Help Buying Individual Municipal Bonds

[greenalfalfa]

A few questions concerning how you buy your municipal bonds:

1) What is considered a 'fair' markup on Municipal Bonds by a broker?
It seems that if you buy-and-hold an individual bond for 10-years, that a 1.5-2% markup (which would correspond to a 0.15-0.2% annual fee) is a reasonable charge for the broker helping to manage a muni bond ladder specified to my risk tolerance & cash flow needs in retirement. I can research recent transactions on http://emma.msrb.org/ to ensure a 'fair' markup (not the 4-7% which is occasionally seen).

2) From what I've read (Swedroe's book), I would save on the markup charge & get a much better deal (relative to risk) buying during the 'Retail Offer Period.' Where can I find currently available new issue bonds? I've looked on Fidelity.com & see only 34 new muni's being offered by 3/1/2016. None of them are NJ bonds. How often are NJ muni bonds issued? Is there a place that compiles recent issues? Future issues? So that I can shop for them? Or does this technology only exist for brokers?

3) Clearly I would get a better deal by organizing my own municipal bond ladder. I would need to understand exactly the term/credit risk I was willing to take & diversify my holdings. Any practical suggestions for screening individual bonds? How do you like to create your ladder?

Thanks for your help!

[patrick013]

If the new issues on Fidelity aren't satisfactory try Merrill Lynch or
JPMorgan for new issues. Sometimes Schwab or TradeKing have more
muni's in inventory. Just put in AAA/AA and NJ. Current prices are
reflected in the yield table on the website there.

[dratkinson]

Simplicity and diversification.

A small cost savings is one thing. But did you also notice in Swedroe's bond book, that individual muni bonds come with more risks than a muni fund? To me, any small cost savings was not worth taking on the additional risk and personal-management requirement of an individual bond portfolio. (Disclosure. Sold all my savings bonds last year to get rid of individual bonds.)

In this case, I use the motto: "Don't be greedy, leave 10% for the other guy." So the other guy may get a small cost savings on individual munis, but I get the lower risk, better diversification, and self-management ease of a muni fund. I believe it to be a more-than-fair trade.

Options: http://www.investopedia.com/articles/in ... -funds.asp

Option: To save money, Vanguard has an Admiral share class of its NJ muni fund (VNJUX). Don't believe you could buy better diversification at a lower total cost.



Research "death spiral states" before investing in any single-state munis.

[patrick013]

Option: To save money, Vanguard has an Admiral share class of its NJ muni fund (VNJUX). Don't believe you could buy better diversification at a lower total cost.

The only thing wrong with that fund is it is carrying a 24% premium.
You could buy new issues at Fidelity at par or very close and avoid
that call risk today. Alot of high coupon bonds in that NJ muni fund
it looks like. Most bonds I try to buy at a discount.

[greenalfalfa]

The only thing wrong with that fund is it is carrying a 24% premium.
You could buy new issues at Fidelity at par or very close and avoid
that call risk today. Alot of high coupon bonds in that NJ muni fund
it looks like. Most bonds I try to buy at a discount.

What's wrong with premium? Higher interest should offset. Total yield should be similar. Less interest rate risk with higher coupon bonds...

[patrick013]

The only thing wrong with that fund is it is carrying a 24% premium.
You could buy new issues at Fidelity at par or very close and avoid
that call risk today. Alot of high coupon bonds in that NJ muni fund
it looks like. Most bonds I try to buy at a discount.

What's wrong with premium? Higher interest should offset. Total yield should be similar. Less interest rate risk with higher coupon bonds...

If not callable - no problem. More than a few muni's are callable. Just
something to be aware of, that call risk.

[Artsdoctor]

Individual investors run the risk of paying too much for the individual muni on the secondary market. That's not to say it always happens and if you do your homework, you can get something in the 0.5%-1.0% range above the recent sales price--but you can pay much more if you're not careful.

You'll have no control over which brokerage house handles the auction for the initial offering, although the WSJ tells you on Mondays what's happening for the coming week. You can always call your own brokerage house (Vanguard doesn't handle inital offerings).

Don't assume that the auction price will necessarily be better than what you can get on the secondary market. There's a lot of pent up demand so you can actually get a better deal on the secondary market if you know where to look.

Even at auction, I would always opt for the premium bond. You can amortize the premium easily and your income is tax-exempt. If you buy a bond at discount, you'll ultimately pay capital gains on maturity unless the amount is de minimus. We're purchasing munis for the tax-exempt status and it makes very little sense to make a taxable event out of the transaction. If you have to sell the bond prior to maturity, it's usually easier to unload a bond with the higher coupon.

Before you do anything, read Annette Thau's "The Bond Book." Don't even think about buying individual munis unless you've done your homework.

[patrick013]

If you buy a bond at discount, you'll ultimately pay capital gains on maturity unless the amount is de minimus. We're purchasing munis for the tax-exempt status and it makes very little sense to make a taxable event out of the transaction. If you have to sell the bond prior to maturity, it's usually easier to unload a bond with the higher coupon.

3 methods for the discount will avoid capital gains:
1)The default is to recognize market discount at the time of sale,
redemption, or maturity.
2)Market discount is calculated using the constant yield method
over the remaining term of the bond.
3)Accrue market discount based on a ratable (straight-line) method.

Also, if the bond is ever called the call at par results in a small gain,
not a loss.

Lastly, some bond holders roll down the yield curve. When bonds are
bought at a premium to their face value, their price may not rise as a
result of moving towards maturity.

