Seeking Steady Streams Amid Wild Swings

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

As equity markets continue their eye-popping turbulence, one security has quietly gone about doing what it’s always done: paying investors.

With the action and media attention often elsewhere, municipal bonds have remained a reliable source of tax-free income through all kinds of market conditions.

Now, as equities swing wildly, taking their cue from Shanghai, we’re seeing a renewed interest in munis, especially among investors who have parked cash in money-market funds providing negative returns.

Today’s yields in perspective

Traditionally, nominal tax-free bond yields have averaged from 85% to 93% of Treasuries.

Today, yields on high quality, long-term munis yielding 4.00% equate to more than 130% of 30-year Treasury bonds and provide 33% more income, even before accounting for the fact that the muni income is free from federal taxation.

That 4.00% tax-free muni income is equivalent to more than 7.00% on a taxable bond for an investor in the top tax bracket. Factor in state income taxes, and the equivalent yield becomes even more impressive.

Waiting and watching

Increased interest in munis follows a period in which some investors were frozen, waiting for an undetermined “buy” signal to arrive at an uncertain time. Sadly, they were victims of pundits and financial advisors who have been continually proven wrong in their predictions of higher interest rates.

As we discussed in The Media’s Interest-Rate Myth and in many other articles over the years, obsession over the Fed’s intentions is futile, costly and irrelevant for municipal bond investors. With equity markets currently in turmoil, conjecture will continue over the Fed’s intentions, though it will remain beside the point.

Unique attributes

Municipal bonds make a promise equities can’t: a steady stream of tax-free income and return of principal.

While there is continued concern over Puerto Rico’s financial condition, the Armageddon that some predicted would hit the muni market, after the Great Recession never materialized. Default rates remain miniscule as state and local governments wield their considerable tools and get their fiscal house in order.

The focus of long-time muni investors on generating a steady stream of tax-free income has served them well during all periods of equity market swings. Headline watching doesn’t drive their investment strategy, though in this case, it does serve as a reminder where more tranquil waters can be found.

James A. Klotz is the President of FMSbonds, Inc.
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Sep 2, 2015

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.