Beating the Market with Bonds

Years ago I read a great book by Michael O’Higgins, titled Beating the DOW with Bonds: A High-Return, Low-Risk Strategy for Outperforming the Pros Even When Stocks Go South.

It made a lot of sense, and anyone following O’Higgins’ advice would have made a lot of money since its publication in 1999.

When it was published, the book received chilling reviews. The former bestselling author of Beating the DOW: A High-Return, Low-Risk Method for Investing in the Dow Jones Industrial Stocks With As Little As $5,000 was saying what people didn’t want to hear: that markets were overheated in 1999, and bonds paying 7.5% annually were a better bet than having money in stocks.

It turns out that he was right. Did I follow his advice? Sort of.

Sidenote—O’Higgins went to the school I teach at (Singapore American School) but his dad withdrew him for having such poor grades.

We’ve had a volatile 11 years of market movements that have gone up and down, but overall, they’ve moved sideways.

I believe (most of the time) in having a high bond allocation matching your age. It ensures that your investments are less volatile as you get older, and it gives the dispassionate investor a fabulous war chest when things get cheap. For example, as a 40 year old, I have 40% of my portfolio in bonds.

In 2008/2009, I enjoyed selling off bonds to buy cheap stocks.

A cheap stock market is safer than an expensive stock market. But most people don’t understand that concept.

Unlike O’Higgins’ approach, which was to be “all in” stocks or “all in” bonds (depending on a mechanical decision he explains in his book) I shift my money slowly. When the markets fell in 08/09, I started selling off bonds to buy stocks. The lower the markets fell, the more bonds I sold—and the more stocks I bought.

The market’s recovery in 2009/2010 ensured that I made large profits as the DOW recovered from roughly 7,400 points to something around 11,000 points. And because my account is tax-sheltered, I was able to rebalance again, buying bonds when the markets got more expensive.

But with the current market jitters, I’m starting to take advantage of the short term thinking again. Last night I sold about $70,000 worth of my Canadian short term bond index (XSB-TO) to buy some relatively cheap Coca Cola shares, adding to the shares that I bought in 2003 and 2009.

The more the markets fall, the more bonds I’ll sell and the more stocks I’ll buy. And frankly, if the DOW falls back to the 7000 point level (or below) I’ll be happy to be invested 100% in equities.

Thank you Michael O’Higgins!

Readers, what do you think? Are you prepared to deal with the opportunities of a plunging market? Or do you think I’m nuts?