Ask Money

Municipal bonds

Chris Farrell Nov 6, 2008

Question: Would you suggest waiting until the “dust” settles before starting to invest in muni bond funds, as opposed to CDs at this point? We would like to have some more tax exempt investments. I worry that some local govts still have trouble renegotiating insurance on their bonds. We are almost at retirement age, and have our money at this point, in Treasuries and CDs. Beth, Indianapolis, IN

Answer: Tax exempt bond yields are still very attractive relative to taxable fixed income securities like U.S. Treasuries and certificates of deposit. But that higher yield reflects greater risks. State and local government revenues are falling with the economy in recession. There are concerns that the muni bond default rate could be unusually high during the latest downturn. The insurance on tax exempts is essentially worthless. For example, on November 4, Vanguard announced plans to merge its $3.2 billion Insured Long-Term Tax-Exempt Fund into its $2.8 billion Long-Term Tax-Exempt Fund. “The municipal bond market has changed to a point where insured bonds provide little, if any, additional benefit over high-quality uninsured credits. We concluded that a fund focused solely on insured bonds no longer provides tangible benefits,” said Gus Sauter, Vanguard’s Chief Investment Officer. “Shareholders will be better served by merging the two portfolios to create a single, well-diversified, high-quality fund.”

So, part of the answer is whether you want to move your money out of default free securities–U.S. Treasuries and CDs if under the $250,000 FDIC limit–into a slightly riskier investment. My bias is toward conservatism. If you think the extra yield is worth the risk with at least some of your money I would stick to a high-quality broadly diversified tax exempt mutual fund portfolio. Don’t reach for even higher yields by investing in the riskier sectors of the muni market.

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