Learning about Bonds

[DenverCraig]

I've begun researching individual bonds, specifically municipal bonds, for building a bond ladder. Some of the interest rates seem higher than I would have expected. I use Schwab and they have a nice research portal and through it I found a bond fund called "Harris County Texas GO 7%". It has a maturity date of 8/1/2023, a AA rating, not callable. I'm looking for something safe and tax-free. Why wouldn't I put this as the first rung of my ladder? What am I missing? Thanks for any help!

 

[COcheesehead]

You need to look at yield to maturity. The 7% refers to the coupon, but you will pay a premium for that coupon which lowers your yield. So use YTM to make your bond buying decisions.

 

[njhowie]

Get familiar with emma.msrb.org - it is a requirement for all municipal investors when doing research.

As far as your Harris County muni - do you have the CUSIP for it?

It may be a 7% coupon, but with interest rates on 5-year fixed income at 2%, it's very likely priced at something like 120 cents on the dollar, so you'd pay $1200 for each $1000 bond - that is, you'll pay $1200 for it today, collect 7% interest on the $1000 face value, watch it decline in value, and in 4 years get $1000 back.

 

[kaneohe]

You may want to check if it is callable and if so, get the yield to call also
(YTC) as well as the YTM.

 

[njhowie]

kaneohe...

It has a maturity date of 8/1/2023, a AA rating, not callable.

 

[OldShooter]

The guys on the Schwab bond desk are quite good. I would start by talking to your rep with questions, then ask him/her for the bond desk phone number.

 

[wolf]

Bonds, in concept very easy to understand. Interest rates rise, bond value falls, etc.

Hard part is, to buy and sell in the secondary market. Better the rates, higher the rate of default. Bond funds, value is always changing. Individual bonds, may be more difficult to sell. etc.

Which is why, I stick to CD's. Find the base rates, nationwide.

 

[njhowie]

Bonds, in concept very easy to understand. Interest rates rise, bond value falls, etc.

Hard part is, to buy and sell in the secondary market. Better the rates, higher the rate of default. Bond funds, value is always changing. Individual bonds, may be more difficult to sell. etc.

Which is why, I stick to CD's. Find the base rates, nationwide.

You are generalizing and it's really not the case with the municipal bond market. Defaults are very rare and the default rates are extremely low. It is true that municipalities which are riskier credits do pay more, however, even so, the default rates are low - significantly lower than corporates.

https://www.vaneck.com/blogs/muni-nation/muni-bonds-report-reinforces-stability/?vecs=true

The five-year all-rated cumulative default rate (CDR) on municipal bonds throughout the study period (1970-2017) remained quite low, at just 0.09%, especially when compared to the 6.7% CDR of global corporates over the same time period. In this context, it is perhaps unsurprising that even in a year with a relatively elevated number of defaults, there were only ten in all of 2017 out of many thousands of issues.

Understand that 0.09% cumulative default rate is 9 out of every 10,000 issues. I would contend that someone who knew absolutely nothing about municipal bonds, and simply purchased Moody's/S&P A-rated (or better) issues would find it virtually impossible to acquire one which will default.

 

[gwraigty]

I spent most of the past 15 years buying individual bonds, both muni and corporate. I've been transitioning away from them and buying ETFs instead. I grew tired of the research needed when I had new money to invest, and the tax complexity. Individual bonds can be more difficult to sell, although not lately.

Anyway, to satisfy curiosity, I did a search for the bond at Schwab. I couldn't find any from the issuer with a coupon of 7%. However, those that were available have a YTM of 1.2% to 1.5%, as you might expect, with coupons of 3% to 5%. So, no, you're not really getting anywhere near the coupon rate if you hold until maturity. And the closer those get to maturity, the more the price will drop closer to par value.

 

[DenverCraig]

Thanks for all the info. Oddly, I just looked for the bond again on Schwab and couldn't find it, but I saved the search results in Excel, so here's the details:

Action

State

S&P Rating

Moody's Rating

Description

Coupon

Maturity

Callable

Taxable

Quote

Qty

Price

Min

Max

YTM

YTW2

Accrued Interest

Estimated Total

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2022, 41422TDP2

7

8/1/2022

No

No

Ask

10

116.284

10

10

1.173

--

221.67

11,850.07

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2023, 41422TDQ0

7

8/1/2023

No

No

Ask

10

121.006

10

10

1.378

--

221.67

12,322.27

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2024, 41422TDR8

7

8/1/2024

No

No

Ask

10

126.767

10

10

1.289

--

221.67

12,898.37

I understand now that the coupon rate is not what my return is going to be, thank you for that clarification. I'll get with my Schwab adviser, start the discussion and then probably start buying CD's.


DC

 

[COcheesehead]

Bonds, in concept very easy to understand. Interest rates rise, bond value falls, etc.

Hard part is, to buy and sell in the secondary market. Better the rates, higher the rate of default. Bond funds, value is always changing. Individual bonds, may be more difficult to sell. etc.

Which is why, I stick to CD's. Find the base rates, nationwide.

Way too generic an answer.
I use Fidelity and have had zero problems buying or selling in the secondary market. I have never, over hundreds of bonds, had one default.
If held to maturity, a quality bond will usually outperform a CD.
CD’s are also not appropriate for some in a taxable account.

 

[COcheesehead]

Thanks for all the info. Oddly, I just looked for the bond again on Schwab and couldn't find it, but I saved the search results in Excel, so here's the details:

Action

State

S&P Rating

Moody's Rating

Description

Coupon

Maturity

Callable

Taxable

Quote

Qty

Price

Min

Max

YTM

YTW2

Accrued Interest

Estimated Total

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2022, 41422TDP2

7

8/1/2022

No

No

Ask

10

116.284

10

10

1.173

--

221.67

11,850.07

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2023, 41422TDQ0

7

8/1/2023

No

No

Ask

10

121.006

10

10

1.378

--

221.67

12,322.27

Buy

TX

AA

NR

Harris County Texas GO 7% 08/01/2024, 41422TDR8

7

8/1/2024

No

No

Ask

10

126.767

10

10

1.289

--

221.67

12,898.37

I understand now that the coupon rate is not what my return is going to be, thank you for that clarification. I'll get with my Schwab adviser, start the discussion and then probably start buying CD's.


DC

Your yield on that bond if it were still available would have actually been 1.378%. Which sort of sucks.

 

[OldShooter]

... I understand now that the coupon rate is not what my return is going to be, thank you for that clarification. I'll get with my Schwab adviser, start the discussion and then probably start buying CD's.

Well, if your tax situation is such that tax-exempts are desirable, you should probably push a little harder to get comfortable with them. Remember, too, that Treasury bills, notes, and bonds are state tax exempt. Whatever you're comparing, be sure to use the net dollars in your pocket after tax to compare yields.

It is not uncommon for people to be so delighted by the idea of a tax-free bond that they end up with less money than they would have gotten from buying a taxable bond and paying tax on the interest.

 

[gwraigty]

It's a hot market for bonds right now. When I was buying individual munis around the time of the financial crisis, I was picking up coupons of 4% to 5% easy, all below par. Those were sweet times. They are not so sweet now, as your above spreadsheet shows.

 

[COcheesehead]

It's a hot market for bonds right now. When I was buying individual munis around the time of the financial crisis, I was picking up coupons of 4% to 5% easy, all below par. Those were sweet times. They are not so sweet now, as your above spreadsheet shows.

That’s why ladders are good. Forces reinvestment when who knows the future. I was buying long bonds a few years ago when prevailing wisdom said rates are going up. Happy to have those now.