Tag Archive | "investing in bonds"

Municipal Bonds Offer A Safe Way to Earn Tax Free Income


Municipal Bonds Have Fallen In Value Due to Default Concerns

Municipal BondsMunicipal Bonds have been out of favor during 2011 because the well regarded financial analyst Meredith Whitney warned in November 2010 about potential defaults in the Municipal Bonds sector, which caused many investors to sell their holdings in Municipal Bonds.  Many Municipal Bonds, and Municipal Bonds investment vehicles such as Municipal Bonds Exchange Traded Funds (ETFs), lost 10% to 20% of their value due to the analyst’s warning, and have yet to fully recover from the price drop.  This price drop has created an excellent buying for opportunity investors interested in investing money in Municipal Bonds.

Many investors rely too heavily of stocks for generating investment returns over long periods of time.  This is largely due to the allure that the stock market has for exceptional profit opportunities and the media coverage of the stock market versus other asset classes.  However, investment advisors almost universally recommend that maintaining a balanced investment portfolio is the best way to protect one’s investments from downturns in various asset classes, such as stocks and real estate.  Typically, a 20% to 30% investment in highly rated bonds is recommended, with even higher bond investment percentages for investors who are near or in
retirement.

Municipal Bonds Offer Tax Free Income

For those looking to shift some of their investment portfolio into bonds or increase their exposure to bonds, now could be the right time to buy Municipal Bonds, as they continue to trade at reduced levels after the late 2010 analyst downgrade.  This is due to ongoing concerns about Municipal Bonds defaults, as the United States economy continues to expand slowly, with indications that a new recession could be brewing due to the European debt crisis.  However, these concerns about Municipal Bonds defaults so far appear to be overblown, as the default rate for Municipal Bonds has not be unusually high in 2011.

What really makes investing in Municipal Bonds appealing is the tax free income that they provide.  Depending on the type of Municipal Bonds and where one lives, an investor may be able to earn tax free interest that is free of local, state, and federal income taxes.  With some Municipal Bonds offering 7% yields, their tax free income is especially appealing in the current low interest rate environment in which many savings accounts earn less than 1% in taxable interest.  Another reason that Municipal Bonds are an appealing investment at this time is that if the Municipal Bonds market recovers from its current slump, investors will not only earn tax free interest on their holdings in Municipal Bonds, but could also make money on the appreciation of the price of the bonds, as they increase in value.  The money made on the appreciation of the price of the bonds would be considered a taxable capital gain when the Municipal Bonds are sold.

Since it is not practical for most individual investors to research the risks associated with investing in specific Municipal Bonds and putting all one’s investment eggs into one bond is not a good investment strategy, it is recommended to invest in Municipal Bonds via an investment vehicle such as an ETF or mutual fund.  There are many ETFs and mutual funds that invest in Municipal Bonds in specific states, thus ensuring that the income earned by investing in Municipal Bonds is tax free in the state in which an investor lives.

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Investing In Bonds In 2011


Investing In Bonds In 2011 – What You Need to Know

Investing In Bonds In 2011Investing In Bonds In 2011 is more complicated than usual because investors who were spooked by the sharp drop in the stock market in 2008 and 2009 have invested their money heavily into bonds in recent years, which has caused highly rated bonds and bond funds to trade at elevated values during 2011.  Making the situation even more complicated is the fact that municipal bonds and municipal bond funds are currently trading at depressed levels due to concerns about municipal bond defaults.

What this all means is that Investing In Bonds In 2011 is not the same as investing in bonds during a typical economic period with moderate to robust economic growth.  In 2011, an investor’s bond trading strategy will be influenced by the type of bond one is contemplating investing in and their investment strategy and goals.

Investing In Bonds In 2011 – Investing Strategy Depends On The Type of Bond

Investors often seek out highly rated bonds for the safe and secure returns on principal that highly rated bonds pay out as interest payments.  Bonds are rated by major rating agencies such as Standard and Poors and Moody’s.  Bonds that are rated BBB- and above are considered investment grade bonds.  Investors who put their money into highly rated bonds face little risk of losing the principal invested due to a default on interest payments by the bond issuer.  The risk of bond default decreases with higher rated investment grade bonds, with AAA being highest rated and least risky bonds.  The trade off for investors is that the less risky the bond, the lower the interest payment, due to the higher demand for less risky bonds and the lack of a risk premium.

In normal times, the principal invested in highly rated bonds and bond funds is not considered to be at risk, and the risk of principal loss is not factor into an investors decision to buy highly rated bonds and bond funds.  However, Investing In Bonds In 2011 is different than bond investing is in normal times because highly rated bonds and bond funds are trading at elevated prices in 2011 due to all the buying interest from investors during the preceding three years.  Once the bond market returns to a more normal trading level, sometime after 2011 when the economy makes a sustained economic recovery, the highly rated bonds and bond funds will lose some of their principal as investors sell, perhaps as much as 20%.

Due to the low interest rates and the potential for loss of principal in investment grade bond investments, Investing In Bonds In 2011 means investors need to look at junk bonds to earn substantial interest payments and municipal bonds to earn modest interest payments.

