Municipal Bond Funds Broken

For those who sold or are selling because of fear of higher interest rates soon, buying individual bonds is an option. This is some of what you need to know to redirect money from bond funds to individual bonds.

Municipal bond funds have traditionally been perceived as a good bet for high-net-worth individuals. This is because of their tax advantages, which often lead to a higher overall return than taxed bond funds for the wealthy.

But, municipal bonds also tanked in price in May and continue to do so. This is primarily due to the pervasive feeling that there will be an increase in interest rates. In fact, this has been self-fulfilling.

From WellsFargo.com. There is an inverse relationship between bond prices and their interest rate. As prices decrease, inerest increases.

When bonds are sold on a mass basis, as they were, their price decreases and the effective interest on the bond increases. This occurrence suggests that we don’t even need Ben Bernanke to intervene in the bond markets to see a drastic change. Investors, as a group, can move the market themselves out of fear (in this case, a fear that rates will be increasing).

Intermediate and long-term funds were affected the most by this selling spree but short-term bonds, normally less influenced, felt the pain as well. For example, the Wells Fargo Advantage Short-Term municipal bond fund STSMX (below) fell 0.04% since May and briefly dropped even more.

From YahooFinance.com

Since selling after everyone else has is not a good option, for those that haven’t bailed yet, now is a time to consider it. But with that choice comes another problem. The seller has to decide what to do with the resulting money that will, hopefully, preserve it and, at the same time, earn reasonable interest.

You may remember the Meredith Whitney scare a few years ago when she predicted municipals would fail and, thereby, not pay their debt. That would leave the owners of the municipals holding the bag.

Fortunately, Whitney was wrong. This means that buying single municipals to replace municipal bond funds is still on the table. When they come to term, the principal is returned if the municipality is solvent. The caution here is that not all municipals are created equal. States with growth are safer bets. For example, Whitney endorses Indiana, North Dakota and Texas as potential candidates. I do as well.

Buying single state municipal bonds instead of funds is not easy. Either the investor or his/her broker has to ferret out the possibilities. In the past, this has taken me up to an hour per bond. Brokers have it easier because they can negotiate prices more rapidly with the more advanced electronic system available to them.

For those who choose to buy a bond on his or her own, it may be necessary to ask the brokerage representative to walk you through the process the first few times.

In brief, normally there is a bond and CD tab on all brokerage sites. Go to it and a municipal option should appear. The AAA bonds have a lower interest rate than the A bonds because the AAA bonds are considered safer. Generally, the shorter term bonds have a lower interest rate than the longer term because they are less likely to move as much with interest rate changes.

Choose the level of safety and term with which you are comfortable and then try to find a municipal from the preferred states of Indiana, North Dakota and/or Texas. Going through a long list may take a while.

Another option is using a bond wizard, or its equivalent, which also is on most brokerage websites. Then, criteria can be entered and a list that fulfills the requirements is provided. This can be disheartening. There may not be any available municipal bonds that meet the desired conditions. Then, it is back to start for another day.

Sometimes, it is up to a week before I can fulfill my special requirements. It might be for you, too, if you do it on your own. But then again, no one ever said that investing for both security and to glean the best yield is easy.

Read more:

Bonds and Brokers: Put Money in Your Pocket

Losing Dollars in Municipal Bond Funds

Municipal Bonds Have Teeth: Do They Need Braces?