Muni Bond Calls

[DavidS980]

Hi All - this is my recent post to "Hi, I am...":

"I am a recent early retiree. I currently have 30% more interest and dividend income than my annual expenses. I reinvest the surplus in order to compound it.

I wrestle with the real definition of what true financial independence is. I've read multiple times that it is when your passive income eclipses your expenses. The problem I have with this is that there is no wiggle room.

Does anyone have an opinion on this or their own definition? How do you know if you truly have enough?"

I was feeling pretty good after the feedback (with caution) and whistling past the graveyard...

About 40% of the income described above is muni bond income. Last week, I was notified that about 10% of that muni income was called. I have the potential for another 40% to be called this year (actually I've come to the realization that it will happen). I've been looking at my portfolio for about a year trying to figure out what I would do if the calls actually happened. I had no good answers then and I don't have any now. Bond prices are horrible and yields are just as bad.

I would be reinvesting at about 20% less coupon. If the other 40% gets called it leaves me with only about 20% wiggle room instead of the 30 described above. Should something else come up that is out of my control such as dividend cut or future calls, I could have a real problem.

My portfolio income looks like the following:

40% muni income
60% cd, mlp, etf, mutual fund, reit

Aside from swallowing hard and paying substantial premiums to buy up the coupon, I'm at a loss for how to reinvest the muni calls.

I'm sure others on this forum have faced this issue. I'm wondering what you may have done or what you may suggest. Thinking about all of this is what lead me to the earlier post about financial independence. I'm out of answers and I need the income.

Any insight would be appreciated.

 

[audreyh1]

Using the passive income generated by a portfolio - particularly a portfolio invested heavily in muni bonds - is a pretty high bar for financial independence, because your % of income from the portfolio will be fairly low.

Some of us live off a total return approach which may mean occasionally selling assets to meet annual needs. We don't mind if we draw down most of the portfolio during our lifetimes as long as it doesn't go to zero while we are living. Using this approach folks may be drawing 3 to 4% of their portfolio (depending on how many decades they plan for) and can reasonably expect they will keep up with inflation and not run out of funds.

But if your goal is to end up with as much as when you started, inflation adjusted, then you are constrained and have to live with lower income from the portfolio.

 

[MBAustin]

As audrey said, most of us expect to and then do spend down our principal - that's why all of the discussion here about "safe withdrawal rates" (SWR).

Have you tried putting your numbers into FIREcalc?

 

[ERD50]

...

Have you tried putting your numbers into FIREcalc?

+1.

From your other thread:

....My dividends and interest on an annual basis are 30% greater than all of my annual expenses on average.
.... My portfolio is 60stock/40bond. Am I missing anything?

Yes, Inflation.

Your current div & uint may be 30% above your spending, but as you are seeing, that may not hold into the future.

In that quote, you say you are 60stock/40bond, which seems reasonable for growth to counter inflation, but in this current thread, you say:

My portfolio income looks like the following:

40% muni income
60% cd, mlp, etf, mutual fund, reit

So it's not clear to me if your portfolio asset allocation is 60/40, or if your income is split 60/40 - I guess it could be both, with something less than 40% of portfolio in munis, but they provide 40% of the income, and the rest of income from the cd, mlp, etf, mutual fund, reit.

I guess it's not really clear what your 'stock' allocation is - REITs are not really considered 'stock', and some of those etfs and mutual funds etc, may have some fixed income component.

As other's have said - take the 'total return' approach and understand what your AA is so a historical report like FIRECalac can provide some basis for you.

-ERD50

 

[DavidS980]

I'm sorry if I wasn't clear. My asset allocation is 60/40. This takes into consideration a mutual fund that has a fixed income component to it (mclox).

40% of the income that the portfolio generates (dividends, distributions and interest) comes from muni interest. I never thought about it this way, but the asset allocation is 60/40 and the income generated is 60 (everything else) /40 (muni) as well.

I have run it through Firecalc and many other retirement calculators. The results are either 100% or in the 90's depending upon which calculator I use.

 

[MichaelB]

Aside from swallowing hard and paying substantial premiums to buy up the coupon, I'm at a loss for how to reinvest the muni calls.

I'm sure others on this forum have faced this issue. I'm wondering what you may have done or what you may suggest. Thinking about all of this is what lead me to the earlier post about financial independence. I'm out of answers and I need the income.

I bought a large quantity of muni bonds around '09 and have been getting >6% tax free. Like yours, mine are being called at a high rate. Nothing to do except say "it was good while it lasted" and reinvest the cash back into my portfolio at the target allocations.

 

[stepford]

This is why it's advisable to check whether bonds are callable and/or have sinking fund protection before purchase. In a period of declining interest rates like the last several years the price of bonds can easily go above par, in which case it becomes advantageous for the issuer to call if possible (and you lose those extra juicy gains). The saving grace is that so long as you didn't purchase the bond above par you don't actually lose money - you just don't make as much as you'd hoped.

This doesn't solve your problem, but gives you a bit more information if you continue to shop for individual bonds among the current rather slim pickins.

 

[phil1ben]

I have not retired yet (Age 55) but have been FI for a while and have not pulled the plug. About 35% of my investments are in individual tax free muni bonds that I buy for my own account. I have about 150 different bonds spread across states, maturity, credit ratings and revenue source.

