Municipal Bonds

[gooddecisions]

I watched Suze Orman (yeah, yeah) the other night and she was really emphasizing buying municipal bonds right now (not bond funds, but actual bonds). She said since bonds are at 5.5-6% and you don't have to pay federal or state taxes on them, you're guaranteed a 10% return. She said to talk to a financial adviser about buying a "good quality" municipal bond.

The problem is, I don't have a financial adviser, so how do I go about determining which municipal bond is "quality" and then buying it? I've mostly stuck with individual stocks or index funds in my vanguard account. Do I have to open a different account on Vanguard to invest in bonds?

[justme]

I'd advise staying away from any that are close to bankruptcy or have a large debt/tax revenue ratio. Personally I wouldn't buy any, there's a reason why they are giving you 6% interest when the T bill for 10 years is 2.65%. There's a bond rating out there, I presume municipalities would be under it too, wouldn't buy anything other than AAA, AA, or A.

[gooddecisions]

Thanks for the response. It seemed odd she didn't say anything risky or negative about buying municipal bonds- other than make sure it's "quality" and not a fund.

[Deleted]

Consider the downside though.

If the Municipality goes bankrupt, the Bonds like everything else become worthless or at least worth a hell of a lot less than even what you may have paid.

Then consider how many Cities, Towns and Counties have been going bankrupt of late.

Additionally, consider that any rise in Interest Rates will cause the Price of those Bonds to fall. Granted the yields will go up, however that won't mean much for anyone who already bought them as they will only get the Yield they "locked" in when they bought them.

So: If the Bond Costs $160 ($1,600) with a face of $100 ($1,000) and has a yield of 5% - but then Interest rates go up; the price of the bond will fall, and the Yield will go up..

So even then if you saw that bond at $98 ($980) with a face of $100 ($1,000) and a Yield of 8%; You would still be scorched....

Because: You would have paid $1,600 to be guaranteed a payment of Face at maturity ($1,000) with a Yield of 5%; a Yield which for you DOES NOT CHANGE;

So what you would have is a Bond worth roughly HALF of what you paid for it & a yield that well less than others would then be able to get...

Truth is that if one wants to do well with Bonds they really need to Purchase them at a DISCOUNT to FACE VALUE; Not at a PREMIUM, which is the state at this point and what many folks continue to do..

[Deleted]

here is a good Boglehead conversation on this topic.

www.bogleheads.org/forum/viewtopic.php?f=1&t=126586&newpost=1857472

[justme]

Well, most assume they are rather safe at least compared to company bonds, and historically they have been. The company you buy the bonds from could just close up business one day (though, there's some companies that are pretty solid like GE but since they are so solid their interest rates are usually closer to the T bill rates), but a city/state is always going to be there. But right now a lot of them are over leveraged, are increasing the interest rate to increase buyers, and one city has already declared bankruptcy (Detroit). It's a whole new world what happens when a city declares bankruptcy.

I'm sure there's some good cities out there that aren't in a whole, but you'd need to research. It's very much like buying individual stocks. Any money I have in bonds is in a bond fun...there's probably some municipalities in there, but I see it sort of like being in a total stock market fund that's diversified.

[gooddecisions]

She made it sound like you lock in at the current rate and cash out at the original rate when they mature, but maybe I'm confused. It sounded almost like how CDs work. I'll read that bogglehead discussion and see if I can get my head around this.

[justme]

You do - if you buy them directly from the issuer, which from what I know never happens. The bond world is quite complicated...I used to know more back in my school days, but lack of using it has made me forget the complexities to be able to explain. Plus I'm young, so my investments are mostly going into the stock market.

[Deleted]

99.9% of ALL Bonds have a Face Value (PAR) of $1,000; Par Value is the "Guaranteed" Payment at Maturity..

So if you paid $1,700 to buy it, at Maturity You would take a $700 hit to your Principal Invested..

Whether or not you Actually made money on the Deal comes down to how much you actually made in Interest over the course of the Maturity Period..

If you only made $600 in Interest you Lost $100, If you made $700 you broke even, More than $700 you made money..

You have to figure out the Interest over the period, and you have to also understand that you need to figure the Interest Payments off of the FACE VALUE (Par) {$1,000 for 99.9% of ALL BONDS}; Not off of the amount you paid...

[Deleted]

Nov 18, 2013 15:02:02 GMT -5 @di said:

99.9% of ALL Bonds have a Face Value (PAR) of $1,000; Par Value is the "Guaranteed" Payment at Maturity..

So if you paid $1,700 to buy it, at Maturity You would take a $700 hit to your Principal Invested..

Whether or not you Actually made money on the Deal comes down to how much you actually made in Interest over the course of the Maturity Period..

If you only made $600 in Interest you Lost $100, If you made $700 you broke even, More than $700 you made money..

You have to figure out the Interest over the period, and you have to also understand that you need to figure the Interest Payments off of the FACE VALUE (Par) {$1,000 for 99.9% of ALL BONDS}; Not off of the amount you paid...

Do most retail investors buy munis on the open market after they have been issued or as part of the initial offering?

[Deleted]

Do most retail investors buy munis on the open market after they have been issued or as part of the initial offering?

Most Retail Investors buy in the Secondary (Retail) Market. Then again last I looked only about 12% of all Retail Investors are "Accredited Investors" as per The SECURITIES ACT OF 1933;  Rule 501 of Regulation D.

[The Virginian]

I'd stay away from all Bonds right now and especially Municipal Bonds - Too many cities in financial trouble right now. Instead consider Utility Stocks that pay a good dividend.