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FMSbonds, Inc.'s Bond Forum™ is an exclusive opportunity for investors to submit questions and comments on the bond market or to respond to one of our articles.
To participate, just send us an e-mail. Be sure to include your name or initials and your state of residence. Posted e-mails may be edited for length and clarity. If you prefer a private response, please note that in your e-mail. Responses are provided by James A. Klotz, president and co-founder of FMSbonds, Inc., a municipal bond specialist for more than 35 years; Dr. Jay H. Abrams, chief municipal credit analyst; and other members of the firm as noted.
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I like your articles, but stocking up on long-term bonds and paying par plus a premium to get maybe 5% yield with investment grade ratings is setting yourself up for a big loss of principal when interest rates increase, and they certainly will at some point over the next 20 years. You also assume that the issuer will remain solvent over the entire 20 years. I'm a fixed-income guy, but it's tough these days to rationalize all these variables and go out 20 years or more.- J.G., Florida
It’s a funny thing: To us, “these days” don't seem to be significantly different from the old days. Although you have valid considerations, they would have been equally reasonable 10 and 20 years ago.
As you know, an investment contains elements of risk, so it can't be analyzed in a vacuum. It must be evaluated within the context of possible alternatives.
In our article, “Avoiding Interest Rate Roulette,” we attempted to illustrate that for income investors, the yield on CDs and short-term bonds are not attractive options, while 5.00% tax-free yields that can be equivalent to 8.50% or more on taxable investments are extremely compelling.
Over the life of your bonds, they will sometimes be worth more than you paid for them and sometimes less, but on investment-grade munis, your tax-free interest clock keeps ticking.
Suze Orman (“Suze Orman, James Tisch on Common Ground”) didn’t address the concern that if interest rates go up, a purchaser may regret not waiting to get the higher rate. It may be that it's still better than the 1% taxable at an FDIC-insured institution, and that a bond purchaser can always hold back some funds and ladder. And, of course, there is no perfectly safe, highest rate guaranteed investment. Bonds are a good part of a balanced portfolio, but Suze's assessment is very limited.- V.L., Florida
We agree with Ms. Orman's approach to the municipal bond market.
More than 40 years in this market has taught us that attempting to predict the direction of interest rates is a futile exercise, even for the most renowned economists. In fact, most of these "seers" have been warning of rising interest rates for more than a decade.
The "cost of waiting" in a CD or sacrificing 40%-50% of available, reinvestable, tax-free income by laddering can be extremely prohibitive. In our experience, it has been the investors with laddered portfolios who have expressed regrets as they have been forced to reinvest their maturing bonds at lower and lower rates. Waiting in a money market, for any period of time can make it almost impossible to recover the income forfeited by not buying the longer-term bonds.
There is no question interest rate fluctuations will impact the market value of your bonds, which is why we continually state that over the life of your longer-term bonds, they will sometimes be worth more than you paid for them and sometimes less. Neither occurrence should trigger a sale.
The bond portion of your investment portfolio is designed to provide income, not capital gains. Maximizing your tax-free income on every purchase produces more reinvestable income that can enhance your portfolio's yield when rates are rising.
Today, due to the mass liquidation of muni-bond fund shares, higher yields have resulted in improved valuations and greater protection against further price declines if Treasury rates do rise. Munis typically trade at a ratio to Treasuries of approximately 90%. Today this ratio is more than 110%.
Perhaps this is what captured the attention of Ms. Orman and Mr. Tisch.
In your article, “Clouds Darkening for Tobacco Bonds,” you don't mention the status of tobacco bonds that are insured. I have California tobacco bonds insured by BHAC. Should I be concerned?
- R.G., Texas
Your state-enhanced BHAC-insured California tobacco bonds should not be confused with those referred to in our commentary. Your bonds carry high investment grade ratings by Moody's and Standard & Poor's (Aa1/AA+).
Our message is aimed at investors holding tobacco bonds that have been downgraded below "investment grade," particularly if their investment objectives do not include speculation.
This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.