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posted on 12 May 2016

What Investment Strategy Does Wall Street Use?

by Sam Seiden, Online Trading Academy

Online Trading Academy Article of the Week

What I'm sharing with you today is an investment strategy that allows you to participate in market gains without exposing your savings to stock market risk. In previous articles, I shared with you the common mistakes the average investor makes and how it might be costing you hundreds of thousands of dollars.

The three biggest mistakes we discussed were investment fees, investment losses, and asset allocation and its impact on your tax liability. We learned that, over time investment fees can make a significant dent in your wealth. We also looked at some of the common Wall Street mantras that guide investor decisions but are in the best interest of the financial institutions, not yours. Lastly, we looked at the impact of saving in taxable vs. tax-efficient buckets.

Let's look at a better investment strategy that benefits you and not the big banks and financial institutions. An investment strategy that keeps investment fees low, that's designed to be tax-efficient (you keep more of your money), includes safety for your principal, all while still achieving high rates of returns in market gains. This strategy utilizes a multi-prong methodology that leverages predictable monthly income payments which can then be utilized to invest and profit from. Here's how it works (See image below):

Low Risk Investment Strategies

Overview of 2 low risk investment strategies

Let's assume we have a $500,000 portfolio. Since this is a multi-prong methodology, we take $475,000 and put in into a fixed income portfolio, and then the remaining $25,000 would remain in a trading/cash account. Your fixed income portfolio can be made of up individual bonds, bond funds, or other safe investments that generate interest. The goal in this fixed income portfolio is twofold; generate the highest possible interest income with the lowest amount of risk. This can be accomplished by the following:

  1. Buy multiple bonds: With a $500,000 portfolio you want to buy between 50 to 75 individual bonds.

  2. Purchase high credit quality bonds: We don't want our bonds to default so we purchase investment grade bonds. No junk bonds. Even in today's low interest rate environment, there are very attractive rates available if you know how to find them.

  3. Maturity short to medium duration: You also want to minimize interest rate risk by purchasing bonds that are maturing in four to seven years. If interest rates creep up as your bonds mature, you can put the principal back to work at the higher interest rate.

  4. Multiple sectors: we want to spread the risk between various industries.

This fixed income portfolio will generate predictable periodic interest payments (See image below). In this real account example, you'll notice the income stream from July of 2015 to June of 2016 ranging from $500/month to $2,500/month.

Ways to utilize periodic interest income for additional profit.

That's the first part of the methodology. It's very important when purchasing bonds to take into account the following considerations: Where should you buy your bonds? What will your after-tax return be? When is the most optimal time to purchase bonds (supply and demand is key)? What type of an account are the bonds being purchased in? Should you buy them all at once or over a period of time?

The next step in the process is figuring out what to do with the interest income generated from your fixed income portfolio. Here are two of three different strategies. I employ all of these investment strategies but will only discuss the first two here, as the third is beyond the scope of this article.

  • Strategy 1: Keep the interest income - The fixed income portfolio will generate periodic interest payments, as seen above, which you can simply pocket or reinvest. This is the most conservative approach.

  • Strategy 2: Leverage Predictable Directional Market Moves - This strategy utilizes the predictable monthly income payments to enter directional positions in the stock market (and/or other markets). Meaning, you don't always have to be long the stock market or buy in on your contract anniversary date like most annuities which makes no sense. You can buy into the market when it declines to price levels where demand exceeds supply (where banks buy), short the market (leveraging options) meaning you can profit from market declines, trade other markets; gold, oil, and sector ETF's. You're able to take advantage of stock market moves without stock market risk to your principal.

Here is an example of strategy 2 from my own portfolio. I am currently invested in about 135 of these bonds. As of the day I'm writing this article (5/4/16), I am currently invested in "put options" on the stock market which has declined over 200 points since the positions were initiated (put option increases in value from a market decline). The funds tied up in this position are from interest income, not principal. This is one of the many simple and safe strategies financial institutions use for their capital. Are you using it for yours? Financial institutions and banks don't teach you this strategy because they want your money flowing into the stock market at any price which benefits them. So, instead of your investment capital sitting in the stock market with all the risk and fees, why not use interest payments from a very safe fixed income portfolio to buy options on stock market moves.

For more information on either of these investment strategies, or strategy 3, contact your local Online Trading Academy.

Hope this was helpful, have a great day.

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