If you took our “hard trade” advice one year ago, congratulate yourself…
You made 22.4% in capital gains… and another 5.6% in income. You did it by ignoring the crowd…
Last year, the stock market did nothing.The benchmark S&P 500 index finished the year essentially flat.
But the “hard trade” – buying municipal bonds when they were out of favor – was a big winner for readers of my Retirement Millionaire advisory (and DailyWealth readers who acted on this essay).
And if you can continue to stay in this “hard trade,” you’ll continue to collect safe, tax-free income streams…
Around this time last year, Wall Street sensation Meredith Whitney – best known for her bearish call in the fall of 2007 on Citigroup – foretold 50-100 “significant” municipal bond defaults that would add up to “hundreds of billions of dollars.”
Municipal bonds are loans made to state and municipal governments.
To encourage folks to invest in the government, interest received from “munis” is exempt from federal income tax and, in many cases, state and local income taxes.
That makes them a favorite for retirees looking for income.
A wave of municipal defaults was a truly frightening prospect… So buying municipal bonds at the time was a “hard trade” to make.
But as I told my readers, there was no reason to panic. The situation wasn’t nearly as dire as headlines suggested. Going against the crowd then paid off… And it’s still paying off.
The crowd is still scared of municipal bonds, which are paying 25% more than comparable – and taxable – Treasurys. That’s uncommon. Normally, munis pay less than U.S. government bonds because of the tax-exempt feature. In fact, over the last 58 years, munis have yielded more than Treasurys less than 10% of the time.
There’s no reason for investors to avoid municipal bonds right now…
First, the ratings agency Fitch reports that interest payments on debts like muni bonds makes up less than 10% of those governments’ budgets. Income and property taxes are half that percentage at the state and local levels. So there’s little reason for the vast majority of municipalities to default.
Second, after falling 1.7% in 2009, state personal income rose in 2010 and 2011. And tax revenue has climbed for the past eight quarters. Revenues in the third quarter of 2011 totaled $292 billion. This is 4% more than the same time last year. More tax revenue means more secure interest payments and lower default risk.
In 2011, defaults totaled just $2.6 billion. While that narrowly beats the $2.8 billion defaults in 2010, it’s hardly the disaster industry “experts” were expecting. And it’s a tiny portion of the total. The muni bond market is gargantuan: more than $3.7 trillion in outstanding municipal bond debt.
Over the 40-year period of 1970-2009, the default rate for investment-grade municipal bonds was only 0.06%, compared to 2.5% for investment-grade corporate bonds. Despite recent negative media attention, this illustrates that munis remain a high-quality, low-default asset class.
Finally, you can buy municipal bonds that are insured against default and still collect a super-rich yield. For example, my Retirement Millionaire readers own the Invesco Insured Municipal Income Trust (IIM).
This fund holds investment-grade bonds from several states, including California, Texas, and Colorado. It spreads your risk across many different bond issues. And right now, it’s paying a 5.6% yield. For someone in the 35% tax bracket, that’s taxable-equivalent yield of about 9%.
Last year, attention-grabbing calls from analysts like Meredith Whitney – along with general panic about the state of municipal finances – led to a great opportunity in muni bonds. It was a hard trade to make. But it worked.
And it’s still working.
Here’s to our health, wealth, and a great retirement,
Doc Eifrig
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Source: Daily Wealth