Profiting from Muni Bond Redemptions

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

You’re using a laddering strategy for investing in municipal bonds and it’s time to reinvest proceeds from your maturing bonds.

What now?

That’s the gist of a question posed by an investor who read our recent article (“Summer Forecast: A Muni Redemption Flood, Supply Drought”), where we discussed the deluge of bond redemptions expected this spring and summer and the opportunity for muni bond buyers to continue and perhaps enhance their flow of tax-free income.

How, this investor wondered, could he enhance his tax-free income when today’s yields are more modest than they were a decade ago?

Profiting From Muni Bond RedemptionsThat’s easy: Ditch the laddering strategy.

As many clients and friends know, we have never been proponents of laddering municipal bond portfolios (“Bond Laddering: An Idea Whose Time Still Hasn’t Come”). Though popular for years among stock brokers and financial planners, it’s never paid off for investors.

The longest maturity in a typical ladder is 10 years.

Bonds mature every two years, which means for more than two decades, the investor in question would have been forced to reinvest funds at lower yields in every instance.

When munis are redeemed, go long

Our clients buy longer-term bonds to maximize their tax-free income. For the most part, they are buy-and-hold investors, and purchase longer maturities, which significantly enhances their tax-free income.

Consider, for example, that according to Thomson Reuters’ “Municipal Market Monitor,” a 10-year, AA-rated bond yields approximately 2.01% in today’s market. A similarly rated 30-year muni will yield 2.89%.

On a $100,000 investment, the 30-year bond will produce $880.00 more tax-free income annually, which is 30% more than the 10-year security. This can be extremely significant when applied throughout an investor’s portfolio.

When munis are redeemed, focus on what’s important

Ladders are usually recommended by brokers who inordinately focus on maintaining level market values.

Our investors understand that the market value of a long-term bond will sometimes be less than they paid and sometimes more. Neither situation in itself should trigger a sale.

Certainly, redemptions are an issue in a market that is sensitive to supply and demand factors, but investors should never lose sight of their primary objective: keeping their interest clock ticking. And remember, the greatest value is invariably in longer-term bonds.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Jun 12, 2017

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.