Municipal Bond Risk And a Good Night’s Sleep

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

For some, municipal bonds are baffling.

Sure they make sense as part of investors’ portfolios – they generate income free of federal and, many times, state and local taxes, and they support important local projects, like hospitals and schools.

But why, some wonder, do so many investors make them the centerpiece of their investing strategy?

The answer is simple: A good night’s sleep.

Munis doing their job

Consider the recent swings in the stock market. Equities swooned at the end of last year, then seemed to do a U-turn in January. Yet despite the recent swell, stocks are generally still well off their 52-week peak.

For municipal bond investors, ups-and-downs aren’t an issue. They know sometimes their munis will be worth more on paper, than what they bought them for, and sometimes less. Meantime, their bonds will continue to do what they’re supposed to: Generate a steady stream of tax-free income, and return the principal at maturity.

Municipal Bond Risk and a Good Night's Sleep

Understanding the municipal bond risk

But steady income in times of tumult explains only part of the attraction to munis. Consider too, the municipal bond risk, relative to both equities and other income-producing investments. They score high marks there, as well.

“An often-overlooked measure of income generation efficiency is risk-adjusted income,” according to a prominent advisory firm. “Relative to other income-producing asset classes, municipal bonds generate higher levels of income per unit of risk.”

How bonds can help cure insomnia

So with relatively low municipal bond risk and steady tax-free income, where’s the drama? Ironically, it comes from the pundits, who incessantly warn of imminent interest rate spikes triggering Armageddon for bond investors.

These are the same seers who were predicting the end of the 30-year bond bull market five years ago, and who are now prophesizing the end of the 35-year bull market.

It’s a line of thinking we’ve been hearing regularly for years. But a look at the Fed Funds rate for almost 40 years belies the fear mongering, as would the Fed’s most recent thinking, in which it said it was backing off its plan to raise rates.

Seems the real municipal bond risk comes from the so-called experts, who would have investors do nothing and miss out on the opportunity to generate tax-free income they’ll never recoup.

If wild fluctuations in stock prices result in insomnia, the surest cure are the securities that do nothing but what they’re supposed to. Municipal bonds are boring, and that’s the point.

James A. Klotz is the President of FMSbonds, Inc.
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Feb 5, 2019

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.