Discount Bonds Can Grow Your 401(k) Profits
Looking for a legally guaranteed way to boost your 401k returns? Buying discount bonds can make a big difference when it comes to your long-term profitability.
When most people hear the word “bonds” they think of boring investments that generate paltry income payments. But buying discount bonds is a completely different type of investment.
When done right, investing in discount bonds can give you double-digit yields. They can also help double your money in a few years (or less in some cases). Best of all, discount bonds give you a legal contract, requiring companies to pay you.
Editor’s Note: This is part four in our series on how to invest your 401(k) account. See also:
- How to Maximize Your 401k Plan
- Should You Actively Manage Your 401k?
- Harnessing the Power of 401k Dividend Stocks
- How to Generate Instant 401k Payments
- Common 401k Mistakes To Avoid
- Three 401k Options To Consider When Switching Jobs
Discount Bonds Are Anything But Boring
It’s understandable that many people have a jaded perspective with bonds. The traditional Wall Street approach to bonds is boring. These professionals typically pay full price for highly-rated bonds, and collect small interest payments.
Buying high yield discount bonds, on the other hand, can be very lucrative.
A bond is basically a debt obligation that a company owes to investors. If you own a $1,000 bond, that means the company who issued the bond owes you $1,000. Bonds also require companies to pay interest to their investors. This interest is paid out twice a year as a “coupon payment”.
Bonds are traded on a market much like stocks. So the value of bonds moves higher or lower. But regardless of what you paid for a bond, the company still owes you the full “par amount” which is usually $1,000 per bond.
So if you buy a bond for 50-cents on the dollar (or $500 per bond), the company is still legally obligated to pay you $1,000 when that bond comes due. Also, if the bond carries an 8% interest rate ($80 annually for every $1,000 bond), you still get all of the payments.
So if you buy this bond for $500 and receive $80 each year, you’re actually receiving a 16% interest rate.
I’m sure you can see now, why buying discount bonds can be very profitable.
Why Bonds Sometimes Trade at a Discount
A bond may trade at a discount price because investors are worried that the underlying company may not be able to pay back the debt it owes to investors.
So investors are willing to sell the bonds at a discount, in order to get some money back from their investment. In their eyes, this is better than waiting to see whether the company will be able to repay the debt or not.
There are times when it makes sense for bonds to trade at a discount.
If a company is likely to go out of business (and has very few assets it can sell), investors may be right in assuming that the bondholders will not get repaid.
But other times, discount prices for bonds is more representative of the fear investors have. In reality, the company may be in fine enough shape to repay investors.
Consider a manufacturing company who sold bonds to raise money to build a factory. If this company is unable to turn a profit, its bonds might trade at a discount. But even in a worst case scenario, bond investors could still be paid.
If this manufacturing company goes out of business, the company could then sell its equipment, it’s buildings, and its land. Legally, the proceeds from these sales must be used to repay the company’s debt. That’s how bondholders can make money, even if the company who issues the bonds doesn’t fare well.
Buying Discount Bonds In Your 401k
If you have a brokerage option in your 401k account, then it should be easy to buy discount bonds in your account. The key is knowing which bonds to buy. After all, you want to make sure that your bonds get repaid, and that you get plenty of interest income.
I have a special method — I call it my C.A.S.H. system — for analyzing the bonds I recommend. Here’s how the acronym works:
Cash: I look carefully at the cash balance of our companies to ensure that they can make interest payments and will ultimately be able to pay back their debt.
Assets: I analyze the value of the company’s assets. This way if things go poorly and the company has to sell things to repay its debt, we know the value of what can be sold.
Safety: We want to invest in bonds that give us a margin of safety. Buying at steep discount can be really helpful here, because even if the company can’t pay back ALL of its debt, we still get something (and we didn’t pay full price for the bonds to start with).
Health: I look carefully at the underlying health of the business. Obviously, if we’re buying bonds at a discount, there will be some issues with the company. But I look carefully to make sure that the issues can be resolved.
If you’re interested in this style of investing, the best way to get started is by subscribing to my Contract Income Alert service. This is where I recommend the very best discount bond opportunities. I also give you all of the information you need to get started with discount bonds in your investment account.