You’re using a laddering strategy for investing in municipal bonds and it’s time to reinvest proceeds from your maturing bonds.
That’s the gist of a question posed by an investor who read our recent article (“Summer Forecast: A Muni Redemption Flood, Supply Drought”), where we discussed the deluge of bond redemptions expected this spring and summer and the opportunity for muni bond buyers to continue and perhaps enhance their flow of tax-free income.
How, this investor wondered, could he enhance his tax-free income when today’s yields are more modest than they were a decade ago?
That’s easy: Ditch the laddering strategy.
As many clients and friends know, we have never been proponents of laddering municipal bond portfolios (“Bond Laddering: An Idea Whose Time Still Hasn’t Come”). Though popular for years among stock brokers and financial planners, it’s never paid off for investors.
The longest maturity in a typical ladder is 10 years.
Bonds mature every two years, which means for more than two decades, the investor in question would have been forced to reinvest funds at lower yields in every instance.
When munis are redeemed, go long
Our clients buy longer-term bonds to maximize their tax-free income. For the most part, they are buy-and-hold investors, and purchase longer maturities, which significantly enhances their tax-free income.
Consider, for example, that according to Thomson Reuters’ “Municipal Market Monitor,” a 10-year, AA-rated bond yields approximately 2.01% in today’s market. A similarly rated 30-year muni will yield 2.89%.
On a $100,000 investment, the 30-year bond will produce $880.00 more tax-free income annually, which is 30% more than the 10-year security. This can be extremely significant when applied throughout an investor’s portfolio.
When munis are redeemed, focus on what’s important
Ladders are usually recommended by brokers who inordinately focus on maintaining level market values.
Our investors understand that the market value of a long-term bond will sometimes be less than they paid and sometimes more. Neither situation in itself should trigger a sale.
Certainly, redemptions are an issue in a market that is sensitive to supply and demand factors, but investors should never lose sight of their primary objective: keeping their interest clock ticking. And remember, the greatest value is invariably in longer-term bonds.