Muni bonds - do others know something I don't?

[Amethyst]

Is there some reason I should beware of tax-exempt municipal bond funds? MD bond funds are paying ~3.5 -4% and the NAV has remained more or less consistent over the years (i.e. little or no capital gains on the original investment). Yet I rarely see anyone list munis in their AA. Is there something bad about them, that I haven't caught onto yet?

Amethyst

 

[RetireBy90]

Many investors have run from them for a couple reasons I can list and probably many I don't know of. First was pojectn that cities would go bankrupt all over the country. I think it was Merridth Whitney who made a widely covered call like that. Then that city in PN filed hat stoked fears. Second, if rates rise will munis loose value along with other bonds? I think that they offer great value today ESP if you can get 28 or higher tax savings.

 

[MichaelB]

Many investors here have tax deferred accounts so they don't need munis. I don't, and munis make up my largest allocation. We hold individual bonds, muni funds and muni CEFs in similar amounts. If Ms Whitney made another scary projection about munis, and they were to fall in price, I would buy more.

 

[eytonxav]

I am holding muni CEFs in an IRA and like other pundints, Meredith's view proved wrong and way overblown.

 

[ronin]

Munis represent about 30% of my investment portfolio. The interest thrown off is all I need to supplement my income, so I haven't had to make any other withdrawals yet. I use a short/intermediate fund to take excess cash that seems dead in money-market. Pays around 2% fed-tax free, in 25% marginal bracket, seems a fine place to park $ that isn't needed for cash flow immediately.

I have seen a number of opportunities to buy more during liquidity crunch/financial "crises" type events, (thanks Ms Whitney for the last one) and wait patiently for the next. Like to bump up to 35% sometime in the next 3-4 yrs.

TR was close to 10% in aggregate for my 3 different muni funds last year and contributed to an eye-popping 2011 portfolio return of 0.0%! Not that the number is significant, but just odd that it was literally within a few c-notes of dead flat.

 

[Lsbcal]

Just because one prominent analyst was wrong does not make the bond markets wrong. If a bond is paying high yields you can bet that there is risk there.

I'm no expert on muni's but do know that you are going for total return in you bond investments, not just high yield. Here is one chart showing how a few Vanguard muni funds have done versus intermediate treasuries:

Current SEC yields:
Calif LT tax exempt 2.9%
Ohio LT tax exempt 2.6%
Intermed Treasury 0.8%

 

[scrabbler1]

I have been in tax-free muni bond funds since 1990 when I first started investing in mutual funds (not counting my 401(k)). In my working years, I had a sizeable part of my portfolio in those funds because I was in a high marginal tax brackt (28% federal, 8% state).

But later on, as the booming stock market took hold in the mid-1990s, I put more into stock mutual funds and less into my muni bond funds. Now in my ER years, my marginal tax bracket has declined greatly so I have not only been slowly draining the munis but have not added anything to them. They are about 13% of my non-retirement investments. They have checkwriting privileges and still earn a decent monthly dividend (3.5%-4%, as the OP wrote) I use to help cover my monthly expenses, so I keep them around.

 

[target2019]

We have about 4.5% in NJ long term bond fund. Over the years we re-invested dividends. A few times I withdrew a few thousand, and it grows back like weeds.

We started this fund a long time ago, and if we followed the wisdom of the day, the money would not have gone into this. If we followed the wisdom from last year, OMG the sky was falling, get out while you can.

We used to label this our emergency fund. Now it looks like retirement fund that will generate income.

 

[Midpack]

Many investors here have tax deferred accounts so they don't need munis.

That's my reason. And I'll admit Meredith Whitney spooked me, I happened to be watching that 60 Minutes episode live, and it seemed more plausible at the time. Her timing was clearly wrong...if not the whole prediction.

 

[mb]

I have had on going concerns with regard to both credit and interest rate risk but I still have a sizable amount in CA tax free funds.

 

[Nords]

That's my reason. And I'll admit Meredith Whitney spooked me, I happened to be watching that 60 Minutes episode live, and it seemed more plausible at the time. Her timing was clearly wrong...if not the whole prediction.

... and Bill Gross has apparently started buying Treasuries again.

 

[Huston55]

Still working and in high marginal tax bracket. Have 15-20% AA to muni/tax free bond funds.

 

[MichaelB]

That's my reason. And I'll admit Meredith Whitney spooked me, I happened to be watching that 60 Minutes episode live, and it seemed more plausible at the time. Her timing was clearly wrong...if not the whole prediction.

If she, or someone else, were to spook the muni market again, I would increase my allocation. Most muni finances are in decent shape or improving and this asset class is very broad, so there can be serious risks and at the same time still plenty of decent options. I doubt I'll buy any more individual bonds, however, because they are too hard to sell, and just stick with funds.

 

[justplainbll]

If she, or someone else, were to spook the muni market again, I would increase my allocation. Most muni finances are in decent shape or improving and this asset class is very broad, so there can be serious risks and at the same time still plenty of decent options. I doubt I'll buy any more individual bonds, however, because they are too hard to sell, and just stick with funds.

