The One Safe Way to Invest in Municipal Bonds Now

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The One Safe Way to Invest Now in Municipal BondsLate last year, outspoken banking analyst Meredith Whitney rattled the staid world of municipal bonds with a bold prediction on 60 Minutes that hundreds of billions of dollars in munis would soon default because of declining local tax revenues and expenses such as underfunded public pensions.
That prediction succeeded in scaring the small investor out of the muni market. According to market researcher TrimTabs, some $31.5 billion has been yanked from muni mutual funds since that fateful broadcast.
But Whitney's dire scenario hasn't come to pass: Are we out of the woods on the municipal bond front? And, if not, is it still possible to invest in that sector safely?

Pre-Refunded Munis: Your Payout Is Waiting
Marilyn Cohen, CEO of Envision Capital Management, a fixed-income management firm in Los Angeles, says it's still too early to invest anew in munis.
"I think we're going to have a second wave of selling," says Cohen, co-author of the new book, Surviving the Bear Bond Market. "I think the default rate in the next 12 months is going to be significantly higher than we've ever seen before, because the market has changed."
So what is a conservative investor to do, given that Treasuries are yielding almost nothing? Well, Cohen isn't spurning all munis. She recommends buying one select group that carry virtually no risk: pre-refunded munis, or escrowed to maturity bonds.
These bonds function exactly like regular munis, complete with the tax-free income. The only difference is that the money to pay off the principal and interest has been set aside in an escrow account.
There are several methods used to fund these escrow accounts, but Cohen recommends buying only pre-refunded munis that have U.S. Treasuries in the escrow. She says even though bonds issued by the government-run Fannie Mae and Freddie Mac mortgage issuers are sometimes used, investors should steer clear of those.
The only risk with these bonds is if the U.S. government goes bankrupt, and there's little risk of that, despite the budget battle in Washington.

Investing in the Real Necessities
Dick Bellmer, CEO of Deerfield Financial Advisors in Indianapolis, is also a fan of pre-refunded munis, noting that the more attractive ones are issued by budget-challenged states like California and Illinois. "People say 'I don't want one of those things,'" he says. But they still carry no risk, even when the issuing state's finances are a mess.
The only real drawback is that so many people have cottoned on to the fact that pre-refunded munis with U.S. Treasury escrow have essentially no risk that they are no longer such a great deal as they once were.
Consequently, Bellmer recommends essential revenue bonds as a possible alternative. These bonds are issued by states for such things as municipal water companies. "If they're going to cut off your water, you're probably going to pay your water bill," Bellmer says, "which means the risk as it relates to essential revenue bonds is probably not a lot of risk. You can still get a pretty decent yield off of those kind of bonds."
Bellmer cautions small investors to make sure the bonds they invest in are not illiquid, because few institutional investors can be bothered to get involved in $25,000 bonds. That means there may not be a big market for them, and they could prove hard to sell in a pinch. He prefers holding bonds to maturity, but not every small investor has that kind of flexibility.

Beware of the Price/Yield Dichotomy
Bellmer isn't a big believer in muni mutual funds: He prefers to hold individual muni bonds.
"I know exactly what I am going to get -- a stream of interest payments and the value of the bond back when it matures," he says. "With a longer-term bond fund, people are buying because it pays a higher interest rate."
But what they don't recognize is that when interest rates go up in the economy because of rising inflation, the entire value of the bond fund is going to go down since price and yield move in opposite directions.
Suddenly the higher-yielding fund doesn't look so good, Bellmer says. Then the only possibility of the fund rebounding is if interest rates go down again -- and that may be years in the future.

