Will today’s plump municipal bond yields look puny down the road?
We are often asked this question, and because it touches on the fundamentals of successful bond investing, we think it merits further discussion.
Compare to alternatives
The question, posted in the Municipal Bond Forum, is usually proffered in relation to inflation: Years from now, won’t today’s yields, in effect, shrink because of inflation and the time value of money, i.e. the concept that today’s money is worth less over time?
Our response is simple: Economics dictate that no investment can be analyzed in a vacuum. Rather, it can be judged only in comparison to alternatives.
Which leads to the all-important question: What other investment choices provide returns that reward investors with dollars that are not subject to having less buying power over time?
For instance, even during stock bull markets, profits return dollars to investors that also have less buying power after periods of inflation.
Although stocks may outperform bonds over extended periods of time, they also have down periods (bear markets), which leaves investors vulnerable if bear markets occur when they need their investment funds.
Gold, which has traditionally been perceived as a hedge against inflation, has performed terribly during these higher-inflation years. Likewise for bitcoin.
Ironically, it is inflation that has produced the whopping rates on high quality tax-free bonds.
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Obviously, since most crystal balls are foggy, it seems wise to diversify among various investments in attempting to mitigate any future economic climates.
And that’s the point: No one knows what inflation or interest rates will be in the future. That involves guessing, which experience tells us is impossible to do successfully over the long run. It’s also anathema to fixed-income investing, which seeks to avoid uncertainty to the extent possible.
Value in today’s municipal bonds
As a fixed-income investor, your goal, regardless of the economic climate, is to generate a steady stream of income over time. Today, with elevated yields, you can maximize and lock in higher income, a unique opportunity compared, for example, with short-term securities that are garnering headlines (see “Rethinking Your Reinvestments“).
Because municipal bonds over the last decade have had yields of 2.00% to 3.00%, we think today’s yields of about 4.50% on high-quality, tax-free bonds will be looked upon with nostalgia when the Federal Reserve Board has completed its tightening cycle.
Of course, taking advantage of unusually attractive yields today doesn’t preclude you from investing in the future. Indeed, that’s what successful municipal bond investors do: When funds are available, they look for quality first, then yield.
It just so happens that today, it is a particularly propitious time to do so.
