In the midst of current stock market volatility and continuing low yields on investment grade corporate bonds, the returns on municipal bonds, while not outstanding, have caused sales of these securities to hold steady.
Municipal bonds may not be exciting, but most have delivered a predictable return for some time, which makes them attractive compared to the unpredictability of the stock and corporate bond markets. Interest paid on municipal bonds is free from federal income tax and may be tax free from state income depending on individual state rules.
In my opinion, there are several reasons why the trend favoring municipals may be overblown:
As stated above, the tax-free nature of municipal bond interest is something that only pencils out of a 35 percent+ tax bracket taxpayer; if you are not in that bracket, then you may do better to buy taxable bonds and pay the tax.
As our country’s demographics shift from more people working and few retired or not working to one in which more people are retired or not working than those who work – a state that we are closing in on rapidly – government at all levels is going to encounter greater difficulty in generating the tax or other revenues needed to pay their expenses, including bond principal and interest. Just look at the ration of credit downgrades versus upgrades by rating agencies such as Moody’s or Standard & Poor’s to get a sense of the direction of municipal finances.
While it is widely known that state and local governments have varying degrees of unfunded pension liabilities, the true magnitude of this crisis has yet to be reflected in most municipal financial statements. I saw a recent study that estimated that unfunded obligation at $3.4 trillion and climbing. Needless to say, if state and local governments have to raise billions to meet their pension funding requirements, their ability to provide services to citizens and pay their debt obligations may suffer.
These trends will not cause municipal bond issuers to all crash and burn at the same time; these are circumstances that will erode their debt capacity over a period of time. It has already begun, however, as we witnessed in Detroit, Birmingham and Harrisburg just to name a few. If you are thinking about adding municipal bonds to your portfolio, consider how to do so in a way that mitigates some of the risk. Owning a slice of a pool of bonds can reduce the impact of a default, and owning bonds which all mature in a couple of years can mitigate interest-rate risk. Knowing and understanding your options is key.
Frederic “Ric” Schilling is a Florida native, born in Jacksonville, Fl. Ric is President of Senior Guardians of America, a local North Florida firm specializing in tax reduction, long term illness planning, asset protection, probate avoidance and life income planning. Ric is a National Speaker and Advocate on Senior Issues and has been featured by the Florida Times Union and WJXT, TV-4 in Jacksonville as an authority on Estate Planning and Retirement Issues. Senior Guardians has an A+ rating with the Better Business Bureau and is a member in excellent standing with the National Ethics Association. Contact Frederic: 904-371-3302 or 888-891-3381 Please visit: www.seniorguardian.comThis article is not intended to give tax or legal advice. Securities offered through Center Street Securities, Inc. (CSS), a registered Broker-Dealer and Member of FINRA & SIPC. Senior Guardians is independent of CSS.