Muni Bonds

[mark-ER]

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I have been intrigued for some time... I am in a high-state tax environment (illinois). Previously I have used state-specific, short-intermediate term munis to great advantage in California... HOwever, there does not seem to be a state-specific Illinois Muni. Perhaps that should speak for itself but the contrarian in me says with all the bad news (Detroit bankrupsy, etc) already accounted for by the market why not pounce now and see if I can 'risk' on a broadly-balanced muni mutual fund or ETF with exposure to Illinois? Mostly for tax advantages and income... Anyone has any ticker suggestions (low cost too, or am I asking too much)??

 

[michaelrack]

I have been intrigued for some time... I am in a high-state tax environment (illinois). Previously I have used state-specific, short-intermediate term munis to great advantage in California... HOwever, there does not seem to be a state-specific Illinois Muni. Perhaps that should speak for itself but the contrarian in me says with all the bad news (Detroit bankrupsy, etc) already accounted for by the market why not pounce now and see if I can 'risk' on a broadly-balanced muni mutual fund or ETF with exposure to Illinois? Mostly for tax advantages and income... Anyone has any ticker suggestions (low cost too, or am I asking too much)??

This article does mention an Illinois state specific muni fund: http://www.mepbfinancial.com/2011/06/ten-top-performing-national-municipal.html.
(although it is from 2011). Your brokerage may be able to tell you about the current existence of Illinois muni bond funds

It looks like Morningstar may have some info, but it requires paid membership

 

[Neuronix]

Illinois muni bonds are unpopular because they are taxable like any bond for state residents. California muni bonds are exempt from most taxes for state residents due to different state laws. This is the main reason why you'll find state specific bond funds for some states and not others.

I have no state income taxes, so I've been buying a Vanguard muni fund. But all of those funds are doing terribly over the past year, so you're not missing much.

 

[krl7044]

I have been intrigued for some time... I am in a high-state tax environment (illinois). Previously I have used state-specific, short-intermediate term munis to great advantage in California... HOwever, there does not seem to be a state-specific Illinois Muni. Perhaps that should speak for itself but the contrarian in me says with all the bad news (Detroit bankrupsy, etc) already accounted for by the market why not pounce now and see if I can 'risk' on a broadly-balanced muni mutual fund or ETF with exposure to Illinois? Mostly for tax advantages and income... Anyone has any ticker suggestions (low cost too, or am I asking too much)??

Hi Mark,
I always use individual muni bonds, especially if you want to get a higher rate of return than muni funds at a lower cost (and of course, a much more predictable income). You can lose money with muni funds/ETFs, and they are always more expensive than buying individual muni bonds (because they are often overpriced). Illinois is a problem - the bond quality is quite low (but bonds are quite abundant). Depending on how much you plan to invest, I'd think about diversifying around the country. This is also another advantage of using individual bonds - you can diversify relatively easily. Also, it is much easier to get a better deal on specific individual bonds, especially when interest rates fluctuate (like they are doing now).

 

[deleted126335]

I would stay away from Illinois completely. The state will default on someone: Its retirees, Its employees, Its citizens or its bondholders or other creditors. Or some combination of the above.
Try Vanguard Bond funds-thousands of holdings, well diversified, high credit quality. If you really want safety and the highest credit quality muni bond fund try BMBIX.
Don't even consider individual bonds till you have spent some serious study on the bond market.

 

[krl7044]

I would stay away from Illinois completely. The state will default on someone: Its retirees, Its employees, Its citizens or its bondholders or other creditors. Or some combination of the above.
Try Vanguard Bond funds-thousands of holdings, well diversified, high credit quality. If you really want safety and the highest credit quality muni bond fund try BMBIX.
Don't even consider individual bonds till you have spent some serious study on the bond market.

It depends what your goals are. A bond fund is great for diversifying an after-tax portfolio. But if you want relative safety of principal and predictable income, bond funds aren't a good choice. A state can default. But it is much less likely to default than a city. If a state defaults on muni bonds, their bonds become junk, and because they can't print money (or raise taxes when taxes are already too high), it is extremely unlikely that a state defaults on its highest quality bonds (specifically, GO bonds), as that's the only way a state can finance itself. I do not believe there has ever been a state bankruptcy, but there is always a first time for everything.

Imagine the following scenario. Interest rates spike, and the bond fund (many of them intermediate/long maturities) loses 10%-15% of it's value. On the other hand, an individual bond will simply be redeemed at par at maturity and you won't lose anything.

So back to goals. If this is short-term money (vs. buy and hold investment money), I would stay away from bond funds. Worst case scenario, get CDs.

 

[michaelrack]

On the other hand, an individual bond will simply be redeemed at par at maturity and you won't lose anything.
.

