Corporate/Muni bonds for income

[thedaily]

I was looking at my broker's site and I noticed that some 30 year bonds are paying 5 something and the muni's a bit higher. I want to RE. Good strategy to put your money in these long term bonds? Looks like your risk would be bankruptcy and if rates were high and you wanted to get out. Also, I would do non-callable bonds. Also, I wouldn't do this today but in a few years as I feel rates will rise shortly. Also, say you had 1M. What increments would your break it into to spread your risk (10K, 20K)? Thanks

 

[Mr._Graybeard]

My recent bond investments are based on kind of a mirror image of your scenario. I don't see interest rates doing much for the next few years but the long-term trend headed upward. So I'm investing now on the secondary muni market in bonds maturing in about 10-12 years. Nearly everything Schwab can offer on the secondary market is callable, so I view the call date as the de facto maturity, since the bonds are mostly yielding 4% to 5% and a prudent debtor is almost certainly going to refinance the debt at the earliest possible date.

As an example, I just bought a couple bonds issued by the Washington, DC airport authority, 4.75% and 5%. The maturity date is 2024 but they're callable in 2017. I paid a premium of about 5.5% over par. It'll all come out to about 2.4% yield on my investment if the bonds are called at the first opportunity.

 

[haha]

One problem is negative convexity. As long as rates stay where they are or fall, your call date with be a de facto maturity date. But if you are a little off on when you think interest rates may begin to climb and they start climbing, that call date can go by and the actual maturity date is what counts. So when bonds are falling, yours are getting longer durations and your bonds start acting like the long bonds that they actually are. Part of your return is a premium for giving your counterparty his call optionality.

People do this all the time, and lately it has been without penalty. But it doesn't have to be that way.

Ha

 

[Mr._Graybeard]

Right, that's why I'm not going too far out. 20- and 30-year maturities scare me. If my DC airport bond keeps paying 5% on par value until 2024, I won't mind. People are locking in 3% yields for five years these days and are thrilled to do it.

I don't expect to see 5% interest rates in three years. But yes, there's risk. It's investing.