Municipal bonds

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Green Investor
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Joined: Tue Jul 30, 2019 5:23 pm

Municipal bonds

Post by Green Investor » Tue Jul 30, 2019 5:57 pm

Hello, I am a new poster who is brand new to the world of investing. I listen to Dave Ramsey every day, and I know he pushes good growth stock mutual funds. I actually hired one of his Smartvestor Pros. Dave always says that bonds are not a good long term investment. I will be investing in mutual funds, but am also investing in municipal bonds. No matter how much I try, I cannot wrap my head around how they work.

I'll give a round number to make the math easier. If I buy 50k worth of municipal bonds, why am I paying 57k for them? Let's just say they mature in 2040, and I am getting 4.5%. I would be earning around $2,250 per year, so it would take me over 3 years to get out of the hole. I feel like I am being ripped off, does this sound right to you guys?

Why am I "down" for the first three years? Please tell me I am missing something here. When I look at the total value in my portfolio, I am already in the red before getting started. Would I be better off just putting all of my money in mutual funds like Dave said? All I see next to my municipal bonds is red, no green at all. Please help me out, and tell me (in simple terminology) what is going on. Thank you very much.

Green Investor

Gill
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Re: Municipal bonds

Post by Gill » Tue Jul 30, 2019 6:19 pm

You have purchased bonds at a premium, I.e., selling above par value because their coupon is higher than prevailing rates.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

CppCoder
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Re: Municipal bonds

Post by CppCoder » Tue Jul 30, 2019 6:26 pm

Yes, you should buy bonds via funds. There is nothing intrinsically wrong with buying individual bonds. However, you have bought a financial instrument that you clearly do not understand; this behavior is ill advised.

MikeG62
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Re: Municipal bonds

Post by MikeG62 » Wed Jul 31, 2019 8:01 am

Green Investor wrote:
Tue Jul 30, 2019 5:57 pm

...I'll give a round number to make the math easier. If I buy 50k worth of municipal bonds, why am I paying 57k for them? Let's just say they mature in 2040, and I am getting 4.5%. I would be earning around $2,250 per year, so it would take me over 3 years to get out of the hole. I feel like I am being ripped off, does this sound right to you guys?

You are NOT being ripped off. You want to buy an ~20 year muni bond today and expect to get a 4.5% annual yield when 20 year muni bonds are probably yielding around 3.0%? Investing does not work that way. When you buy today you will get the current market yield - regardless of the bonds coupon. So if the coupon is higher than the current market yield for a comparable bond you will pay a premium for the bond. Then every coupon payment you receive will have a component which will be a partial return of the premium you paid. If the current market yield is higher than the coupon (unlikely in the current market), then you will buy at a discount.
Real Knowledge Comes Only From Experience

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Sandtrap
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Re: Municipal bonds

Post by Sandtrap » Wed Jul 31, 2019 8:53 am

Welcome.
1
Read the following for a deeper understanding of bonds and bond strategy:
The Only Guide to a Winning Bond Strategy You'll Ever Need by Swedroe
https://smile.amazon.com/Only-Guide-Win ... way&sr=8-1
The Bond Book by Annete Thau
https://smile.amazon.com/Bond-Book-Thir ... W4KST7W676
2
Read the forum wiki on "bonds", "muni", etc.
3
Search the forum archives for threads/posts on "municipal bond strategy".
4
Doing #1-3 will far expand your knowledge base far beyond Mr. Ramsey.
5
When you are ready, do this:
Asking Portfolio Questions
https://www.bogleheads.org/forum/viewt ... =1&t=6212

j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

not4me
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Re: Municipal bonds

Post by not4me » Wed Jul 31, 2019 9:05 am

Green Investor wrote:
Tue Jul 30, 2019 5:57 pm
If I buy 50k worth of municipal bonds, why am I paying 57k for them? Let's just say they mature in 2040, and I am getting 4.5%. I would be earning around $2,250 per year, so it would take me over 3 years to get out of the hole. I feel like I am being ripped off, does this sound right to you guys?

