STOP! Read This Before Buying Municipal Bonds…

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It’s been years (years!) that the muni-to-Treasury spread has been flip-flopped. Now that’s finally back to normal.

In a “normal” economy and interest rate environment, the 30-year municipal bond yield should be lower than the 30-year Treasury yield. It makes sense when you think about it: A tax-free yield should be lower than a taxable yield due to the tax advantage.

For many years the opposite was the case. What did that mean? That municipals were drastically undervalued compared to Treasury bonds. Investors were willing to get less income from a taxable investment because they were afraid of cities and states defaulting on their debt.

Are munis now over-valued? I don’t think so. They’re just making up lost ground. The above-mentioned yield spread needs to be much larger just to get back to normal. Then the spread needs to be even higher for munis to be overvalued.

And municipal bonds are 60%-owned by individual investors. This makes them less volatile than other bonds like Treasury bonds which have many international owners (like China and Japan) and institutional owners (like mutual funds and pensions) that can add to price volatility.

What’s the big point? Keep buying those munis. You get a big yield and even bigger yield when your tax bracket is factored into the return.

Of course, use them for a small portion of an intelligently allocated portfolio. You should have many other asset classes like US and international stock, real estate, short-term bonds, etc.

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