Municipal Bonds: Hi-Yields at High Risk
Is it easy to make money with municipal or muni funds? Yes it is, provided you play your cards well. There is a flip to it. Muni funds can be a lot more risky. If you are not averse to a little bit of risk then you can take your discretion to a better field of yields.
Issued by state and local bodies like university or airports, munis are long-term IOUs— that gives you interests minus the mandatory federal income taxes. If it happens to be a state issued muni, state taxes are exempted as well. If a muni bond yields an interest of $500, you get to keep the whole of it as no taxes are levied but with treasury bonds you have to shell out $125 as taxes, and so you get to pocket only $375. However, interest on a muni is always less because it happens to be tax free. Surprisingly, a recent Bloomberg report says a 10-year high-grade muni bond and a 10-year Treasury note yield the same rate at 1.84%.
The problem with munis is that the yield is low because of the low interest rates and that the bond prices fall when interest rates rise. A discreet way out is to buy short-term bonds at fixed intervals. With each maturity, you get to reinvest your money at higher interest rates. Investing in bonds with shaky credit ratings is also a good option, though it is open to risks. Municipal borrowers with bad credit ratings pay higher interests and when their credit ratings improve — something which is bound to happen in a recovering economy — then they should rise in price. Bonds rated by the top rating agencies have low default rates. So you need to bring your judgment into play. Some top performing high yield munis over the last few years include: Franklin High Yield Tax-Free Inc, Delaware National High-Yield Muni, and DWS Strat. High Yield.
If you aren’t averse to courting risk for the extra yield you can opt for a high-yield muni fund. Only that, you have to choose one with the right past and keep a close watch on your investments.