Why am I "down" for the first three years? Please tell me I am missing something here. When I look at the total value in my portfolio, I am already in the red before getting started.
OP, you didn't include enough to determine exactly what is going on. I'll add a few things to what has already been said. As has been pointed out, it sounds as if you paid a premium for this bond. when you buy individual bonds, you may have paid a commission as well as a wide spread. That would also need to be understood. The tax treatment of premiums for munis can be a bit complicated. Basically when you look at your "statement", the premium will fade away as you approach the maturity date. That doesn't show you the tax treatment so it isn't complete

When you said "I am getting 4.5%...would be getting"...are you sure that isn't the coupon rate? That is a common mistake if so. If you are getting $2250/year & paid $57k, that would be more like 3.9% you are actually getting (whether that is adequate for the risk is unknown based on what you said. Need to factor in your tax situation, likelihood of default, etc).

hudson
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Re: Municipal bonds

Post by hudson » Wed Jul 31, 2019 9:12 am

I personally stick with muni funds like MUB, VTEB, or Vang. Intermediate Muni. These funds have high amounts of AAA/AA/A bonds and have low expense ratios.
I researched buying individual bonds, but it was too complicated and too much work. It's easy for a novice to get a "haircut". I personally wouldn't use Dave Ramsey, his associates, or any advisors for my investments. The Boglehead forum works for me.

straws46
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Re: Municipal bonds

Post by straws46 » Wed Jul 31, 2019 12:26 pm

It is not legal to charge a commission and a spread. A broker may charge one or the other. Commissions are disclosed so most brokers do not charge them. Instead they "mark" up the bond. The terminology is a "mark" rather than a "spread," but that is just semantics. You can go to EMMA and track all prior sales so you can pretty much find out what the mark is. If you don't understand an investment, best to study up and find something else in the meantime.

alfaspider
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Re: Municipal bonds

Post by alfaspider » Wed Jul 31, 2019 12:32 pm

Before you buy Munis, make sure they are appropriate for your investment goals and tax situation. You generally need to be in a high tax bracket for them to make any sense.

Topic Author
Green Investor
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Re: Municipal bonds

Post by Green Investor » Wed Jul 31, 2019 3:00 pm

Thank you all very much for the responses, I really appreciate it. Obviously, I should have done my homework before doing any investing. I feel completely lost and frustrated. I am worried I will lose all of my money. I can't take it out now, because I will take a beating on his commission/fees.

Like Dave says, park your money in a CD until you understand what is going on. I will read all of the literature you guys are recommending. For me, it feels like I am in the red until the interest I receive gets the total amount equal to or greater than the original amount I invested. Does anyone understand what I mean by that? Thanks again for all of your help.

MikeG62
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Location: New Jersey

Re: Municipal bonds

Post by MikeG62 » Wed Jul 31, 2019 3:40 pm

Green Investor wrote:
Wed Jul 31, 2019 3:00 pm

...For me, it feels like I am in the red until the interest I receive gets the total amount equal to or greater than the original amount I invested. Does anyone understand what I mean by that? Thanks again for all of your help.
This is not true. If you go and sell the muni bond you will get a premium - in all likelihood more of a premium than you paid (given current Muni yields are as low as I remember). So you will be just fine.

Agree with your other comment (and some of the other commenters), in that you should increase your knowledge of investing before you start selecting and purchasing securities.

A newbie (don't take this the wrong way) should probably not be purchasing individual muni's, but instead should just use a muni bond fund. In fact, this is probably true for most people who want exposure to muni's.
Real Knowledge Comes Only From Experience

Topic Author
Green Investor
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Re: Municipal bonds

Post by Green Investor » Wed Jul 31, 2019 4:36 pm

Thank you for the info, Mike. That does make me feel a little better. Also, no offense taken, I am a newb! To be clear, I do have a 20 year professional (Smartvestor Pro vetted by Dave Ramsey's team) picking and choosing these bonds. Having said that, I definitely need to study and learn all of this stuff for myself.

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dratkinson
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Re: Municipal bonds

Post by dratkinson » Wed Jul 31, 2019 5:54 pm

Green Investor wrote:
Wed Jul 31, 2019 3:00 pm
Thank you all very much for the responses, I really appreciate it. Obviously, I should have done my homework before doing any investing. I feel completely lost and frustrated. I am worried I will lose all of my money. I can't take it out now, because I will take a beating on his commission/fees.