On a nominal basis you aren't losing anything, but you are on a real basis

 

[deleted126335]

On a nominal basis you aren't losing anything, but you are on a real basis

Correct. Even if you plan on holding to maturity you should be marking to market the value of your holdings and realize you have lost money.

Other poblems with individual munis are small investors often get killed on trade execution, lack of diversification is another problem. I have been a serious student of investing for two decades and have spent the last 18 months considering taking my portfolio of Vanguard bond funds into individual munis. I am not even close to pulling the trigger. For now I am sticking with Vanguard and the one Baird fund that I mentioned.

 

[deleted126335]

It depends what your goals are. A bond fund is great for diversifying an after-tax portfolio. But if you want relative safety of principal and predictable income, bond funds aren't a good choice. A state can default. But it is much less likely to default than a city. If a state defaults on muni bonds, their bonds become junk, and because they can't print money (or raise taxes when taxes are already too high), it is extremely unlikely that a state defaults on its highest quality bonds (specifically, GO bonds), as that's the only way a state can finance itself. I do not believe there has ever been a state bankruptcy, but there is always a first time for everything.

Imagine the following scenario. Interest rates spike, and the bond fund (many of them intermediate/long maturities) loses 10%-15% of it's value. On the other hand, an individual bond will simply be redeemed at par at maturity and you won't lose anything.

So back to goals. If this is short-term money (vs. buy and hold investment money), I would stay away from bond funds. Worst case scenario, get CDs.

You are correct that a state has never defaulted, but not all GOs are the same. Note that Detroit is planning to default on its GO bonds. THe bondholders will be made whole by insurance and or the state of Michigan. But the insurance companies don't have enough reserves to cover every bond they insure and if defaults occur they won't be isolated. If I were to buy individual bonds I would limit them to AA or better, most of them AAA. Also that they get that rating naturally not through insurance. I would buy only with the idea of holding to maturity. That said if one is patient they can occasionally pick up small lots that individuals are looking to sell at a decent price. This is not for novices.

Illinoiss G.O. Bonds have been downgraded and are something like A. I would take AAA individual water or sewer bonds from a strong municipality over that any day.

 

[krl7044]

Correct. Even if you plan on holding to maturity you should be marking to market the value of your holdings and realize you have lost money.

Other poblems with individual munis are small investors often get killed on trade execution, lack of diversification is another problem. I have been a serious student of investing for two decades and have spent the last 18 months considering taking my portfolio of Vanguard bond funds into individual munis. I am not even close to pulling the trigger. For now I am sticking with Vanguard and the one Baird fund that I mentioned.

Marking to market is only of interest to you if you are going to sell the bonds. As long as you design your bond portfolio correctly (depending on your needs and the market conditions), you shouldn't have to worry about losing money.

There are ways to make sure you are getting a great deal. There are many online tools now (including emma) so you know whether you are getting a good deal or not. Actually, Vanguard has a great bond desk - they recently upgraded their capabilities, and I'm extremely happy with them and their prices.

 

[krl7044]

You are correct that a state has never defaulted, but not all GOs are the same. Note that Detroit is planning to default on its GO bonds. THe bondholders will be made whole by insurance and or the state of Michigan. But the insurance companies don't have enough reserves to cover every bond they insure and if defaults occur they won't be isolated. If I were to buy individual bonds I would limit them to AA or better, most of them AAA. Also that they get that rating naturally not through insurance. I would buy only with the idea of holding to maturity. That said if one is patient they can occasionally pick up small lots that individuals are looking to sell at a decent price. This is not for novices.

Illinoiss G.O. Bonds have been downgraded and are something like A. I would take AAA individual water or sewer bonds from a strong municipality over that any day.

Yes, indeed. I agree about bond quality. However, there are towns in my state whose bonds are rated AAA, yet I wouldn't touch them with a 10 foot pole ;-)

Nobody knows what can set the roller coaster off, though in many cases it would be a gradual decline due to all the debt, so I'd say it could take decades to unravel (so maybe you don't want to buy those 30-year bonds). In some cases though, the reckoning may come sooner. However, I'd still argue that most state GOs are nearly as safe as Treasuries, though I would definitely avoid some of them (if I have that choice).

And yes, Illinois bonds are rated much lower than similar GO bonds from other states. So it is a tradeoff. Looks like Illinois residents can pay as much as 10% in state/municipal taxes. Is it worth the extra risk to buy the bonds? Something to ponder. In any case, once you have high six figures to invest, it pays to diversify. Many bond funds hold lower rated debt because it pays higher interest. Most munis are loaded with CA, MA, NJ, IL, etc., so back to square one.

 

[krl7044]

dupe, the editor keeps hanging for some reason...

 

[mark-ER]

As another "income" producing alternative, and tax-advantaged at that I was considering MLPs. They have done amazingly well over the past 10years, so that would be band-wagon jumping. Bogle seems to like them.