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socioeconomist1

tons of risk for very little return

April 11 2011 at 2:46 AM Report abuse rate up rate down Reply
socioeconomist1

municipal bonds are one of the worst investment choices.... first look at the corporation aka city... almost everyone is severely in debt.. Would you invest in a company that continuously loses money ?.... second, It is nothing for a state or federal government to let a municipal government take the fall and lose credit ratings to save their own ass... Ever since the Stimulus came out, Obama has been giving grants to cities and counties to keep their government operational and cops on the payroll... It would take $100 trillion to pay off all the bonds coming due... third.... 9-11 created two wars... later this year all those 10 year war bonds that financed Bush's administration will also start coming due... 9-11-01 means this Sept and on is time to start coughing up the money on 10 year mature bonds from the treasury... and in 2021, the 20 year notes will start to be due.. that's your debt tax payer.. where is the money coming from if the rest of the world stops using the dollar as the world's reserve currency ??

April 11 2011 at 2:44 AM Report abuse rate up rate down Reply
1 reply to socioeconomist1's comment
socioeconomist1

either the value of the dollar will significantly plummet as more gets printed up to pay these debts... or the government will default on it's debts like General Motors did to it's share holders.....

April 11 2011 at 2:45 AM Report abuse rate up rate down Reply
jim and judy

The stock market is a shell game and for the most part the only entities that make money are the financial firms and stock brokers. While there are exceptions the average joe does not have the time or knowledge to make a buck that lasts, unless he gets out completely at the right time. I read recently that those in the stock market have just now recovered from the losses sustained in 2007. WOW! We have been on an upward climb for about a year in the market. When it crashes, as it always does plan on waiting another 4 years to get back to zero.

April 09 2011 at 11:33 AM Report abuse rate up rate down Reply
fpecar4525

Meredith Whitney will go down in history as the greatest headline hysteria creator in years. The facts are exactly opposite of her hysterical prediction. According to Standard & Poor’s, municipal-bond defaults in the first two months of 2011 are down 50 percent from the same period last year. Eight bond deals totaling about $222 million have entered default this year, compared with 16 totaling more than $329 million during the same period of 2010. And so far this year, there has been only one bankruptcy filing. It was by Boise County, Idaho, which has no outstanding municipal bonds.

http://moneywatch.bnet.com/investing/blog/wise-investing/first-quarter-update-on-2011s-sure-things/2214/

April 09 2011 at 11:09 AM Report abuse rate up rate down Reply
Ange Purs

If an "investor" is so scared of the markets and their future that he/she feels a sound, safe investment is munis, then that person has my every sympathy. Find a cave, go hide, and bring a good matress and a truck load of beans to see you thru. Munis are not an investment that have value worth pursuing. Where's the comfort in an "investment" that pays nothing...an investment that will go down in value as inflation heats up? If you cant stand risk and dont understand the first thing about the markets, then just sit on your money. You have little to lose.

April 09 2011 at 5:07 AM Report abuse rate up rate down Reply
ronsjigslures123

if you have and exrta 10 grand or a 100 grand to spend the safest bet is in pure silver coins, even buying them at 44 bucks each right now when they hit 50 bucks and go beyond that to 85 buy Dec. 2011 look at all the profit you will get in return when you sell, and heres the best part you pay NO ONE no fees to sell your stuff. Silver whent up over 1 buck today in a single day. and has been going up 20 cents a day for many weeks. When you sell its a no braner no hours at the computer wasted trying to find stocks that pay anything and watch then loose % for weeks and months, you just buy the silver hord it in bank boxes AND SIT BACK and watch your investment grow, and it costs you nothing to sell it or hoed it, and a lot of big companys will BUY your silver back when you want to sell, and like i said when you sell your stuff YOU WILL GET BACK ALL THE CASH YOU PAID FOR THE SILVER PLUS YOUR PROFIT .. its a no brainer.

April 09 2011 at 1:49 AM Report abuse -1 rate up rate down Reply
ronsjigslures123

The stock market is like the banks that pay on savings, most pay .07 % or around there, most bonds if you buy in at 10,000 bucks the first year you get a lousy 100 bucks for tieing up your 10 grand for a year. 100 bucks buys nothing these days, they want you to buy 30 year stuff, heck if you have no one to will it over to it gets lost if you die, and the bank winns and the people handling the account wins for 30 years. Before you tie up your money make them tell you how much you will make after that 5-10 years and how much will the tax man take and how much THEY will take for handling the account, ill bet you will end up on the short end of the stick. For most its better to invest in a Credit union bank they pay higher interest rates than banks and keep it in savings.