Like Dave says, park your money in a CD until you understand what is going on. I will read all of the literature you guys are recommending. For me, it feels like I am in the red until the interest I receive gets the total amount equal to or greater than the original amount I invested. Does anyone understand what I mean by that? Thanks again for all of your help.
We all understand it, because we've all been there when things didn't turn out as expected. (And some of us never got our money back.) Take comfort from knowing that yours is a relatively cheap lesson because you're not losing money as you're earning the market return.

You're just annoyed because the DR salesman told you that you were earning 4.5% (on a $50K bond), but the premium paid lowered your return to match the current market return---expected. (N.B. You'll feel like a financial genius and come out ahead if you get lucky and the market rate drops lower. But "luck" is not a recommended investing strategy.)

Your remaining worry is if the bond issuers go bankrupt (think: Orange County CA, GM,...). This is why most prefer owing funds---we're less affected by bankruptcies of individual bond issuers. We let an experienced fund manager worry about selecting good individual bonds, while we worry about how to rebalance/spend our monthly dividends.

So your only worry could be as simple as selecting good funds. And the folks here can recommend several for your financial situation.


If you vacillate between feeling like you are being "ripped off", to feeling like you are a financial genius, and didn't know to expect either going in, then you are investing without knowledge. Don't do that.

Add to Sandtrap's list and read The Bogleheads' Guide to Investing. You can get all of the books from your local library or through inter-library loan.

After finishing all of your required reading, start a new topic (it's easier if all of your information is in your OP: original post/poster), and post your financial situation in the requested format (makes it easier for us to find your information), for a forum review and advice.



Welcome.



P.S. Stop buying from the DR salesman until after your required reading and forum review. He may be a good guy and you can return to him, if you want, after you know more.


P.P.S. If you get lucky and the market rate drops lower, the premium on your bonds will increase, and you can sell for a profit. Less the salesman's commission/spread. And less the short-term capital gains tax, paid at your highest fed tax bracket rate. And less any state/city/local income tax.

And if you are lucky and can sell after owning your bonds for >1yr, then you'll only pay tax at the long-term capital gains tax rate: 0%, 15% or 18.8%.

But if your LTCG rate is 0%, then most would recommend that you NOT own muni bonds.
d.r.a., not dr.a. | I'm a novice investor, you are forewarned.

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abuss368
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Re: Municipal bonds

Post by abuss368 » Wed Jul 31, 2019 7:48 pm

Sandtrap wrote:
Wed Jul 31, 2019 8:53 am
Welcome.
1
Read the following for a deeper understanding of bonds and bond strategy:
The Only Guide to a Winning Bond Strategy You'll Ever Need by Swedroe
https://smile.amazon.com/Only-Guide-Win ... way&sr=8-1
The Bond Book by Annete Thau
https://smile.amazon.com/Bond-Book-Thir ... W4KST7W676
2
Read the forum wiki on "bonds", "muni", etc.
3
Search the forum archives for threads/posts on "municipal bond strategy".
4
Doing #1-3 will far expand your knowledge base far beyond Mr. Ramsey.
5
When you are ready, do this:
Asking Portfolio Questions
https://www.bogleheads.org/forum/viewt ... =1&t=6212

j :happy
I owned The Bond Book by Annete Thau. It was the driest book I ever read. Could only get through the first 100 pages or so. I simply read Jack Bogle's books where he discussed bond funds.
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

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abuss368
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Re: Municipal bonds

Post by abuss368 » Wed Jul 31, 2019 7:49 pm

I would consider a low cost and diversified investment grade bond fund that is short or intermediate term only. Avoid individual bonds.
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

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Sandtrap
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Re: Municipal bonds

Post by Sandtrap » Wed Jul 31, 2019 7:58 pm

abuss368 wrote:
Wed Jul 31, 2019 7:48 pm
Sandtrap wrote:
Wed Jul 31, 2019 8:53 am
Welcome.
1
Read the following for a deeper understanding of bonds and bond strategy:
The Only Guide to a Winning Bond Strategy You'll Ever Need by Swedroe
https://smile.amazon.com/Only-Guide-Win ... way&sr=8-1
The Bond Book by Annete Thau
https://smile.amazon.com/Bond-Book-Thir ... W4KST7W676
2
Read the forum wiki on "bonds", "muni", etc.
3
Search the forum archives for threads/posts on "municipal bond strategy".
4
Doing #1-3 will far expand your knowledge base far beyond Mr. Ramsey.
5
When you are ready, do this:
Asking Portfolio Questions
https://www.bogleheads.org/forum/viewt ... =1&t=6212

j :happy
I owned The Bond Book by Annete Thau. It was the driest book I ever read. Could only get through the first 100 pages or so. I simply read Jack Bogle's books where he discussed bond funds.
+1
Yes.
It was as tough and dry as the worse cut of discount pork chops my mom cooked in 1958.

