Jeff Tjornehoj on "Business for Breakfast" 1060 KRCN Tuesday, November 7, 2006 - Boring Old Munis
Q: Good morning, Jeff. We usually talk about stock funds, but you'd like to turn the conversation to muni bond funds. Anything new we should pass along? A: Nothing especially new--just great returns! Nothing like the S&P 500 Index, of course, which is up 11% this year. Investment-grade bonds don't generally appreciate that much, unless the stock market really falls apart or interest rates are at extremely high levels. That said, this past year the average municipal debt fund is up 4.9%.
Q: But you could find a one-year CD that pays 4.5%. Why bother with munis?
A: Assuming that CD is in a taxable account--meaning not inside an IRA, for instance--the interest earned is taxed. And if you're in one of the higher tax brackets, that 4.5% is worth 2.9% after Uncle Sam gets his share. Put another way, you'd have to find an investment paying 7.5% to get the tax-equivalent return the average muni fund provides.
Q: True--that's 50% better. What are some of the mistakes people make with muni funds?
A: One word: expenses. Muni funds are usually sold--not bought--meaning people often don't seek munis out themselves; their brokers do. But if you're thinking of researching or buying a muni bond fund, paying higher expenses very rarely pays off in terms of better performance.
Q: Muni funds are also done on a state-by-state basis. So, if you live in Colorado or Florida, is it always the case you'll need a Colorado or Florida muni fund?
A: That's a great question and one not often explored properly. There are a number of states, for instance, that don't have enough muni debt or investor interest to sustain a dedicated fund--think Wyoming or South Dakota. There are several national munis that cater to those investors and that work well for investors in larger states, too.
Q: Some people warn that munis can have a nasty alternative-minimum-tax (AMT) surprise. Is that true of muni funds as well?
A: Yes. As an investor the first thing I'd research is the best muni fund for my situation. Then I'd call the customer service rep at the mutual fund company and ask if they invest in AMT bonds (it's also found in the prospectus). If it's a very small portion I may not worry about it. If I'm more concerned--and only your tax professional can tell you if you should be--then another option is AMT-free muni funds. The yield may be slightly lower, but the April 15 headache will be smaller.
Q: Something to think about even now. Thanks, Jeff.
A: Always a pleasure; thank you.
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