Junk bonds provide significantly higher yields than more highly rated investment grade bonds, due to the higher risk of default associated with issuers of junk bonds.  Investors demand higher yields from junk bonds in exchange for assuming a higher risk of default.  However, this trade off may be worth it to bond investors Investing In Bonds In 2011, since junk bonds offer attractive interest rates that are not available elsewhere.  Junk bonds also have little risk of principal loss, if they are brought via a junk bond mutual fund or Exchange Traded Fund (ETF).  These funds spread the risk out and avoid junk bond defaults.  Unlike investment grade bonds, junk bonds and junk bond funds are not trading at a premium in 2011, so as long as an investor avoids the principal risk associated with owning individual junk bonds by buying junk bonds via a mutual fund or Exchange ETF, their principal invested will be relatively safe.  For more information about junk bonds, see:  The Junk Bond Market Offers High Yield Returns.

With the potential for appreciation of the principal invested, Investing In Bonds In 2011 is different than normal times in the municipal bond market.  Because concerns have been raised regarding potential defaults in municipal bonds, as local, county, state governments struggle with fiscal challenges due to the 2008/2009 recession, bond funds that invest in municipal bonds are trading at depressed levels in 2011.  A sustained economic recovery after 2011 should cause municipal bonds and municipal bond funds to increase in price, thus providing an increase in the principal invested in municipal bonds and municipal bond funds.  It should be noted that if the economy goes into another severe recession, funds invested in municipal bonds could fall substantially if defaults in municipal bonds occur on a widespread scale due to cash flow problems at local, county, and state governments.  For more information about municipal bonds, see:  Municipal Bonds Offer a Safe Way to Earn Tax Free Income.

Investing In Bonds In 2011 is very different than a typical year, and therefore, investors need to look closely at what kind of bond or bond fund they are thinking of investing in during 2011, and what market forces are impacting the bonds and bond funds they are considering investing in.

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Is It Too Late to Buy Bond Funds?


How Bond Funds Reached Current Elevated Levels

Bond FundsBond Funds, including mutual funds and Exchange Traded Funds (ETFs), that invest in a wide variety of bonds (both government and corporate) have done well since the financial crisis of 2008 and 2009.  The reason why Bond Funds have done well in recent years is because investors who were spooked by the sharp drop in the stock market in 2008 and 2009 sought out safer places to invest their money.  Not wanting to put their cash in low yielding bank savings accounts, investors piled into Bond Funds, which pushed the price of Bond Funds higher.

Many investors have done well over the past two to three years with the strategy of investing their money in Bond Funds, as their money has been earning a decent steady rate of return.  The weak economic recovery and reluctance of the Federal Reserve to raise interest rates has caused demand for bonds and Bond Funds to continue to be strong, which has supported the price of Bond Funds, as strong money flows have keep buy side pressure on Bond Funds.

While investors jumped into Bond Funds because they were looking for a safe haven during the 2008 and 2009 financial crisis, investment advisors recommend maintaining a 20% to 30% investment in highly rated bonds during all times to diversify one’s investments across multiple asset classes.

The Current Risk Associated With Buying Bond Funds

With bonds and Bond Funds currently at elevated levels due to the buying pressure over the past three years, the question must be asked whether buying Bond Funds is currently risky since in a normalized economy the bonds and Bond Funds should revert to their mean and fall in price.  Those who brought Bond Funds before or early on in the 2008 and 2009 financial crisis are sitting on good positions that have earned interest over time, and have little risk of losing money on the principal that they invested in Bond Funds.  However, those who are contemplating purchasing Bond Funds now, at their current elevated price levels, need to realize that there is a real risk that once the economy returns to normal, and growth rates and interest rates start to rise, the Bond Funds will fall in price, as buying pressure eases and holders of bonds and Bond Funds sell.  This will put their investment capital at a risk of a slight loss as the value of the Bond Funds they hold decrease.

The potential for a slight loss from buying Bond Funds now may seem acceptable to some investors since the economy currently appears to be slowing, and another recession may be on our doorstep.  Another recession would ensure that Bond Funds will maintain their elevated levels for a prolonged period of time, allowing the buyer of Bond Funds to recoup some of their initial investment via interest payments on the bonds held by the Bond Funds.

It should be noted that due to concerns about defaults in municipal bonds, Bond Funds that invest in municipal bonds are actually at depressed levels, so the risk of buying these funds at elevated levels is not a factor.  However, funds invested in municipal bonds could fall substantially if defaults in municipal bonds occur on a widespread scale due to another recession causing cash flow problems for state and local governments.  For more information about municipal bonds, see:  Municipal Bonds Offer a Safe Way to Earn Tax Free Income.

There are many different Bond Funds that invest in a wide variety of bonds with various bond ratings and maturity dates.  Although, the risk associated with buying Bond Funds now and incurring a loss of principal when the economy recovers is something to consider, Bond Funds are worth considering for the relative safe and secure returns that they provide.

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