April 09 2011 at 1:28 AM Report abuse +1 rate up rate down Reply
ronsjigslures123

The whole stock market is rigged, look at what happened to the banks they rigged the whole nation, and the CEO,s these days are getting tons of money, the small investor should not even try to invest in any of the markets, you will make nothing, look what happened to everyones 401ks, Let the Buffets, and Gates of the world HAVE the market, let them spend there money in the billions ... LET THEM PAY ALL these CEO,s and FLUSH these big companys with cash, when you invest in a company your buying stock so that company has cash to grow and operate with, companys are NOT putting on workers, producing products like before, and the CEO,s are getting richer,and most of all doging taxes like crazy, so whats wrong with is picture, Why should you give them your money and get charged fees to buy stocks for a return that is a small % and then i belive you pay taxes on that income, these brokers and companys are getting rich off the stock buyers .. its a suckers game, don,t be a sucker, they get the big % and you get the thrown a bone % for using your money.

April 09 2011 at 1:19 AM Report abuse -3 rate up rate down Reply
1 reply to ronsjigslures123's comment
Ange Purs

The market is rigged??? Have you ever had any investment in any market at any time?

April 09 2011 at 5:09 AM Report abuse +5 rate up rate down Reply
Sam Das

Most muni's are safe and loose talking people are not rating agencies...don't listen to other people's opinion and loose that which is good. Have faith in the best country in the world.

April 09 2011 at 1:12 AM Report abuse +2 rate up rate down Reply
2 replies to Sam Das's comment
ronsjigslures123

nothing is safe in the market today and will not be for a long time, nothing, millions of Americans thought that there 401ks would be safe, there pensions,there bank loans on homes well guess what they were not, most americans had stock in many companys only to see it hit the bottom, over the past 3 years, most people thought the American buck was safe its not, the USA is bankrupt,all the bonds are at the bottom, pays nothing. There is only one thing that is safe and has made a contuious raise in investment is that 999.9 silver Eagle coins people bought for 12 bucks each now is up to 42 bucks a coin and going to hit 50 bucks in next couple months, cold hard silver cash is the investment to make money.

April 09 2011 at 1:39 AM Report abuse rate up rate down Reply
Ange Purs

We have always heard we are the best. It's repeated to us on a daily basis. Yet we have a totally dysfunctional political system and a country where the infrastructure is crumbling and a country without a sound energy policy and a country with unsustainable national debt and a country with a massive military that cannot be used to police its own borders. This is the country wherein the investment bankers nearly brought down the entire economic system of the Western world. Yep, we are the best, and Im sure it will all get that much better going forward.

April 09 2011 at 5:21 AM Report abuse rate up rate down Reply
Sam Das

In order to be revenue neutral a flat tax has to be set at 20% but most Americans pay taxes way below that and many corporations do not pay any tax at all...so why do you think these people will agree to a flat tax. You are listening to Steve Forbes way too much.

April 09 2011 at 12:59 AM Report abuse +1 rate up rate down Reply
2 replies to Sam Das's comment
dsnrntrng

You are wrong. There are a lot of people that pay tax upwards toward 50% combined state and federal (those that live in states with high tax brackets). Even GE that didn't pay tax had huge rightoffs because the LOST so much money. Do some homework before you make blanket statements.

April 09 2011 at 1:39 AM Report abuse rate up rate down Reply
Ange Purs

Where did you get your "facts"? Thinking so doesnt make it so. The corporate tax rate is 35%, and some corps are dumb enough to pay it. Many corps on the other hand have moved their operations to foreign shores where the corp rates are less than half. Do you blame them? Is it any wonder that job creation here in the "best" country is sputtering? The tax code needs to be rewritten
from the ground up. A flat tax is the best way to cut special interests out and to keep the tax process simple and fair. Many economists have written positively about this since the 1960s.

April 09 2011 at 5:35 AM Report abuse +2 rate up rate down Reply