So, there's good and bad about both, but I still would hesitate to buy at
a premium a callable muni. Otherwise, depending on YTM of course.

[dratkinson]

Later recalled Swedroe has posted a list of his muni bond requirements for when he buys them for his clients. Can search for his list to get a head start on the due diligence required to manage your own individual bonds.

Just because it's not my preference doesn't mean you shouldn't do it. Best of success.

[Artsdoctor]

Patrick,

I have to admit that my personal experience with individual munis purchased on the secondary market at a discount is limited. When I've done that, the discount has always been so small that it's fallen within the de minimus rules. I've been put off by the potential tax implications associated with their purchase as noted here:

http://www.investopedia.com/articles/06/munibond.asp

To me, premium bonds are preferable for the reasons stated above. But I'm relatively strict about considering yield to call on callable bonds (I never purchased callable bonds that are more than 1-2 years away from the maturity and I always figure the YTC [or YTW]--not the YTM on callable bonds).

[frequentT]

All of your requirements can be done via the Fidelity website. There are adequate new issue bonds to build your portfolio over time. With new issue bonds on the Fido site, you get the same pricing as institutions. Their bond portfolio analysis tool is excellent and will allow you to slice and dice your portfolio to look at it in a way that works for you. Graphic or tabular. They will also message you with regulatory filings and status changes. Fidelity does keep a 4/5wk advance calendar of upcoming muni issues so you can plan your buys.

The secondary market has very little transparency, so be very careful, and use a limit order and learn to live with rejection/no execution. Fidelity has a broad third-party net work of bond brokers. They can be lazy and in-attentive, ie. if they are at lunch, you will get your cancellation (non-acceptance) or executed confirmation when they return. Stick to the price you believe to be fair value.

Take your time building your ladder. Most people on the board here are big believers in bond funds. I don't use them at all except for short term holdings, then I always put a stop loss underneath the bond etf. New issue munis are easy to buy, select your principle value, maturity, then place your order. HOWEVER, you must know the credit quality of the issuer. Not easy, but doable. As an NJ resident, you likely have awareness of which issuers are credit worthy based on geographic location, use of the borrowed funds, and revenue sources.

With new issues, the issuer pays the distribution costs and commissions. Don't be afraid of the secondary market. Just be cautious and do your homework/research. Since you post of this site, you are definitely capable of getting a fair price.

Good luck.

frequentT

[stlutz]

If you buy a bond at discount, you'll ultimately pay capital gains on maturity unless the amount is de minimus.

Market discount income is treated as taxable interest income at maturity or when you sell the bond. That is the problem with buying munis at a discount--you do create taxable interest income for yourself.

The only thing wrong with that fund is it is carrying a 24% premium. You could buy new issues at Fidelity at par or very close and avoid that call risk today.

Call risk is not necessarily a bad thing with muni bonds. Here is an example I looked at about a year ago where it didn't seem particularly bad:

viewtopic.php?t=157242

OP: I know you didn't ask about funds, but one thing to consider before buying a bunch of individual munis is the chances of your tax bracket changing before they mature. That is why I use munis funds and won't really consider individual issues for my own portfolio--there is a very reasonable chance that I won't still be in my same tax bracket 10 years from now. If that was to happen, with a fund I can unload my entire muni portfolio all at once; with individual issues I can't.

Finally, I wouldn't load up on NJ issues. As I'm sure you know, NJ does have significant issues with pension funding which makes these bonds higher risk than those of many other states.

[patrick013]

Hi,

I don't want to pretend to be a tax expert because I certainly am
not. But I've done a few tax returns in my time. New rules allow
the amortization of premium and discount so the plus/minus of that
is thru the life of when you hold the bond and adjusts the cost
basis of a sold/called/put/prerefunded bond to compute taxable
capital gain. So the discount is amortized and is usually 1% or less.
Zero if held to maturity.

I guess I'd rather pay some taxes on a discount muni bond than get stuck
with a 5% or higher tax loss carry forward if a premium bond was called,
or receive back less than original purchase price if I hold till maturity.
And call risk or reinvestment risk is avoided and cash flow is predictable.
I usually let HR Block do this stuff anyway. Here's a couple of pics anyway.

[Artsdoctor]

^ I think that the arguments centered around discount versus premium bonds are as old as the hills. Unfortunately, the tax laws have changed a few times which makes the arguments even more challenging. I believe stlutz is correct in his comment above.

If you're going to buy a premium bond with a call date, you always look at the Yield-to-Call in order to decide if you want the bond. If I buy a bond that matures in 2020 and the call date is 2019, I'll amortize to 2019. There are no surprises there.

I find it difficult to know what to do with bonds with call dates far away from the maturity date. I buy bonds at this stage in my life to spend when they mature (or are called), not to reinvest. Having one year difference isn't a big deal, but if I buy a bond with a maturity date of 2030 and a first call date of 2018, I don't know how to put that bond into my overall spending scheme.

[patrick013]

^ I think that the arguments centered around discount versus premium bonds are as old as the hills. Unfortunately, the tax laws have changed a few times which makes the arguments even more challenging. I believe stlutz is correct in his comment above.

I think so too. I just downloaded some de minimis info, apparently the
laws haven't changed so much, just the broker's options for info. Tax
exempt is certainly a tax exercise somewhat. I looked at one bond
inventory and they had quite a few muni's actually trading at 100, how
much easier that could be.