Municipal bonds going forward

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northstar22
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Municipal bonds going forward

Post by northstar22 » Sat Apr 06, 2013 10:15 am

I have a moderate amount of cash I've been thinking about moving into a municipal bond fund (may be needed in the next year or so, and yes I could stand to lose 10%). My question is, are theoretical risks to the tax-exempt status of municipal bonds already priced into the municipal bond funds, the same way they would be priced into a stock fund?

This is not meant to be a political discussion or a discussion of future legislation. I know the usual risks involved with investing in this sort of fund and want to know if there is additional risk I should be aware of. If the risk is already priced in then I'm fine with it.

am
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Re: Municipal bonds going forward

Post by am » Sat Apr 06, 2013 10:34 am

I dumped my munis earlier this year. I do not like the idea of investing in something whose fundamental properties may change at any time. Seems like munis tax exempt status has been threatened for years, and more recently much more seriously. I invest in bonds for stability and safety, and this uncertainty surrounding their tax exempt status makes me want to stay away for good.

Scooter57
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Re: Municipal bonds going forward

Post by Scooter57 » Sat Apr 06, 2013 10:41 am

The risks seem to be priced into the interest right now, which is higher relative to corporate bonds than usual.

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Noobvestor
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Re: Municipal bonds going forward

Post by Noobvestor » Sat Apr 06, 2013 1:58 pm

If you may need the money in a year, it's a bit of a crap shoot - if interest rates go down or stay the same, you win. If they go up, you lose. Why not just leave it in savings/CDs? Or are you saying you're really unlikely to need it in a year, but maybe just maybe you will (like an emergency fund component if you lose your job or something)?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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SpringMan
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Re: Municipal bonds going forward

Post by SpringMan » Sat Apr 06, 2013 4:41 pm

I am not too worried about municipal bonds. If they lose value, they can be tax loss harvested. In my opinion, they will never change status and become taxable.
Best Wishes, SpringMan

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bottomfisher
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Re: Municipal bonds going forward

Post by bottomfisher » Sat Apr 06, 2013 4:51 pm

My question is, are theoretical risks to the tax-exempt status of municipal bonds already priced into the municipal bond funds, the same way they would be priced into a stock fund?
I'm not a bond expert - but I don't feel this consideration is priced into the current price. I don't think many investors consider the risk of losing tax-exempt status a serious consideration at this point. Perhaps there will be some sort of cap put in place. But there really has not been that much discussion about this consideration either. A few months ago the media did bring it up and there was no massive outflow from munis. There was a slight decrease in fund value towards the end of December; but nothing compared to October 2010 when Meredith Whitney inaccurately predicted mass municiple defaults and some investors fled.

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gasman
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Re: Municipal bonds going forward

Post by gasman » Sat Apr 06, 2013 6:51 pm

Long term concern, I just believe that if it happens current bonds will be grandfathered. So it doesn't affect what I do. RIGHT NOW High quality Munis are yielding more than 100% of treasurys. So that is where my new fixed income dollas are going.

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Re: Municipal bonds going forward

Post by Grt2bOutdoors » Sat Apr 06, 2013 6:55 pm

In taxable space, my fixed income money is going in two places - intermediate muni's which I purchased earlier in the year and my mortgage. Either way, I can not find a higher yield today.

In tax deferred - Total Bond Market Index and a smaller slice of Stable Value - yes, I know, my duration is being shortened - this is by design. I'm taking my risk on the equity side.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Stevewc
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Re: Municipal bonds going forward

Post by Stevewc » Sat Apr 06, 2013 7:02 pm

gasman wrote:Long term concern, I just believe that if it happens current bonds will be grandfathered. So it doesn't affect what I do. RIGHT NOW High quality Munis are yielding more than 100% of treasurys. So that is where my new fixed income dollas are going.
Are you buying funds or individual bonds?
Thanks for info
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Scooter57
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Re: Municipal bonds going forward

Post by Scooter57 » Sat Apr 06, 2013 7:13 pm

A bigger concern than loss of the tax exemption is that federal cuts put financial stress on already stressed municipalities, making defaults more of a concern.

