Municipal Bond Forum
CDs vs. tax-free bonds
Q
In today’s market, I can get a four- or five-year CD for 4.50%, AAA, with no risk and no premium. If I’m buying an A-rated muni bond, I want at least 2.5% to 3.0% above prime.
A
James A. Klotz responds:
We don’t think the comparison is valid. CDs are taxable and provide no call protection. Even if an investor is in the 28% tax bracket, the net-after-tax return on the 4.50% CD is only 3.24%. The tax-free bond net is 4.50% – 39% more after-tax income.
In the past, during periods of high short-term rates (Fed tightening), many investors were dismayed to find that when short rates started dropping, it was too late to take advantage of long-term rates, which dropped even more precipitously than short rates.
“Income Risk” is a legitimate concern during periods when the Federal Reserve is pushing up short-term interest rates.
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