The Motley Fool Discussion Boards

Previous Page

Investing/Strategies / Bonds & Fixed Income Investments


Subject:  Using Stocks as Bond Substitutes Date:  2/8/2013  1:49 PM
Author:  globalist2013 Number:  34766 of 35648

What, really, is the difference between ‘the stock game’ and ‘the bond game’ from the point of view of making money? If a stock doesn’t pay a dividend, then your profits can only come from cap-gains. But if a stock pays a dividend, then it can become “bond-like” in the sense that profits can come from both ordinary-income and capital-gains, just as profits from bonds can come from both.

The standard rule of thumb is that stock gains will come from four sources: earnings (and, hence, the multiple investors are willing to pay for what they hope will be future earnings), the premium/discount investors are willing to pay for the difference between the company as an ongoing enterprise and its takeover or breakup price, dividends (if any are paid), and inflation (as the company re-prices its goods/services). Extending that same rule suggests that bond gains come from the coupon as a fraction of the purchase price of the bond, the inflation-premium imbedded in the bond, and (when they occur and when the bond is sold before maturity) improving credit-worthiness for the issuer and/or falling interest-rates. In other words, the stock game and the bond game are cousins, and they offer exactly the same money once the price of the embedded put that a bond is has been discounted. It wasn’t my intention to do so, but I ended up running an experiment that somewhat demonstrates this.

It’s no secret that Apple’s stock price crashed and that a lot of people who bought the stock because they loved the company got hurt. It’s super easy to sit on the sidelines and to laugh at them for their failing to do even the most basic of risk-management, namely, look at a price chart before putting on a position. If a price is failing, with no obvious bottom in sight, then you’re trying to catch a falling knife. Not smart, and it doesn’t matter whether what is falling is a stock, a bond, a commodity, a currency, real estate, or an actual knife. Let it hit bottom before you make your move. There were lengthy discussions in another forum initiated by people who had screwed up on their timing and who ended up being sliced by the knife of falling prices. Rather than having no skin in the game, I put on a position in AAPL and promptly discovered that I, too, had screwed up on my timing.

The day I entered, I was working off a 1-minute chart. I correctly caught a low, and the trade immediately went into the money. However, I had made the most basic of mistakes by not looking at prices in a longer time-frame, and --predictably-- I got cut as prices rolled over again and headed back down toward where a bottom could have/should have been predicted from a longer-term chart. Also, I failed to set both profit-target stops and loss-stops. My excuse that I was using Scottrade’s order-entry platform, not the one I would have used if I had been executing though IB. But that’s a lame excuse. Always, always, always, you should identify before a position is put on w