Is it too late to jump on that gravy train?
Does it make sense to invest in a single MLP (say LINN) after doing your homework, several LMPs or a mutual fund/ETF that tracks a basket of MLPs? (I am sure the short answer is it depends)
Does anyone have any info, or better yet a link to an article to see how MLPs track with S&P, REITS, commoditiies in general... ie does anyone think they are a solid part of a portfolio to maximize returns while limiting beta?
Do they ever make sense in a tax-advantaged portfolio (aka ROTH ira or even a non-roth 401K)?
What about a stock-equivalent of a MLP (say LINCO) to avoid the paperwork? And do the stock equivalents make sense in a tax-advantaged account?

Discuss...

 

[krl7044]

As another "income" producing alternative, and tax-advantaged at that I was considering MLPs. They have done amazingly well over the past 10years, so that would be band-wagon jumping. Bogle seems to like them.

Is it too late to jump on that gravy train?
Does it make sense to invest in a single MLP (say LINN) after doing your homework, several LMPs or a mutual fund/ETF that tracks a basket of MLPs? (I am sure the short answer is it depends)
Does anyone have any info, or better yet a link to an article to see how MLPs track with S&P, REITS, commoditiies in general... ie does anyone think they are a solid part of a portfolio to maximize returns while limiting beta?
Do they ever make sense in a tax-advantaged portfolio (aka ROTH ira or even a non-roth 401K)?
What about a stock-equivalent of a MLP (say LINCO) to avoid the paperwork? And do the stock equivalents make sense in a tax-advantaged account?

Discuss...

The question is, what are your goals? Do you need income? Safety of principal? MLPs are extremely risky (even 100 of them combined in an ETF). For the ETF, the income is taxable (the tax issue is very complex) so a 4% muni (if you are in a 40% bracket) is equivalent to a pre-tax yield of 6.7% (AMLP yields 6% right now). Actual side by side comparison is difficult (because of how MLPs are taxed on a personal and corporate level - AMLP pays taxes on the corporate level, while you'll get a 1099), but a 40% effective tax rate is a good assumption (individual MLPs might have a lower tax bill). Once you start picking individual MLPs, you are on your own (not to mention that your taxes can get quite complex as you'll have to do a K1). Also, individual MLPs might have liquidity problems, and your principal is not guaranteed. There is also the interest rate sensitivity. You can design muni portfolios to take advantage of that. MLPs - not so much (and they can tank just as REITS when interest rates rise). So on a risk-adjusted basis, I would not pick MLP ETFs over munis. And income-wise, munis are just fine.

As far as pre-tax, yes, you can have MLPs in an IRA, but again, what would be the point? Its just another non-diversified speculative investment, like a single stock or a sector fund. Any investment has to play a role in your overall investment plan. What is your overall portfolio goal? Most diversified portfolios are exposed to oil/gas/natural resources. If an MLP is 5% of your portfolio, it won't do very much for you. If it is 50% - it is too risky. I'd stick to basic asset classes for IRAs, and munis for after-tax accounts, now that the spreads between munis and treasuries are pretty high (probably because of QE). To me, the point of investing is to beat inflation with as little risk as possible without having to spend too much time worrying and looking for the next hot investment.

 

[ferning]

Do you find it funny that your high state and city income taxes (detroit), that your are tryig to avoid, are heavily related to these institutions debt making ability (bonds)?

Its the tax they cant charge today so they charge you and your kids next year. But you buy in, encouraging this for a measily return thats nontaxed while your actual taxes increas.

 

[michaelrack]

As another "income" producing alternative, and tax-advantaged at that I was considering MLPs. think they are a solid part of a portfolio to maximize returns while limiting beta?
Do they ever make sense in a tax-advantaged portfolio (aka ROTH ira or even a non-roth 401K)?
QUOTE]

Maybe, but it is very complex to do this and your retirement account will have to pay some taxes:


http://www.naptp.org/PTP101/MLPs_Retirement_Accounts.htm

 

[krl7044]

Do you find it funny that your high state and city income taxes (detroit), that your are tryig to avoid, are heavily related to these institutions debt making ability (bonds)?

Its the tax they cant charge today so they charge you and your kids next year. But you buy in, encouraging this for a measily return thats nontaxed while your actual taxes increas.

Great point, hard to argue with this. However, you don't have to buy Detroit bonds. One can buy state bonds (Michigan) or better yet, if you like another state, you can buy Texas or Alaska bonds if you like. You still get a federal tax deduction even if you will pay state taxes. If you have any money in the bank you are buying Treasuries, and the government is hiking taxes left and right, so I can make the same argument about investing in treasuries. Better yet, states don't get to print money, so they actually have to alter their finances to manage their future liability (even if it comes down to a bankruptcy). I think the bottom line is to make sure that what you buy is relatively safe, so if you only buy high quality bonds you'll probably avoid the bonds from the states which are mismanaged.