Time Flew, But Interest Rates Didn’t

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

A lot has changed in 10 years, but for municipal bond investors who eschewed sitting on the sidelines waiting for interest rates to rise, it’s been a fruitful decade of monotony.

Despite persistent predictions to the contrary, interest rates have barely budged, and based on the current state of the economy, they’re not likely to move anytime soon.

The cost of waiting

Predicting the direction of interest rates is a futile and unrewarding exercise. And for those who bet their financial future on trying to outguess the market, there has been a steep price to pay.

In 2001, rather than locking in 5.00% to 6.00% yields on high-quality munis, many investors chose to forego a substantial amount of annual income by either remaining in cash or laddering short-term portfolios at considerably lower rates. They did so in the mistaken belief that they would later be rewarded by the opportunity to reinvest at the higher rates they were promised by so-called experts.

Few of these investors considered how long they’d have to wait and, unfortunately, even fewer knew how much they were sacrificing by testing the gurus’ powers of prognostication. Waiting requires you to surrender income you will almost certainly never recoup, regardless of where interest rates go.

This incongruity prompted us to begin writing the series of articles, “The Cost of Waiting,” which was later featured in Forbes Investment Guide’s “Supercharged Munis.”

Bonds aren’t stocks

Veteran municipal bond buyers know that the “buy low, sell high” mentality associated with equity investing has no place in the municipal bond market. For muni bond buyers, the goal is to generate and lock in a steady, dependable stream of tax-free income. Their experience has shown that rather than trying to outthink the market, they are better off committing their investment funds when available.

The cost of waiting has never been higher. Today, if you choose to park your funds in a money-market account, you’ll earn almost nothing – or pay someone for the privilege of holding your money.

High-quality tax-free bonds, on the other hand, currently yield approximately 5.00%, an incomparable return for fixed-income investors. Thirty-year Treasuries are yielding approximately 3.50%, which for an investor in the highest tax bracket equates to a 2.27% after-tax yield. As for the allure of the stock market, very few Baby Boomers at this stage of their lives can chance another lost decade.

Over the years, municipal bond buyers have taken solace in the fact that they don’t need to stay glued to the financial news channels. They find the monotony of their interest clock ticking a pleasant respite.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Aug 30, 2011

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.