There is no good answer to your question. What I have been doing is replacing the matured or called bonds with maturities skewed to terms between 4 and 7 years. I realize this results in replacing 4.5%+ bonds with 2.25-3.0% bonds. My after tax return is better than I can get in a CD because I am at the 39.6% federal tax rate plus state tax etc...... I have also been able to cherry pick muni-bonds on the secondary market with 2028-2030 maturities with 4% yields but these are far and few between.

So in a nutshell kind of back-pedaling waiting for rates to rise. This back-pedaling just recently started for me. I was comfortable buying 4.0%+ yields out 15-20 years so I had been buying between 2008 and 2013. I have just started to forego longer maturities because I can no longer get my 4.0% tax-free yield with 15-20 year maturities. I do not go out longer than 20 years. A 2035 maturity paying 3.4% is not attractive to me.

 

[Gill]

I have about 150 different bonds spread across states, maturity, credit ratings and revenue source.

Just curious, if you have 150 bonds representing 35% of your portfolio you must have some very small bond holdings unless your portfolio is enormous. Even if the portfolio was $10 million this would average out to $23,000 per bond, quite small holdings and often uneconomical to purchase. Would be interested in hearing more about your approach.
Bruce

 

[phil1ben]

MB Miner sent you a PM

 

[gerntz]

I find munis a good deal regardless of what the going rate is provided your Fed marginal rate is 25%+ as ours is. Besides the after tax rate matching/exceeding the taxable rate, they keep both your AGI & MAGI down, thus lowering taxes on our investments & possibly Medicare rates. When you factor who into the muni rates, deal gets even better.

 

[Gill]

I find munis a good deal regardless of what the going rate is provided your Fed marginal rate is 25%+ as ours is. Besides the after tax rate matching/exceeding the taxable rate, they keep both your AGI & MAGI down, thus lowering taxes on our investments & possibly Medicare rates. When you factor who into the muni rates, deal gets even better.

To clarify, municipal bond interest is included in your MAGI but, because the rates are lower than on taxable bonds they would have the effect of keeping your MAGI down.
Bruce

 

[Texas Proud]

Just curious, if you have 150 bonds representing 35% of your portfolio you must have some very small bond holdings unless your portfolio is enormous. Even if the portfolio was $10 million this would average out to $23,000 per bond, quite small holdings and often uneconomical to purchase. Would be interested in hearing more about your approach.
Bruce

He probably answered your question.... but some bonds are denominated in $1,000 increments.... so if you bought $23K of bonds you owned 23 bonds that had a potential to be called.... they might not all be called either...

When I was a trustee for bonds, I would make calls every month on some issues... there was a program that would randomly pick bond numbers to call.... some people would call an be pissed that their bond would get called when they had just bought it.... well, that is the risk you take....

 

[Gill]

Yes, he responded by PM. I still find 150 bond holdings an enormous number to manage. I'm quite happy managing a few mutual funds, a TIPS portfolio and a Treasury Direct account.
Bruce

 

[Texas Proud]

Yes, he responded by PM. I still find 150 bond holdings an enormous number to manage. I'm quite happy managing a few mutual funds, a TIPS portfolio and a Treasury Direct account.
Bruce

It is according to how many issues he has... he might have all of this in 3 or 4 issues... would you think a portfolio of 3 or 4 stocks with holdings of 15,000 shares is a lot to manage

The brokerage firm handles any calls... so you do not have to do anything... and since there are no more coupons to clip and turn in it is even easier....

But yea, I like funds better myself...

 

[phil1ben]

They are mostly different issues. However, to me, it is not a lot to manage. If a bond is called in whole or in part it really is seamless. I get notice and the money appears in my account. Additionally, interest payments are automatically credited. As I told Miner I spend about 20 minutes per day looking at new issues and bonds for sale on the secondary market. The search engines which Schwab and Fidelity have are good. Once I locate a bond I check prior sales on EMMA (which is a direct link from the brokerage websites) to determine pricing and when necessary do some research on the web regarding an issuer. I also scan the issuing documents. The only additional work is remaining diversified with my focus being maturity/call dates. I also get e-mails from a rep when bonds come up for sale within parameters I set. The commission to buy a bond through Schwab or Fidelity is only about $1.00/bond. Selling is a whole other issue.

I have looked for a software or app to help manage a large bond portfolio but have not located one. Quicken is not very good for this purpose. Someone younger and smarter than I will probably develop something.

I also almost always hold to maturity so I am not looking to sell. Owning individual bonds allows me to customize my risk. So when the pundits said California was in trouble I bought. The same with Illinois. Regardless of what happens to interest rates I know (borrowing a default) that I will get my money back at maturity. Lastly, I steered away from Puerto Rico bonds. Those that own mutual funds likely own such bonds without knowing it. Every one is different. Regarding my finances I have always wanted to steer the car rather being the one driven.

 

[Dakotah]

I agree with Phil1ben.
While I'm not in his class, I have some 90 small holdings in muni's.
Managing them is not really a problem because I buy and hold.
Your broker will take care of the book work.
The biggest challenge is the early calls and the necessity to reinvest at a lower rate (currently).
Alternately, if you're retired you could use some of the early calls as your cash flow for the year.


Sent from my iPad using Early Retirement Forum