A Warning About Municipal Bonds

A warning this week about municipal bonds, or munis as I like to call them.

No, don’t worry: Munis are not going to collapse. Meredith Whitney was just wrong about that. The market is fine and it always has been. That whole thing was just stupid.

[ad#Google Adsense 336×280-IA]No, this warning concerns several articles I have seen recently touting crazy-high yields for munis and, worse, the reverse effect of increasing rates on tax-free bond market values.

One article called tax-free yields “yummy.” I’m not kidding. The yield quoted in the article: 4% tax-free.

Except for issuers that have already demonstrated they have fatal problems – Puerto Rico, Chicago and the state of Illinois – you can go out as far as 20 and 30 years and not see a 4% yield.

No conservative income investor should be anywhere near those Chicago, Illinois or Puerto Rican bonds.

But, maybe even more ridiculous, a Wall Street Journal article called defaults “manageable.”

Believe me, I don’t care who you are, there is nothing manageable about any default.

Another article listed the yield of high-grade bonds as 2% and a total return of 9%.

The 2% is accurate, and if you owned the right bonds, you might – under perfect or theoretical conditions – have seen an unrealized capital gain to get you to 9%. But this idea of 9% is misleading at best.

Virtually no one made 9% last year in tax-free bonds. Throwing around that kind of number in a market of 1% to 3% annual returns for long maturities is nuts!

That 1% to 3% is the norm right now for decent, quality bonds. And you have to go way out on the maturity curve to get that.

But a Barron’s article may take the cake for bad information. It called munis a great place “to ride out the expected volatility” created by rising rates.

This is so wrong on so many levels.

Munis are tied to rate increases almost as closely as Treasurys are. There is almost a 1-to-1 correlation between Treasurys and rates, and that means they and munis will drop in value as rates move up.

This Barron’s article quoted a money manager who seems to think longer-maturity munis will actually go up in value as rates increase. This can’t happen!

This might be the worst advice I’ve ever seen in print.

Don’t get me wrong: You can own munis here and you can make safe, tax-free income on them and, in the right situations, capital gains too.

But you have to go into them with a clear understanding of the real risk increasing rates pose and realistic return expectations, or you’ll bail at the first sign of a market drop.

And that will only guarantee a loss.

What I am reading in the money press about munis is anything but clear or realistic.

Tax-frees are great, but make sure you understand what you own.

Good investing,

Steve

[ad#DTA-10%]

Source: Wealthy Retirement