BOND INVESTORS' FORUM More
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Interest Income
I understand and appreciate your answer to BB in Iowa (see
below). However, what if BB requires the interest to be used
as income for day-to-day sustenance? How would that alter your strategy?
B.C., New York
08/06/04
Mr. Klotz responds: Having a need for income
doesn't make it easier to predict interest rates. What if he is
wrong? If he needs the income, how can he live on money market returns
while waiting for higher long-term rates, which may or may not materialize?
Identifying AMT bonds
Being a complete newbie to tax frees, I am trying to determine
how you know whether a bond is an AMT bond.
08/06/04
Mr. Klotz responds: The fact that a bond
is subject to AMT should be clearly noted in the description of
the bond.
Difference between market value and income
Your response to "What's Wrong With This Picture" did
not recognize that the loss of equity pretty much amounts to the
loss of income (5% to 6%) in the first year. I would rather sit
with cash and be sure.
J.M.
08/06/04
Mr. Klotz responds: We can't agree that
a 5% decline in the market value of an asset is a "loss of
equity," and it certainly doesn't equate to a loss of income,
since bonds continue to pay interest as market value fluctuates.
You say that you would rather sit with cash and "be sure."
The only thing you can be sure of is that this strategy is costing
you 4 ½% to 5% per year. If you plan to hold your bonds,
the temporary decline in market value is unimportant. Bond prices
fluctuate. The key to municipal bonds is the steady flow of tax-free
income.
I agree that there is little out there in the media for bondholders.
It is lamentable. I hold $500,000 in tax-free municipal bonds and
I can't get any information about trends in the muni-market. There
is some scattered "generic" type commentary, but little
of it, if any, is really useful.
I am now trying to decide whether to divest myself of a large portion
of my long-term muni bonds. With interest rates going up rapidly
(or even slowly), I am concerned that there will be more of a bond-value
depreciation than is generally acknowledged. I don't want to be
sitting with a bond portfolio that has depreciated 10-20-30% as
interest rates rise. It is true that I don't need to cash in the
bonds for anything in particular, but if new bonds are going to
pay a full point or two more six months to a year from now, I would
rather have the cash now to set aside for a new buy when the time
comes. If the bonds are depreciated significantly then I would be
"trapped" in my holdings and not be able to take advantage
of new, higher paying bonds in the near and intermediate future.
Since my bond portfolio is about 40% of my net (non-real estate)
assets, it is a serious question to ponder.
My gut reaction tells me to sell them off, park the money for the
next three to 10 months and re-buy into the "new" bond
market. I would like to get advice from my traditional full-service
broker, but all comments are usually neutral (for liabilities sake,
I guess)! I am in a real quandary as to what to do. Most of the
bonds have now depreciated by about 5% in just the last several
months. I don't want to see them go down 10% to 30% in marketable
value. Perhaps you could share some basic insight and the likelihood
of buying into the market in a few months or more with your products.
Great article and very interesting, informative site.
B.B., Iowa
07/26/04
Mr. Klotz responds: Although your guess
is as good as ours regarding the future direction of interest rates,
we can't go along with your strategy of selling all your bonds while
waiting for the "new" bond market.
Our philosophy has always been to maximize income on each bond
purchase and ride out any rise in interest rates by reinvesting
your interest payments in the new higher rate bonds if they become
available.
Let's assume you are correct and you sell your 5% bonds today and
a year from now 6% bonds become available in the marketplace. It
will take approximately five years to make up the interest you sacrificed
by moving your funds to the money market. If long-term rates go
down, you may never be able to replace the income.
There are also transaction costs to be considered. As with all
securities markets, you sell your bonds on the bid side of the market
and purchase your new bonds on the offering side. If the spread
between the two is approximately two points, you then have an additional
$10,000 to recover with what you hope are higher paying bonds.
By the way, if rates do move up to 6%, do you buy bonds then or
maybe wait for 6 1/2% or 7%?
What you are suggesting is pretty tricky. We don't think bond investors
should attempt to time the market even though sometimes your bonds
will be worth less than you paid for them. Your strategy provides
too many ways to outsmart yourself.
And we would be remiss if we didn’t add a final note: The
thoughts you express are common to many investors; we help investors
navigate through these concerns everyday. If your current broker
isn’t much help, perhaps it’s time to find a new one.
*****
I am a new customer of FMS and have found your material and execution
very good so far. As a new investor in bonds, preparing for retirement,
I absolutely agree with your assessment: the interests of "invest
for income" investors and economists are not aligned and the
media (surprise) is less than helpful (verging on irresponsible).
M.P., Florida
7/7/04
*****
And you thought you knew what politics are all about?
F.D.
7/7/04
*****
Agree.
J.E., New Jersey
7/7/04
*****
I agree.
F.H., New Hampshire
7/7/04
*****
I agree with you. The pundits confuse the individual investor –
especially in the municipal bond market. I have never sold a client
a 10-year treasury, and I think I have obtained only two clients
who owned any type of treasury. The lost opportunity of waiting
it out over the last couple of years cost investors a lot. In my
opinion, it will take a long time for them to recuperate the income
lost while waiting on the sidelines. Keep up the good work.
