I was recently the guest speaker at an investment seminar. After my presentation, I opened the floor to questions.
A local physician, the spokesman for the group, jumped to his feet and exclaimed, “We all have the same question. How do we return to the days of growth in our portfolios without taking on additional risk?”
They were pleased with the advice I offered and it was a much simpler approach than they had expected. I suggested they call a tax-free bond specialist and ask about high-quality, zero coupon tax-free bonds.
Buying At A Discount
Zero coupon municipal bonds pay no current interest. They are purchased at a substantial discount from par value and accrete (grow) to their full face value at maturity. The best part is they are completely exempt from federal income tax as well as capital gains tax.
Zero coupon bonds will usually have higher yields than comparable coupon bonds. This is an additional edge for investors who can afford to defer current income payments. A top quality (AAA), insured, 18-year, full coupon bond should yield approximately 4.75% in today’s market, whereas a zero coupon bond of like quality and maturity will yield approximately 5.25%.
Guaranteed Growth
Zero coupon bonds are unique because they provide guaranteed growth in your portfolio. Notice I use the word “guaranteed.” With other growth investments, we can only talk about expectations.
Today, you can invest $39,300 in that previously mentioned 18-year, AAA insured zero coupon bond knowing that it will grow to $100,000 its full face value – at maturity.
Along with adding balance to an equity-heavy portfolio, zeros are an excellent vehicle for funding a future event such as a grandchild’s college education or any balloon payment.
One important caveat: Some zero coupon bonds are callable and some of the call features can be confusing. I advise you to consult a bond specialist who is familiar with how accretion schedules work.