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Re: Municipal bonds going forward

Post by Grt2bOutdoors » Sat Apr 06, 2013 7:57 pm

Scooter57 wrote:A bigger concern than loss of the tax exemption is that federal cuts put financial stress on already stressed municipalities, making defaults more of a concern.
How so? G.O.'s are backed by the general taxing ability of the state, and revenue specific bonds are backed by specific revenue generating entities such as toll roads, water/sewer taxes.
If you selectively purchase the right kind of bonds, the default concern in minimized.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Scooter57
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Re: Municipal bonds going forward

Post by Scooter57 » Sat Apr 06, 2013 9:05 pm

If you buy bond funds in a market where money is pouring into bond funds forcing managers to buy lesser quality bonds, who knows what bonds are in your portfolio?

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Re: Municipal bonds going forward

Post by Grt2bOutdoors » Sat Apr 06, 2013 9:21 pm

Scooter57 wrote:If you buy bond funds in a market where money is pouring into bond funds forcing managers to buy lesser quality bonds, who knows what bonds are in your portfolio?
Sorry, not buying it. You buy the "right fund with the right charter" and your problem above becomes non-existent. Otherwise stick to individual issues where there is no compromise.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Qtman
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Re: Municipal bonds going forward

Post by Qtman » Sat Apr 06, 2013 9:46 pm

Buy individual, highest quality bonds and hold to maturity. For another well thought out strategy read " Bonds" by Hildy and Stan Richelson. Great book.Well thought for the conservative investor.
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Valuethinker
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Re: Municipal bonds going forward

Post by Valuethinker » Sun Apr 07, 2013 3:09 am

northstar22 wrote:I have a moderate amount of cash I've been thinking about moving into a municipal bond fund (may be needed in the next year or so, and yes I could stand to lose 10%). My question is, are theoretical risks to the tax-exempt status of municipal bonds already priced into the municipal bond funds, the same way they would be priced into a stock fund?

This is not meant to be a political discussion or a discussion of future legislation. I know the usual risks involved with investing in this sort of fund and want to know if there is additional risk I should be aware of. If the risk is already priced in then I'm fine with it.
You would presumably get warning of a change in legislation leading to a loss of tax exemption? Speculation on my part, but to quote Bill Murray in Ghostbusters 'Lennie you have the opportunity here to save the lives of millions of..... registered voters'.

No I do not believe such a risk is priced into the US muni market. Yields would go up maybe by a lot.

With the improvements in housing markets I think the worst has passed for many US municipalities and some states. Revenues are often quite housing linked. However there are long term issues with pensions and there are going to be some pretty bloody fights about it.

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Re: Municipal bonds going forward

Post by richard » Sun Apr 07, 2013 5:43 am

northstar22 wrote:My question is, are theoretical risks to the tax-exempt status of municipal bonds already priced into the municipal bond funds, the same way they would be priced into a stock fund?
Most probably the risks are priced in. A risk being priced in takes into account both the magnitude of the risk and the probability of the risk happening. I doubt many investors believe there is a large probability of munis losing their tax-exempt status. The odds of current munis losing their tax-exempt status is almost certainly much lower.

Accordingly, I'd say the risk is priced in, but munis would likely decline in price if they were to lose their tax-exempt status because the odds of damage would go from low to 100%.

cks
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Re: Municipal bonds going forward

Post by cks » Sun Apr 07, 2013 5:46 am

One thing I've come to believe about investing is that there's no such thing as a free lunch.

Higher Yield = Higher Risk

Currently munis are yielding more than historical norm relative to treasuries. I think current bond traders think that munis are a riskier investment than they have been historically.

In a situation like yours, where you may need the funds in a year or so, I've read multiple articles where Jack Bogle puts his short-term funds into limited-term tax exempt (VMLTX).

