Amid conflicting and unpredictable signals from the economy, what does it mean to pursue a conservative approach to tax-free municipal bond investing?
To some, it’s constructing a municipal bond ladder – a strategy that has failed for more than 40 years.
In an online note, a bond trader contends that in times of economic crosswinds, like today, assembling a portfolio of bonds in staggered maturities makes sense.
Investors can’t predict the future, he says, so why not take a “conservative” approach and purchase a variety of bonds maturing in the short, medium and long term? Then, when the bonds mature, the proceeds can be reinvested at higher yields, they hope.
While we certainly agree with this premise – that no one can predict the future – we take issue with the conclusion.
Trying to outguess the future
Indeed, it’s a tough time to read tea leaves.
The Fed has declared war on inflation and is aggressively hiking rates – for now – while the costs of gas and food are edging down. Surveys indicate prices for raw materials are moving up, albeit at the slowest rate in months. Employment is up, while at the same time the economy is contracting.
Economies in Europe are also shrinking, and China is struggling. Global political issues cast a further pall of uncertainty over prognostications.
Why, then, is this a good time to predict the future, which a bond ladder forces investors to do?
Nothing conservative in a short-term ladder
Conservative investing has been our position across all economic conditions for as long as we’ve been in business. A key tenet of conservative investing is avoiding prognostications. That’s why we think it makes sense to avoid short-term bond ladders.
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Unfortunately, the idea of using bond ladders persists. It’s why we have reiterated our position many times over the years, including to Forbes more than a decade ago (“Supercharged Munis”).
It’s simple.
Recently, yields on 30-year, AAA-rated municipals were about 30% higher than yields on similarly rated 10-year bonds. The difference is even wider on shorter-term munis.
Though this is an especially fraught time to be guessing about the future of markets, it’s beside the point. It’s impossible to consistently and accurately predict the future at any time. This makes it difficult to see the wisdom of plowing cash into shorter-term bonds and immediately sacrifice significant tax-free income.
Look for quality first, then yield
Successful municipal bond investors first look for quality, then maximize yield. They generally invest in long-term bonds when funds are available and hold them until they’re called or mature.
Of course, the market value of longer-term bonds fluctuates more than short-term bonds, but it seldom concerns buy-and-hold investors. Their main focus is keeping their interest clock ticking.
There are plenty of headlines and pundits devoted to seemingly sophisticated strategies of municipal bond investing.
Bond ladders are among the most prominent, even though investors who’ve employed this strategy have been forced to reinvest at lower rates over the past 40 years as their bonds matured, making it anything but conservative.
Public commentary that commands the most attention is usually contradictory and reflects short-term thinking more suited for stock trading than long-term bond investing.
It also defeats a key attribute of municipal bonds: Unburdening investors from guessing about economic news and helping them sleep soundly at night.