In addition to being hard to sell, the bid - asked spread can be painful. I buy and ladder with yields to call that I am comfortable with. In a volatile interest rate environment, the call feature can make tax exempts a lose - lose proposition for the buy and hold investor

 

[teejayevans]

That's my reason. And I'll admit Meredith Whitney spooked me, I happened to be watching that 60 Minutes episode live, and it seemed more plausible at the time. Her timing was clearly wrong...if not the whole prediction.

I love MW, I bought the VG HY Muni fund 2 days after her dire prediction, great move, if I only had more cash. After 2008 when all the pundits with a few exceptions predicted that the housing problems were overblown, I now bet against them. Did the same when Bill Gross made his prediction...
TJ

 

[gerntz]

I have been in tax-free muni bond funds since 1990 when I first started investing in mutual funds (not counting my 401(k)). In my working years, I had a sizeable part of my portfolio in those funds because I was in a high marginal tax brackt (28% federal, 8% state).

But later on, as the booming stock market took hold in the mid-1990s, I put more into stock mutual funds and less into my muni bond funds. Now in my ER years, my marginal tax bracket has declined greatly so I have not only been slowly draining the munis but have not added anything to them. They are about 13% of my non-retirement investments. They have checkwriting privileges and still earn a decent monthly dividend (3.5%-4%, as the OP wrote) I use to help cover my monthly expenses, so I keep them around.

Good point on the reduced marginal tax rate. Thanks. Now need to factor in. I have about 8% of our AA in state-specific muni funds for combined Fed + State marginal tax rates of 34%, but that is dropping. For me they are paying nearly the same as equal duration taxable bond funds. I don't see a downside vs. taxable funds.

 

[nun]

As previously mentioned munis are good for high rate tax payers in taxable accounts. I don't own any yet, but in ER I'll probably use some MA tax free munis along with a short term bond index for my 2 to 5 year bucket.

 

[67walkon]

We have a high allocation of tax free munis in the taxable savings/retirement accounts. Be careful if you buy them to make sure the ones you buy are not subject to AMT; some are, some aren't.

Prewitt and Keene on Bloomberg were discussing muni's this morning. First of all, the historical actual rate of default is pretty small, so be diversified among a number of issues and you should have safety. I learned for the first time that some tax frees are revenue based as to the particular project while others are GO, or general obligation bonds. Apparently the GO bonds are safer.

The bonds are rated. We have some A bonds, some AA and some AAA. The return is higher for the lower rated bonds because the risk is higher, but you can be picky about how they are collateralized and make a little more money. We're averaging above 4.5% overall, which is pretty good while I've still got some work income coming in.

Subject to some minor risk of default, we look at these as a revenue stream. If interest rates continue to stay low, our older bonds go up in value, but we don't care because we're holding them. If interest rates go down, I care a little, but we've tried to ladder them so we can replace lower rate bonds with higher rate bonds when inflation comes.

It's a choice, but tax free bonds deserve a good hard look.

 

[brewer12345]

I learned for the first time that some tax frees are revenue based as to the particular project while others are GO, or general obligation bonds. Apparently the GO bonds are safer.

Personally, I am not a particular fan of GO bonds. Their credit quality can be significantly affected by politically driven decisions, which are hard to predict and make it difficult to do proper due diligence. I prefer revenue bonds since one can take an objective look at the revenues backing the bonds and assess how likely they are to be insufficient to service the bonds.

 

[jebmke]

I've held them for years but I use funds. I can't develop a compelling case to hold individual bonds. Too much work, need a lot of issues to diversify and liquidity is a problem. Especially for small portfolios.

 

[justplainbll]

I've held them for years but I use funds. I can't develop a compelling case to hold individual bonds. Too much work, need a lot of issues to diversify and liquidity is a problem. Especially for small portfolios.

Seems that individual issues held to redemption can provide some protection from the NAV decline exposure of MFs and can provide a somewhat more predictable forecast of cash flow. ~$250,000 could be a reasonable average amount for a laddered muni portfolio.

 

[jebmke]

At a high level, a rolling ladder is the same (mathematical risk) as a fund basically. These are assets I don't intend to touch for quite some time (or maybe never) -- probably 4-5x the duration of the fund.

 

[brewer12345]

At a high level, a rolling ladder is the same (mathematical risk) as a fund basically.

I hope you have your flame proof armor on.

 

[justplainbll]

At a high level, a rolling ladder is the same (mathematical risk) as a fund basically. These are assets I don't intend to touch for quite some time (or maybe never) -- probably 4-5x the duration of the fund.

If and when I need cash from this portion of my asset allocation, I prefer to have the choice of taking it from a maturing / called bond or a MF. I'm not partial to paying capital gains on tax exempt investments.

 

[RetireBy90]

So for those that are buying individual bonds, couple questions - how do you get through all the bonds available with questions like call provisions, cost to insure them, and keep up with developments that affect them? Just seems to be so much more to have to evaluate with thousands of bonds available.