Investing In Municipal Bonds… The First No-Brainer of 2008
by Alexander Green, Chairman, Investment U
Thursday, December 27, 2007: Issue #746
Looking for a no-brainer investment? Try investing in municipal bonds. There are four good reasons to buy them now:
- One, they pay tax-free income.
- Two, they currently yield the same as taxable Treasuries.
- Three, the Fed is likely to cut rates again, driving bond prices higher.
- And, four, your taxes may go up soon.
Let's take a closer look at each of these...
Municipal Bonds or "Munis" - Safe Tax-Free Bonds
"Munis" are bonds issued by cities, counties and states to raise money for public projects. Like corporate bonds, there are good ones and riskier ones, but most tax-free bonds are pretty safe.
If you want to know what munis are currently paying, a good site to visit is http://www.fmsbonds.com/yields.html.
You can see, for example, that 20-year, ultra-safe AAA Insured municipal bonds are currently yielding 4.4%. If you're willing to drop down to single-A rated bonds - still pretty safe - you can get 4.6%. 20-year Treasuries are currently yielding 4.5%. Shorter tax-free maturities are also comparable to Treasuries.
Of course, munis ordinarily yield less than Treasury securities. To do a comparison, investors usually have to deduct their marginal tax rate from the Treasury rate to see whether municipal bonds make sense. But with the bonds now yielding the same, investors can throw the calculation out the window.
Why has this happened? The credit crunch has driven many nervous investors into Treasuries, driving the prices up and the yields down. With taxable and tax-free yields about the same, who wants to volunteer to pay federal taxes?
It's a fairly safe bet, too, that short-term rates will continue to come down. Concerns that the housing slump may tip the economy into a recession are forcing Bernanke's hand. He may have a few qualms about cutting rates since it undermines the dollar and is potentially inflationary. But given a choice between a lower dollar - which boost exports - and an economy in the tank, he'll choose the former.
Rates are Falling... Tax-Free Bonds are Rising
When rates fall, bonds rise. So it's reasonable to expect that tax-free bonds will trade higher in the weeks ahead.
Lower- and middle-income investors might pick up munis, too. Some may say, "Why bother?" since their taxes are low and Treasuries are super safe. But think a few moves ahead, like a chess player.
We'll have a new President in just over a year. All the leading Democratic candidates are pledging to raise taxes. History shows a two-term President is usually followed by a President from the opposite party. (Bush the Elder was an exception. The country wanted to re-elect Reagan again, but had to settle for his Vice President.)
Of course, Democrats say they only plan to raise taxes on "the rich." But, then, rich can be hard to define. The Census Bureau determined that the U.S. median family income in 2006 was $48,201. Or, as the Cato Institute is fond of saying, if you're a policeman married to a teacher, you're in the top quartile of income earners in the country.
But even if the Democrats don't raise your taxes, they are still committed to raising taxes on the sort of people who buy tax-free bonds. And if you know much about supply and demand, that shouldn't hurt the price any.
You have several choices. There are dozens of no-load, tax-free choices at Vanguard, Fidelity and other major fund companies. There are deeply-discounted closed-end bond funds that trade on the New York Stock Exchange. Or you can buy one of the new municipal exchange-traded funds, like the iShares S&P National Municipal Bond Fund (AMEX: MUB).
All are likely to do well in the months ahead. So start the New Year off with a no-brainer. Buy some municipal bonds.
Today's Investment U Crib Sheet
- For a closer look at the taxable and tax-free bond funds Vanguard offers, see Issue #675. You'll also learn about the best money market funds for maximizing your cash positions.
- In the closed-end fund universe, check out the Western Asset Global High Income Fund (NYSE: EHI), which yields 8.8% right now. You can read more about it in Issue #693.