We frequently discuss the media’s many misperceptions about municipal bonds. Whether on high profile, national financial television shows or in local newspaper columns, many in the media seek to unravel what they consider the mystery behind muni bonds.
However, the real mystery isn’t in the investments themselves, but in the analyses by these so-called experts. While it would be fruitless to address every false assertion, it is worthwhile to point out some glaring errors lest they ultimately become accepted wisdom.
In a recent example, brought to our attention by astute investor S.D., from Connecticut, the magazine “NARFE” (National Active and Retired Federal Employees Association) published an article that took aim at munis as a poor choice for investors receiving Social Security benefits. Mixing the two, he said, is like trying to combine oil and water. However, a further analysis reveals that it may be the chef – not the ingredients – that is spoiling the mix.
Incredibly, the author advises “reducing or eliminating tax-free bonds from your investment portfolio if you are collecting Social Security”. The problem with mixing munis and Social Security benefits, the author says, is the “provisional income” gained through muni bonds. Investors would be better off, he says, considering CDs, U.S. Treasuries or corporate bonds.
We are surprised the author is unaware that interest earned from these instruments is also considered “provisional income”. All taxable interest must be included in your adjusted gross income. Curiously, the author mentioned that provisional income includes adjusted gross income, so why would CDs, U.S. Treasuries, or corporate bonds be preferable to municipal bonds? Since these are taxable investments they will likely pay a higher rate of interest than municipals and when added to the adjusted gross will actually produce more provisional income than tax-free bonds. Clearly, this is not the objective.
In a further effort to make his case, the author asserts that interest earned from munis could also be subject to the Alternative Minimum Tax.
Indeed it could, yet there are literally thousands of municipal bond issues that are not subject to the AMT. The author also neglects to mention that if the investor is an AMT taxpayer, his/her income from taxable investments will also be subject to the AMT, which makes AMT irrelevant in this discussion.
Demonstrating a tremendous command of the obvious, the author declares that muni bonds are not FDIC insured. Right again, but that’s like saying the commissioner of baseball doesn’t govern the NFL. The FDIC doesn’t insure munis. Bond insurers do, and as most investors know, there are many insurers, such as MBIA, AMBAC, and FGIC to name just a few.
Finally, the author says that municipal bonds are subject to price fluctuations.
Right again – but what investment is free from risk? If you have ever tried redeeming an insured bank CD before maturity, you know about the punitive fees and penalties. Treasuries and corporate bond prices will also fluctuate. All however, can be redeemed at face value if held to maturity.
What’s lost in this and many other analyses is the simple objective of municipal bonds: a safe, steady stream of tax-free income. Investors recognize this advantage, regardless of whether they collect Social Security benefits.
Perhaps it’s the simplicity that drives many of these “experts” to distraction.