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What to do with tobacco bonds
Q
Unfortunately, I own $95,000 (face value) of various tobacco bonds maturing between 2035 and 2046. I recently sold one for a profit – the only one I own that is on the plus side (15% bracket, no capital gains tax in 2011). Are tobacco bonds likely to fail? Tobacco bonds in Ohio and Virginia are already accessing reserve funds with 30 years to go. If I sold all of them today, I would lose about $20,000. If I held them for “x” number of years, I would reduce that by about $2,000 per year, providing the price doesn’t drop if smoking continues to subside. These were not speculative bets, they were investment grade.
A
James A. Klotz responds:
As indicated in your question, you are aware that some of the market values of your tobacco holdings have suffered in relationship to your original cost.
It is impossible to predict the eventual success or failure of these securities. Obviously, the domestic tobacco landscape has dramatically changed since their issuance.
After the tobacco companies signed the Master Settlement Agreement (MSA) with the states, smoking has been banned in many public areas, cigarette taxes have grown exponentially and the tobacco companies are currently contesting the states’ enforcement of the MSA, which requires them to police the sales of non-participating manufacturers.
Back in October 2009, we sent a letter to our clients that is also pertinent today. In the letter, we noted the strong performance of municipal bonds and the dramatic price appreciation of middle grade credit quality bonds, such as the various state tobacco securities, in particular. “Although you purchased these bonds for the high rate of tax-free income, if you feel you are overweighted in these securities, you may want to consider using their dramatic price increase as an opportunity to move into higher quality bonds. Since the future economic landscape is still uncertain, we recommend reviewing your portfolio to ensure you are satisfied with the degree of diversification it affords.”
Nothing has transpired to date that would change our opinion on this subject.
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