for the bond. They bought it at a discount and paid just $660. So let’s calculate what this bond will return.

$1,000 - $660 = $340 (capital gain)
5 interest payments x $27 = $135 + $340 = $475 (capital gain + interest)
475 / 660 = 71.96% Total Return
71.96 / 28 x 12 = 30.84% Annual Return

So in this example, we have a safe, investment grade bond that will return 31% annually. That’s more than three times the average long-term return of the stock market. And this is an investment with a contractually bound return. The only way Steve’s subscribers would not receive this return is if this government-sponsored enterprise (GSE) defaults on their obligation in the next two years. According to Moody’s and S&P, which have both rated this bond “investment grade”, this is highly unlikely.

The key to making high returns consistently in corporate bonds is to buy the safest bonds you can find at the biggest discount. That way you can add a significant capital gain to your regular interest payments. Steve issues recommendations like this every week to subscribers of his service, The Bond Trader.

Since September, 59 out of 62 of his recommendations have increased in value, two are essentially even, and only one recommendation has lost value slightly. I’m guessing you would sleep a lot better if nearly 100% of your investments had increased in value over the past year… along with paying you regular income.

If that sounds interesting, consider adding corporate bonds to your investment portfolio. In fact, it’s likely you are under-allocated to bonds anyway.

The simplest rule of thumb is to use your age to determine your allocation between bonds and stocks. If you are 60 years old, you should have 60% in bonds and 40% in stocks. If you are 30, you should have only 30% in bonds, with 70% of your portfolio allocated to stocks.

“Letting it ride” might be an entertaining experiment when you’re up $300 at the craps table in Vegas, but the concept has no place in your retirement plan.  The older you get, the more assets you should move to the safety of bonds.

Not only will you sleep better at night, but if you follow the right strategy, you’re likely to trounce the returns that most investors make in stocks.

To your success,

Jon Herring