R.K., New York
7/7/04
Thanks for this article on watching the Fed. I also have a notion
that anticipation of rising rates has oversold the market, but my
trading program says that this test won't be over until the Dow
goes below 9400 and panic ensues.
I.S., New York
05/24/04
* * * * *
In an age when the media agonizes over every squiggle – or
anticipated squiggle – in interest rates, it is incredibly
refreshing to have your support for the buy-and-hold-to-maturity
style of bond investing. Much of the media seems to imply that a
long-term bond investment strategy with no equities (which I employ)
is totally un-American. My guess is that many financial publications
would simply go out of business if buy-and-hold bond investing were
to gain substantially in popularity with individual investors. At
my current age of 49, with an anticipated retirement in 10 years,
I own no stocks or stock funds, but add regularly to a seven-figure
staggered maturity portfolio of long-term treasury and agency zeroes
(for IRAs and 403(b)s) and zero-coupon insured munis. Many of these
mature around the time I expect to need the funds.
My primary interest is to stay only modestly ahead of inflation
and not to try to maximize return and lose sleep over it (now I
must be un-American!). You provide an incredibly valuable service
in a world obsessed with marking to market and investing in bond
funds (both of which I eschew). Much of the popular and financial
media cannot seem to grasp the idea that not everybody needs to
pay attention to, or even care, about the fluctuations of bond prices
prior to maturity and that bond funds can be a poor way to make
long-term bond investments, especially in a potentially rising-rate
environment. In this crazy world, your support is priceless. Thanks
many times over!
Dr. A.B., California
05/24/04
Thanks for the update on my holdings. You all are so efficient
it scares me in a very pleasant way.
J.K., Michigan
05/24/04
Thank you for a concise alternative view. To express an opinion,
especially a sensibly different one is refreshing. I endeavor to
do the
same for my clients who are ever searching for guidance and solid
ground.
P.K., New York
05/11/04
* * * * *
I just wanted to let you and your colleagues know how much I appreciated
the e-mail alert I received today about Moody's decision to downgrade
Tobacco Bonds on the basis of the U.S. Circuit Court of Appeals'
denial of an en banc hearing in the Spitzer case. I am overwhelmed
by the timeliness and importance of your message on this subject.
Your firm should be very proud of the service you provide to the
serious municipal bond buying public.
On a similar note, I recently told Charles Schwab & Co., who
tried to sell professional bond management to me, that I ONLY buy
my bonds from FMSbonds.com, due in part to their healthy inventory
and excellent pricing, and in other part to their sensitivity to
the needs of their clients. Those who wish to be left alone are
left alone - those who need hand holding get hand holding. You have
figured out just what is right for the public, including a Web site
that is so simple that it blows away all competition. Congratulations!
J.S. and S.S., Washington, D.C.
05/11/04
Crystal ball
Do you believe that yields will be increasing in the near future?
S.W., California
05/11/04
Mr. Klotz responds: We have been in this
business too long to give predictions on interest rates with any
certainty. Short-term interest rates will have to rise at some time
because they are unusually low today. Longer-term yields may be
a different story since they are not extraordinarily low and could
actually decline if the economic recovery falters later this year.
Fixed-income investors should take a longer view, buying bonds
when their funds are available. By maximizing your tax-free income
on each purchase you will be able to ride out any short-term fluctuation
in rates.
Tobacco volatility
With the recent downgrade of most tobacco bonds, would you still
be a buyer? I am somewhat shocked at the spread between bid and
ask. It is wide enough to drive a truck through. Any info would
be appreciated.
D.B.
05/11/04
Mr. Klotz responds: Your observation is
correct. Spreads are wider on tobacco bonds, as they are with any
bonds displaying similar volatility.
We think the situation that caused the Moody's downgrade will be
rectified in the court system, if not in the Legislature. We continue
to be confident about these bonds. Click
here for a more of our thoughts on this subject.
California tobacco bonds
I read your article on California’s
tobacco bonds and found it very informative. I am thinking of
buying these bonds. However, I am still confused as to how the bond
itself will be paid. I understand how the coupon interest is being
paid. But where will the funds come from to pay the bonds at maturity?
Has California set aside any money to secure the bonds? If it has,
will the state also guarantee sufficient funds so that the principal
(as opposed to interest or bond coupon) will be repaid, too?
A.S., California
04/27/04
Jay Abrams, Chief Municipal Credit Analyst, FMSbonds,
Inc., responds: The 2003 B Series of tobacco settlement bonds
issued by California is expected to be repaid, both principal and
interest, from California's share of tobacco settlement payments
made to the states as a result of the Master Settlement Agreement.
As additional security, this issue also has a pledge by the state
to appropriate sufficient funds to make the payments in the unlikely
case that California's receipts from the tobacco settlement are
insufficient. As a result, this bond is what we call "double
barreled," i.e. it has a primary and secondary source of payment
as added security. And yes, both principal and interest are covered
by the state’s promise to appropriate funds for debt service.
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