Muni Bonds Sport Attractive Yields for Retirees
For older investors, municipal bonds can offer diversification as well as tax-free income.
Municipal bonds started 2018 with a whimper. Will they go out with a bang?
The Bloomberg Barclays Municipal Bond index fell sharply at the start of the year, as investors fretted that new lower tax rates would diminish demand for tax-exempt bond income and that rising interest rates would push down muni bond prices.
But the muni market proved more resilient than many investors imagined. “You have the economy humming along, which means tax revenues are strong” for municipalities, says Terri Spath, chief investment officer at Sierra Investment Management. And investor appetite for muni bonds remains robust, she says. “People don’t like to pay taxes, regardless of the tax code.”
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
For older investors, muni bonds can also offer diversification. Because of the unique factors driving their performance—such as shifts in a municipality’s tax base—they tend to have low correlation with other fixed-income investments.
Tax reform has been a mixed bag for muni bonds. On the down side, the sharp reduction in the corporate tax rate has diminished corporate buyers’ interest in munis. But other tax law changes paint a brighter picture for the muni market. For many higher-income individuals, the slight reduction in income tax rates is outweighed by the $10,000 limit on state and local tax deductions. That gives tax-sensitive investors in high-tax states such as New York and California extra incentive to seek out the tax-free income of muni bonds.
A few other factors are working in muni bonds’ favor right now. After a huge spike in issuance in late 2017, the supply of muni bonds has been more constrained this year, helping to support prices. And municipal defaults, which have been historically rare, have lately dropped to their lowest level since 2008, according to investment-management firm Nuveen.
Longer-term munis look particularly attractive now, money managers say. For an investor in the 37% tax bracket, a taxable bond would have to yield 4.32% to equal the 2.72% tax-free yield of 10-year munis. The 10-year U.S. Treasury yields just 3.2%.
Longer-Term Munis Ripe for Picking
While attention has been focused on the flattening Treasury yield curve—meaning longer-term Treasuries offer meager additional yield compared with short-term Treasuries—the muni yield curve remains relatively steep. As of early October, investors can pick up nearly 0.7 percentage point of additional yield in 10-year versus two-year munis, compared with 0.35 percentage point in 10-year versus two-year Treasuries.
Although longer-term munis are vulnerable to rising interest rates (as rates rise, bond prices fall), investors can trim the risk by pairing these holdings with short-term taxable bonds. Short-term Treasuries look particularly attractive right now. (See “U.S. Treasuries: Higher Yields Without the Risk”.)
Vanguard Long-Term Tax-Exempt (VWLTX) is one long-term muni fund favored by investment-research firm Morningstar. The fund avoids loading up on riskier sectors, such as tobacco and Puerto Rico bonds, and charges low fees of just 0.19% annually.
Some managers are also finding bargains among muni closed-end funds, which tend to focus on longer-term holdings. Closed-end funds have a fixed number of shares that trade on an exchange, and their share prices can diverge from the value of their underlying holdings. The funds have been beaten up lately because of fears of rising rates, says Jim Robinson, manager of Robinson Tax Advantaged Income, a mutual fund that invests in muni closed-end funds.
That has left many muni closed-end funds trading at wide discounts. At the end of September, the average muni closed-end fund traded at an 8.7% discount to the value of its underlying holdings, Robinson says, whereas the long-term average discount is about 3.3%.
Robinson likes BlackRock MuniYield Quality III (MYI), which holds higher-quality bonds and trades at a 13.7% discount, compared with a three-year average discount of 3.7%.
-
Use An iPhone? You May Be Hearing From A Class-Action Lawsuit Group
A handful of suits against the iPhone maker seek to crack down on everything from app store purchases to messaging.
By Keerthi Vedantam Published
-
Capital One/Discover: What's In Their Wallet For You?
Push back on Capital One's planned merger with Discover is growing with one group of consumer advocates calling for a public hearing.
By Keerthi Vedantam Published
-
403(b) Contribution Limits for 2024
retirement plans Teachers and nonprofit workers can contribute more to a 403(b) retirement plan in 2024 than they could in 2023.
By Jackie Stewart Published
-
SEP IRA Contribution Limits for 2024
SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $69,000 a year.
By Jackie Stewart Published
-
Roth IRA Contribution Limits for 2024
Roth IRAs Roth IRA contribution limits have gone up for 2024. Here's what you need to know.
By Jackie Stewart Published
-
SIMPLE IRA Contribution Limits for 2024
simple IRA The maximum amount workers at small businesses can contribute to a SIMPLE IRA increased by $500 for 2024.
By Jackie Stewart Published
-
457 Contribution Limits for 2024
retirement plans State and local government workers can contribute more to their 457 plans in 2024 than in 2023.
By Jackie Stewart Published
-
Roth 401(k) Contribution Limits for 2024
retirement plans The Roth 401(k) contribution limit for 2024 is increasing, and workers who are 50 and older can save even more.
By Jackie Stewart Published
-
Is a Medicare Advantage Plan Right for You?
Medicare Advantage plans can provide additional benefits beneficiaries can't get through original Medicare for no or a low monthly premium. But there are downsides to this insurance too.
By Jackie Stewart Published
-
What You Must Know About the Different Parts of Medicare
Medicare Medicare can be complicated but we've got you covered. Here is a quick guide to the different benefits provided through each part.
By Jackie Stewart Last updated