Simple Facts Behind Long-Term Muni Success

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<h3>James A. Klotz</h3>

James A. Klotz

How hard is the $6 trillion in money-market funds working for the investors who put it there?

At first blush, one would think the cash was logging overtime. Investors poured more than $23 billion into money-market funds last week, bringing the total pile of cash to $6.09 trillion, near a record.

Investors are lured by elevated yields and erratic equity markets. But are those seemingly alluring rates obscuring more profitable and durable opportunities that also enable investors to avoid the roller-coaster ride of stocks?

It’s about what you keep

Simple facts behind long-term muni successAs longtime investors know, it’s what they take home after taxes that matter – a fact that we’re particularly interested in as municipal bond specialists.

Income from municipal bonds is free from federal taxes and, in almost all cases, exempt from state and city taxes, too. Just how valuable is that tax exemption?

For example, let’s say an investor pays a federal tax rate of 35% and state taxes of 6.00%, and is eyeing municipal bonds yielding 4.00%. The total tax on investment income would be 41%. That means the investor would need a taxable return of 6.78% to equal the 4.00% net yield on a municipal bond without adding to the investor’s existing tax bracket.

For higher-income investors, or those who live in higher-tax areas, municipals can provide taxable-equivalent yields that are significantly even more attractive.

It’s a fundamental concept, but we are astonished at how frequently some investors miss it.

Setting up for the long term

In previous commentaries, we’ve discussed how money-market yields can drop significantly – and quickly – when the Federal Reserve Board chips away at inflation and decides to lower rates (e.g., “Parking Problem: How Muni Investors Lose Out”).

No one knows when the Fed will lower rates. But when they do decline, money-market yields will follow and investors who once rushed into the funds will quickly head for the exits looking for higher yields. But long-term rates will, of course, be lower than they are today.

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    The swollen yields on available municipal bonds today, on the other hand, can be locked in and will continue to deliver until the bonds are called or mature or, in the exceedingly rare event, default.

    To be sure, it’s not just money-market cash that’s sitting idle. There are billions of dollars more parked in CDs. We can’t help but wonder how many of these investors realize that the only differences between long-term success and remorse are simple, fundamental facts.

    James A. Klotz is the President of FMSbonds, Inc.
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    Jun 12, 2024

    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.