But, I got through it. Learned a lot.
Just like I got through those tough as shoe leather pork chops in 1958.

j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

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bluquark
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Re: Municipal bonds

Post by bluquark » Wed Jul 31, 2019 8:12 pm

abuss368 wrote:
Wed Jul 31, 2019 7:48 pm
I owned The Bond Book by Annete Thau. It was the driest book I ever read. Could only get through the first 100 pages or so.
I am a nerd so I treated this comment as a recommendation and just bought the book :sharebeer
70/30 portfolio | Equity: global market weight | Bonds: 20% long-term munis - 10% LEMB

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bluquark
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Re: Municipal bonds

Post by bluquark » Wed Jul 31, 2019 8:28 pm

Green Investor wrote:
Wed Jul 31, 2019 3:00 pm
I am worried I will lose all of my money.
For what it's worth, it's very difficult to "lose all of your money" investing in municipal bonds. You can relax a bit in the knowledge that this is a predictable and boring asset class. You might see your returns nibbled away at by spreads or unlucky rate timing -- or even suffer the extremely rare haircut from a bankrupt city -- but these aren't stocks, you can't lose your shirt.
70/30 portfolio | Equity: global market weight | Bonds: 20% long-term munis - 10% LEMB

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abuss368
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Re: Municipal bonds

Post by abuss368 » Wed Jul 31, 2019 9:09 pm

Sandtrap wrote:
Wed Jul 31, 2019 7:58 pm
abuss368 wrote:
Wed Jul 31, 2019 7:48 pm
Sandtrap wrote:
Wed Jul 31, 2019 8:53 am
Welcome.
1
Read the following for a deeper understanding of bonds and bond strategy:
The Only Guide to a Winning Bond Strategy You'll Ever Need by Swedroe
https://smile.amazon.com/Only-Guide-Win ... way&sr=8-1
The Bond Book by Annete Thau
https://smile.amazon.com/Bond-Book-Thir ... W4KST7W676
2
Read the forum wiki on "bonds", "muni", etc.
3
Search the forum archives for threads/posts on "municipal bond strategy".
4
Doing #1-3 will far expand your knowledge base far beyond Mr. Ramsey.
5
When you are ready, do this:
Asking Portfolio Questions
https://www.bogleheads.org/forum/viewt ... =1&t=6212

j :happy
I owned The Bond Book by Annete Thau. It was the driest book I ever read. Could only get through the first 100 pages or so. I simply read Jack Bogle's books where he discussed bond funds.
+1
Yes.
It was as tough and dry as the worse cut of discount pork chops my mom cooked in 1958.

But, I got through it. Learned a lot.
Just like I got through those tough as shoe leather pork chops in 1958.

j :happy
:sharebeer
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

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abuss368
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Re: Municipal bonds

Post by abuss368 » Wed Jul 31, 2019 9:09 pm

bluquark wrote:
Wed Jul 31, 2019 8:12 pm
abuss368 wrote:
Wed Jul 31, 2019 7:48 pm
I owned The Bond Book by Annete Thau. It was the driest book I ever read. Could only get through the first 100 pages or so.
I am a nerd so I treated this comment as a recommendation and just bought the book :sharebeer
:beer
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

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dratkinson
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Re: Municipal bonds

Post by dratkinson » Thu Aug 01, 2019 1:07 am

It's good to read more than one book on the same topic. Why? Where recommended authors agree, I consider that to be the central road to Dublin (doublin'). Where they disagree, I consider that to be an alternate route and more risky. We must be able to tolerate more risk to go an alternate route.


Agree. Swedroe was much easier to read, so read him first. Follow up with Thau and look for similarities and differences in advice.
d.r.a., not dr.a. | I'm a novice investor, you are forewarned.

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