Warning: Avoid This Income Investment

Speak up!

Apparently that’s all it takes to thwart cyber attacks.

Based on reports from multiple news agencies, the U.S. Government’s decision to finally start calling out China for cyber attacks in November 2011 might actually be bringing about positive change.

So maybe speaking up can keep us from following stupid investment ideas, too.

[ad#Google Adsense 336×280-IA]Let’s give it a try…

A Trap to Avoid At All Costs

Earlier this week, a Bloomberg article didn’t leave any room for misinterpretation, saying, “The largest exchange-traded fund tracking the U.S. municipal [bond] market is selling at its biggest discount to its underlying assets in almost two years.

If history is any guide, that signals a buying opportunity.”

The fund in question?

The $3.6-billion iShares S&P National AMT-Free Municipal Bond Fund (MUB).

It’s a diversified fund that holds 2,381 municipal bonds. And after a recent selloff to $107.60, it’s trading at its lowest level in over a year.

What’s more, as Bloomberg points out, the fund is selling at a 1.4% discount to its net asset value (NAV). Since its inception in 2007, it’s almost always traded at a premium.

How could we possibly resist such a temptation, right?

All sarcasm aside, I get that traditional safe havens like Treasury bonds and money market funds still yield a pittance. Accordingly, investors can’t help “reaching for yield,” as Brian Jacobson of Wells Fargo Funds Management says.

But come on, Bloomberg!

Muni bonds – heck, any bonds for that matter – aren’t meant to be day traded by retail investors. They’re supposed to be held for the long haul – ideally until maturity – to deliver above-average and tax-free income.

Yet we have one of the world’s most respected financial news sites (or at least its reporter, Michelle Kaske) out telling investors to jump at the bargain.

A Train Wreck Waiting to Happen

Now, ignore for a moment the fundamental problems facing municipal bond investors. Instead, let’s simply focus on the “upside” potential here.

If the fund snaps back to its average price in 2013 of $111.13, we’re talking about a 3.3% profit potential. For every month it takes to do so, of course, we’ll pocket a dividend of about $0.25, too. That bumps up the potential profit about 0.23% for each payment.

However, if interest rates start to rise, the fund is going to start trading down toward $100 (or lower), which represents a potential “downside” of at least 7%.

I’m sorry. But in my world, particularly when it comes to capital earmarked for conservative investments, it doesn’t make any sense to risk twice as much as I could possibly gain.

Even more so in this case, since we’re talking about municipal bonds. Much like the Federal Government, state finances remain in shambles.

What’s more, as Fortune’s Allan Sloan points out, high-grade municipal bonds “have become insanely popular.” And as we know, the way to make money isn’t by following the crowd.

As a result, the muni bond market is “a train wreck waiting to happen,” says Sloan.

I tend to agree, which might be a shocker…

You’ll recall, I originally snubbed Meredith Whitney for making such a dire prediction back in 2011. But she was just early. Not wrong.

In fact, her most recent comments to Steve Forbes are spot on: “There’s so much excess money in the system that everybody’s just chasing yield and sort of thumbing their nose at any type of real risk.”

Indeed.

Bottom line: Don’t be so desperate for yield that you blindly accept investment ideas. No matter how reputable the source appears to be. (Present company included.)

In other words, think for yourself before you invest. Once you do, I’m sure you’ll agree that MUB is anything but an irresistible bargain.

Ahead of the tape,

Louis Basenese

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Source: Wall Street Daily