NOVATO, Calif., Dec. 21, 2012 /PRNewswire/ -- Despite the scary headlines, investments continue to climb an economic wall of worry. However, the biggest financial "head scratcher," is why average investors are still willing to pay such a high price for the troubled waters of municipal bonds in spite of the better tax advantaged yields offered in mid-grade, corporate bonds.
"Even though Stockton and San Bernardino's fiscal problems are still news, investors are chasing low yielding California municipal bonds with maturities as far out as 2033!" says money manager Ken Winans.
These investors are willing to ignore glaring issues in owning municipal bonds today:
- The financial mismanagement of many state and local governments likely means future bond defaults.
- Yields on U.S. municipal bonds are at their lowest level in 49 years. History teaches us that overpaying for long-term bonds in a low interest rate environment leads to huge hits in investment values during interest rate advances in the future. In fact, a 5-year municipal bond, bear market had a huge price decline of 57% following 1963's record high!
- Many tax-free bonds are in fact taxable, because these issues can be subject to the alternative minimum tax, which targets most high-income earners.
- Unlike most other types of investments, transaction costs and investment management fees for most municipal bonds are not tax deductible.
What should tax-conscious bond investors do?
- Diversify into corporate bonds: Not all municipal and corporate bonds are the same, so shop for the best tax equivalent yield. Currently, 5-year mid-grade corporates are yielding over 6.5%!
- Shorter maturities on new investments: Investors should avoid new bond purchases with maturities exceeding 10 years. The investment volatility should be significantly less during the next bear market in bonds.
- Amortize premiums paid on bonds: By amortizing the premium paid on bonds above maturity value, the tax equivalent yield-to-maturity favors corporate bonds.
- Track the bond markets trends: If the Bond Buyer G.O. 20-Year Municipal Bond Price Index crosses below its 100-week moving average, a new price downtrend has begun, so be cautious on new municipal bond purchases.
Caveat Emptor: Municipal bonds are popular with the investment industry. Not because they necessarily offer better returns to their clients, but because they can make more compensation on these investment products!
SOURCE Winans Investments