Stockerblog
submits:
With so much uncertainty in the stock market, and with the
possibility of tax increases on the horizon, investors have been
allocating funds into tax free bonds (municipal bonds), directly
and through tax free income closed end funds. Tax free closed end
funds or CEFs have several advantages over investing in municipal
bonds directly.
Many of these CEFs have yields of 5% or more, such as the
Blackrock Apex Municipal Fund Inc. (
APX
), which sells at a discount to net asset value, uses almost no
leverage, and yields 5.7%. The Nuveen New York Dividend Advantage
Municipal Fund 2 (
NXK
) has a yield of 5.8%, is currently trading at a discount to NAV,
and has about 26.5% leverage, much lower than the average leverage
of 34.7% for all the CEFs. The Nuveen Investment Quality Municipal
Fund Inc. (
NQM
) yields 6.6%, utilizes about 29% leverage, and trades at a slight
discount.
WallStreetNewsNetwork.com
just updated its list of tax free income closed end funds, which
describes almost 200 ETFs,, including yields, discounts/premiums,
leverage, management fees, date founded, and other information.
High income taxpayers love municipal bonds, as they provide
income that is tax free from Federal income taxes, and if the bond
is issued from the state in which the taxpayer resides or from one
of the territories of the US such as Puerto Rico, then the income
is also exempt from state taxes. Munis are generally issued by
states, counties, cities, and other governmental entities such as
school districts, sewer districts, bridges, and water and power
departments. Here are the advantages and disadvantages of munis and
muni CEFs.
Municipal Bonds
Advantages:
1. You can pick and choose what governmental agency you want to
loan money to. Maybe you want to stick with the bonds from the
cities and counties near you that you are familiar with.
2. Bonds have a maturity date. This means that no matter how
high interest rates go, and no matter how low the bonds drop in
value, at maturity, the bonds are paid off at par.
3. What your bond is worth is what your bond is worth; in other
words, the trading price of CEFs may be far higher or lower than
the net asset value of the fund.
Disadvantages:
1. Higher minimum investment. Although munis are issued in
$5,000 denominations, a round lot is generally considered by many
firms to be $100,000.
2. Less diversification. Because of the higher minimum,
investors can't own as many diverse bonds as they could with a
CEF.
3. Interest payments only twice a year.
4. No professional management or monitoring.
5. Illiquidity. Munis are not traded on an exchange, and
estimated prices given on brokerage statements can be way off from
what brokers will actually offer you if you want to sell. This
actually happened to me; I received an offer of five points less
than what the statement showed a couple days before, with no change
in interest rates over those couple days.
Municipal Bond Closed End Funds
Advantages:
1. No minimum investment. You could technically buy one share.
2. Monthly income.
3. With the monthly income, you receive you capital back faster,
and you can do quicker compounding of your income.
4. Very liquid; traded on major exchanges.
5. Narrow bid and asked spreads compared to municipal bonds.
6. Can sell off small portions if funds are needed. In other
words, if you had $10,000 invested and needed to cash in $1,000
worth, you could do it with a CEF but not with municipal bonds.
Disadvantages:
1. You pay a management fee and other administrative fees.
2. Some CEFs use leverage. You should beware that this increases
the risks to the investor.
3. Some CEFs may be trading at a premium to net asset value. You
want to look for those trading at a discount.
4. No maturity date (other than a few target funds). If rates go
up and continue to rise during your lifetime, you may never get
your principal back.
As you can see, there are benefits to both municipal bonds and
municipal bond closed end funds
. Just make sure that you are familiar with the risks and costs of
each.
Disclosure
: Author does not own any of the above at the time the article was
written.
See also
Is Another Treasury ETF Really Needed?
on seekingalpha.com