2008 - A Good Time to Consider Municipal Bonds?
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Greg Smith
Senior Vice President & Director of Private Client Services |
If the seemingly daily swings in the stock market, woes in the real estate market and talk of recession have you looking for an investment that has a lower risk profile and higher yield, you might consider municipal bonds.
Historically, municipal bonds, also known as munis, are a comparatively low-risk investment with the added benefit that the interest they earn is usually exempt from federal tax and the alternative minimum tax (AMT) as well as many state and local taxes.
These investments tend to be more attractive during periods of volatility in the stock market. That trend continues to hold true in 2008. In fact, right now, many municipal bonds are yielding more than Treasuries or corporate bonds of comparable maturities. In short, municipal bonds can provide a buffer against the current ups and downs in the stock market.
For those who are unfamiliar with municipal bonds: Cities, counties, states, schools, water districts and hospitals issue municipal bonds. More than 5 million households as well as commercial banks and insurance companies own them. The trading volume for these instruments tops more than $11 billion each day.
Though every investment comes with some risk, municipal bonds have earned their reputation as being relatively as safe as Treasuries because most local governments make debt payment a top fiscal policy, even in time of crisis. Therefore, municipal borrowers are generally considered good credit risks. Even New Orleans paid its debt obligations after the devastation of Hurricane Katrina.
Municipal bond investors also like the fact that munis are often issued by local entities, making it easier to track the progress of a project for which the bond was issued. Moreover, more than 50,000 state and local entities issue bonds.
While municipal bonds are a particularly favorable investment right now, anyone interested in buying the bonds should work with a professional financial advisor with investment expertise to select a high quality bond. Here are five items to consider when working with your advisor:
- Diversify: Talk to your advisor about the composition of your portfolio vs. the economic climate we are now facing. Would the purchase of municipal bonds help to diversify your portfolio by adding some investments that have a lower risk profile? Or do you have a sufficient percentage of bonds in your portfolio at this time?
- Timing: While now is a good time to let municipal bonds shield your investment from the changes in the stock market, that may not always be true. So you will want to keep working with a professional to manage your portfolio and make appropriate changes when the economy improves.
- Capital gains: Although the interest from municipal bonds is usually exempt from federal taxes, the holder of a bond may incur capital gains or losses if they sell the bond prior to maturity. Again, this is something to discuss with your advisor and your tax accountant.
- AAA Quality: Talk to your advisor about Triple A municipal bonds that have scheduled interest and principal payments and are rated AAA by municipal bond insurers. Given today’s uncertainty surrounding the bond insurers, your goal should be to find top quality municipal bonds with strong underlying credit, regardless of the insurer’s rating.
- Balance with Bonds: An important component of any investment strategy is a balanced portfolio. Bonds are a critical aspect of this strategy. They can provide a steady stream of income and many are tax-free. If you don’t have bonds in your portfolio, consider including some. If you do, talk to your advisor about the percentage of bonds vs. stocks. The balance between the two will vary depending on your stage of life and your proximity to retirement. Make certain you have the best balance for your situation.
Wise investments exist in almost every economic cycle. In today’s market environment, municipal bonds might be an investment that you want to consider in your portfolio. Discuss your alternatives with a financial advisor to determine the proper course of action for your individual circumstances.
Greg Smith is Senior Vice President & Director of Private Client Services for Haberer Registered Investment Advisor, Inc. He can be reached at 513-381-8200 |
