After decades in the municipal bond market, we’re still astonished at the lengths some investors will go to overcomplicate what are essentially simple securities.
The fundamental analysis they apply to other investments – risk, return and objectives, for example – is too often abandoned when they examine municipals.
It’s a remarkable phenomenon when you consider tax-free bonds have a track record of more than 200 years.
Perspective borne of inexperience
We were reminded of this distorted perspective recently when we came across an online article by someone blogging financial information to his professional colleagues. The writer discussed how, as he learned more about municipal bonds, he changed his mind from his earlier posts.
Initially, he regarded municipal bonds as unnecessary. Bonds belong in tax-advantaged accounts, so why bother with munis? he thought.
As his views evolved, he concluded bonds did make sense in taxable accounts and began weighing Treasuries vs. municipals. Zeroing in on munis, he then continued his journey along the learning curve looking at the effects of interest rate changes and the chances of defaults.
Educate then execute
Our firm was founded on the belief that well-educated investors are our best customers, so we commend the writer for learning more about bonds and adapting his outlook accordingly.
On the other hand, we shudder to think of the plight of those who followed his earlier, years-long thinking on the matter.
Buy-and-hold, not buy-and-sell
Most investors hold their municipal bonds in taxable accounts for the same reason they own them: They’re exempt from federal, state and local taxes. Placing them in non-retirement accounts maximizes their value. That’s basic to munis.
As for the author’s concern about interest rates, he revealed a profound misunderstanding of municipal bonds.
The market value of bonds does indeed fluctuate. But the primary benefit for owners of individual bonds is their ability to generate a steady stream of tax-free income. Successful investors generally don’t trade their bonds. They buy and hold them until they’re called or mature, at which time their principal is returned. Market values in the interim are virtually meaningless.
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With individual issues, coupons are fixed and maturity dates are stated. Investors can tailor the munis they own to suit their investment objective, a topic we explored recently (“Muni Investors Drawn to Individual Bonds”).
A history of performance
The author further delved into the risk of default, where he cited a study from 1937, a 60-year-old doctoral dissertation and other material. While we applaud his diligence, a more straightforward way to understand risk – which he also referred to – could have saved him from a considerable slog.
Simply: The default rate of municipals from 1970 to 2022 was a miniscule 0.08%, which was also the average five-year municipal default rate since 2013, according to Moody’s. For context, the default rate for global corporate bonds was 7.8% since 2013 and 6.9% since 1970.
Unique but not uncomplicated
The points that tripped up this blogger aren’t unusual. We hear it regularly from new clients who bemoan the inability of their stock broker to provide insight into their bonds.
Stocks and bonds are different, and municipal bonds are different still. Not complicated, but even sophisticated muni investors profit from help in understanding their nuances.
Yes, in the $4 trillion municipal market where demand is robust, it’s odd that proficiency can be hard to come by. But investors need and are entitled to credible information and it’s best to avoid advisers still trying to navigate the learning curve.
