Thursday, January 20, 2011

Municipal Bond treasures in the trash heap

Municipal bonds are an unloved category and justifiably since almost every government and public entity seems to be in financial trouble. Yet in every trash heap is a treasure for the patient investor.

What is a municipal bond? When you buy a municipal bond, you are lending your money to a State, County, City or other community project like schools, hospitals, bridges roads etc. When you lend your money via a municipal bond, the interest paid to you is usually tax free. Of course you are not only interested in receiving tax free income, you also want to have your principal returned when the bond matures.

Because the muni bond market has suffered big losses lately, I looked for municipal bonds in states that are solid. States like Indiana and Texas are attractive borrowers.

I am looking for a treasure in all of this trash so I looked for a general obligation (GO) bond. GO bonds are issued by a entities that have the power to tax. Tax revenues are the source of your interest income and eventually the pay back of your principal. A revenue bond, on the other hand, raises money for infrastructure projects that create revenue like a toll road or a sports stadium. The interest income and eventually your pay back come from the revenue the project generates.

Insurance helps to reduce risk so my next move is to screen for bonds that are insured.

Finally, I look for bonds that sell at less than par. Par value is $100. It is a little confusing because when you buy a bond, you will buy them in $1,000 increments. One bond selling at par will cost you $1,000 although the par value is $100. If you by at a discount, let's say $95 you would pay $950 for one bond.

Who should buy municipal bonds? Anyone who has cash to invest and wants to pay the least amount of tax on the income is a potential investor.

Who should not buy municipal bonds? Those of you who want to invest your qualified retirement money. You should not buy municipal bonds in a Roth or traditional IRA, pension plan, 401 or any qualified retirement account. These accounts are already tax advantaged and the tax saved on a municipal bond is wasted.

On to finding treasures in the trash heap. Two Indiana revenue bonds seemed attractive with one being insured and I found a very interesting insured Texas transportation bond.

This insured Texas bond has a coupon of 4.5% that matures in 2035 selling between $87.966 and $94.288 for a current tax free yield of 5.396%. This bond is insured. CUSIP # is 882721PA5. You must know the CUSIP number to research a bond.   If we hold the bond to maturity our capital gain, above and beyond our interest payments, will be 13.68%.  My yield will be less as I bought this bond at about $90.  I do not intent to hold this bond to maturity unless I have to.  

You should check out municipal bonds with care, then buy at a discount.  Consider this strategy for your income portfolio.

Very Truly Yours,