Call_Me_Op
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Re: Municipal bonds going forward

Post by Call_Me_Op » Sun Apr 07, 2013 7:36 am

Risks are always priced into a security in an efficient market - of which the muni bond market is certainly one. The spread against treasuries is usually negative, but is now positive. This implies some combination of credit risk and political risk - in addition to the interest rate risk. You are in an environment of essentially zero "risk-free rate." This means that virtually any (nominal) return you are getting now comes with some risk.
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OverTheHill
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Re: Municipal bonds going forward

Post by OverTheHill » Sun Apr 07, 2013 7:48 am

We're retired. While our marginal tax bracket is 25%, our effective tax rate for 2012 was around 12%. Much of our income comes from cap gain and dividend distributions, with the balance from SS and a little part-time by my wife. It's amazing to see what has happend to our taxes over the past several years. We use to have an effective tax rate close to the same as the top maginal rate, while now we've plunged, even though out standard of living has remained exaclty the same. Regardless, it's hard to justify muni bonds when our effective rate is so low.

Scooter57
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Re: Municipal bonds going forward

Post by Scooter57 » Sun Apr 07, 2013 8:52 am

I own the Richelson's book and have read it carefully. However the Richelsons are committed to the idea that only a 100% bond portfolio is a reasonable way to invest and I believe it skews their judgment. If you followed their advice and invested in a ladder and inflation rose to only 5% a year, you could end up with eroded capital. Yes you could reinvest the shorter bonds as they came due, but to get any yield at all now you'd have to have enough intermediate and long bonds that you'd get hammered on their low yields.

Other problems are the transaction costs which are still very high. I paid $250 to sell one inherited long bond holding through VBS, and there is a heightened risk of default when you hold individual bonds. I don't have enough knowledge to evaluate the safety of a bond holding. The Richelson's offer their expertise in selecting bonds, but they charge 1% of assets to do so. Given that the bonds only are paying 2-3% right now, the expenses are too high relative to the gain. And I have zero interest in locking in paltry interest rates for the long term. Short term bonds that you can buy as individual bonds are yielding less than mediocre credit union CDS according to VBS. Were rates to revert to a more normal level and the economy pick up to where it would be clearer whether we were going to get some rebound inflation, I might consider going that route, but the bond rates would have to be high enough that the 1% fee would be a much smaller bite out of the first year's earnings.

Also, in case anyone wonders, when I went out to sell my long muni bonds I found that the actual price I could sell them for was considerably less than the price that Vanguard Brokerage Services has been displaying on my account for the past six months.

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stratton
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Re: Municipal bonds going forward

Post by stratton » Sun Apr 07, 2013 1:37 pm

Scooter57 wrote:I own the Richelson's book and have read it carefully. However the Richelsons are committed to the idea that only a 100% bond portfolio is a reasonable way to invest and I believe it skews their judgment. If you followed their advice and invested in a ladder and inflation rose to only 5% a year, you could end up with eroded capital. Yes you could reinvest the shorter bonds as they came due, but to get any yield at all now you'd have to have enough intermediate and long bonds that you'd get hammered on their low yields.
They discuss dividend paying stocks, preferred stock, convertibles, REITs etc. in their book.

Several years ago I listened to a radio interview they gave and they are about 15% in dividend paying stocks with their personal money. So their definition of "bonds" appears to be a bit different than yours.

Paul
...and then Buffy staked Edward. The end.

carolinaman
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Re: Municipal bonds going forward

Post by carolinaman » Sun Apr 07, 2013 1:53 pm

I think the risk of munis losing tax advantaged status is low. I spent many years in local govt management and know how important munis are to local govt capital financing. The loss of their tax status would dramatically increase capital financing costs for local govts through higher interest rates. Also, it would no doubt reduce capital spending of local govts which is exact opposite of what Federal govt wants and has done through stimulus efforts. I own munis and have no plans to change my allocation.

northstar22
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Re: Municipal bonds going forward

Post by northstar22 » Sun Apr 07, 2013 4:43 pm

Thanks for the responses so far. I may end up taking noobvestor's advice and keep it in high yield savings for the time being since the time frame is relatively short. It's been great getting so many people's thoughts.

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