Individual investors increased their holdings of municipal bonds last year, continuing a decade-long growth trend, according to the Federal Reserve.
Last year, households owned $860.6 billion of muni bonds, a 5.3% increase over 2005. Households have held more tax-exempt debt than any other sector since 1997.
The second largest holder of municipal assets in 2006 was mutual funds, which increased their portfolios by 10% over the previous year, to $343 billion.
It is interesting to note that these increases occurred in a period of declining interest rates. During 2006, the Bond Buyer Index, which reflects the yields on long-term revenue bonds, slipped from 5.09% to 4.56%, or 53 basis points. The growth of holdings underscores the appeal of munis among individual investors for their dependable stream of after-tax income.
Behind the numbers
The data also indicates how investors prefer to obtain their tax-free income. Though mutual funds hold a significant amount of muni debt, their portion represents less than half the amount held directly by individuals, who avoid management and other charges imposed by the funds.
We are pleased that individual ownership of muni debt has increased by more than 70% since 1997, when it totaled $497.6 billion, and has remained the largest holder category of tax-exempt debt ever since.
This falls right in line with our thinking.
We encourage investors to buy individual bonds whenever possible, and employ a buy and hold strategy. Mutual funds can subject their shareholders to substantial sales charges and unnecessary ongoing management fees.
Investor demand for municipals is expected to remain strong or accelerate in the coming years, as more Baby Boomers restructure their portfolios to produce a reliable source of retirement income.
We continue to recommend investors purchase individual bonds and, in effect, create their own bond funds. With some assistance from a municipal bond specialist, you can provide yourself with safety, marketability and a steady stream of call-protected, tax-free income.