Bob Brinker's Municipal Bond Advice

This weekend Bob Brinker started out talking about the mess many of the states of the US are in. He called the politicians in Sacramento, California's capital, dysfunctional.  I agree.  To get elected, the politicians in California gave outrageously excessive pension promises to public unions in exchange for endorsements.

Brinker named the eleven states with triple A  (AAA) credit ratings for their general obligation bonds. The eleven states are

1. Delaware
2. Indiana
3. Maryland
4. Missouri
5. Utah
6. Florida
7. Iowa
8. Minnesota
9. North Carolina
10. Georgia
11. Virginia.

Bottom Line according to Brinker:

"If you are looking at any of those eleven triple A rated states, then you are looking at good paper."

Brinker said states with AA ratings "can be held in a portfolio" if they maintain those ratings. He said he would not worry about owning any of these and he personally owns GO bonds from Virginia and Georgia.

Brinker recommends staying away from these six states:

1. Arizona
2. California
3. Illinois
4. Louisiana
5. New York
6. New Jersey,

• "I would avoid.  I would not purchase in terms of their municipal securities."

Of the double A (AA) rated GO bonds, Brinker said, 

"Generally speaking" of the other 33 states "you are probably OK."

Note, if your money is in a retirement account such as at Vanguard, then the tax savings of Muni bonds do you no good.  

If you have significant funds in a retirement account at Vanguard's prime money fund and don't want to move to another institution (such as mysuggestion to use American Express Savings paying 1.3% APY  in my newsletter), then  I suggest making a ladder of CDs with Vanguard's CD Ladder tool.  Divide the funds into 5 buckets.  Keep 1 bucket (20%) in Prime money fund ready for any buying opportunities (such as a 10% market correction) or potential rebalancing, then put the remaining 80% into CDs for 3, 6, 9 and 12 months.  As the 3,6 and 9 month CDs mature, buy a new 1-YR CD.  After 9 months, you will have four one year CDs with one maturing every quarter.  When interest rates normalize, you can put the CD funds that mature into the total bond fund again. 

You can get an idea what different banks are paying for CDs and savings accounts for various amounts by using the rate tool here.  I use American Express in my newsletters because it is available to everyone and it is "too big to fail."  It is also simple to calculate returns each month for American Express since there are no restrictions to complicate the calculation.   

You can often find better deals with more restrictions such as the 1.3% at Capital One plus 10% bonus and up to $60 credit detailed here, but you have to be a member of Costco.  If you are not a member of Costco, CapitalOne Bank is advertising 1.25% plus a 10% bonus.

Bob's Guest was Perry Mehrling, author of The New Lombard Street: How the Fed Became the Dealer of Last Resort

Perry Mehrling

Bob Brinker Muni, GO and Bond Fund Advice

Many callers have asked Bob Brinker about the potential to lose money in bond funds when interest rates "normalize" from historically low rates. For example, on April 5, 2010 the 10-year US Treasury Bond had a yield of 3.99%. (move the cursor over the chart here for TNX to April 5 to see the rate quoted as a "price").   Much of this year's gains in bonds are due to the yield falling to 2.70% as investors have fled stocks while pouring money into bond funds.  See:

• Equity, Bond & Money Market Fund Flows

• US Treasury Rates at a Glance.

Brinker says if you hold a bond fund the simple thing to do is use a mental stop loss as I explain in the article Bob Brinker's GNMA Advice.

Brinker also points out another way to avoid losing money is to buy bonds directly and hold them to maturity. If you buy US Treasuries or GNMAs directly, then you are guaranteed to get your interest payments plus principle back since the government can borrow money from the Federal Reserve which will turn on the printing press if there are not enough interested in the low rates.

If you own municipal bond funds to lower your taxes, then Brinker says you can buy tax exempt Municipal Bonds directly from your broker. Buy NEW ISSUES to get the lowest fees. If you were worried about the quality of municipal bonds, then Brinker says you could purchase high quality state general obligations (GO Bonds) which have had no failures in over a century.  (As a Californian, I find little relief in that fact given the circus we have in Sacramento giving huge raises and pension benefits to unions that support the people in government that keep spending while the state circles the drain of insolvency.  End of digression.)

My Warning: You need to be careful with Muni bonds because some cities, struggling with the recession, have missed payments and could default. Harrisburg, the capital of of Pennsylvania, is the latest to miss a payment and potentially default.

Pennsylvania capital, Harrisburg, skips payment, may move closer to bankruptcy
Harrisburg Mayor Linda D. Thompson has adamantly opposed declaring bankruptcy, while the move has been been advocated by the city controller and a growing bloc on the City Council. 
and
The city's bond insurance company is expected to cover its upcoming $3.3 million bond payment. But some analysts say relying on that backstop could add to the mounting pressure on firms that provide insurance for the $2.8 trillion municipal bond market.

The good news for investors is the insurance company will make the payments but if enough cities and states like California (even with with insurance) miss payments, it could get nasty.

Seeking Yield for Income Is Risky 

Currently, if you need yield, it means you are taking significant interest rate risk.  Buying bonds directly is fine if your goal is to not lose money but if there is high inflation, then you will lose purchasing power to inflation whereas someone in money funds, TIPS, Ibonds or savings accounts will do much better since we will get higher returns as rates normalize (go up.)  Everyone should be aware that the Federal Reserve is again buying US Treasuries to help keep rates low and nudge investors to take more risk to help the economy grow again.  Rates could surge again when (not if) the Fed stops buying US Treasuries.

Vanguard's GNMA fund, VFIIX, currently has an average duration of 1.7%.  That means if interest rates were to jump 1% overnight, you could expect VFIIX to lose 1.7% in net asset value, NAV.  If they jump 3%, expect NAV to fall by 5.1%, 3 times 1.7%.

• VFIIX Chart and Quotes

I am lucky. I have enough cash flow from my Two Investment Letters, people clicking ads on my blogs and websites plus commissions for products I recommend that I don't need yield to live on.  Thus, I take very little interest rate risk.  I've sold all my bonds and bond funds not indexed to inflation with my own money and in  "Kirk Lindstrom's Investment Letter." 

My personal iBond portfolio currently yields 5.43% (Majority are from Oct. 2001) but of course, I only get the interest at maturity, a great way to defer taxes.  The TIPS fund I got for my Vanguard ROTH by selling the GNMA fund is up 18.4% in under 2 years.  I also hold individual TIPS and a significant holding in the TIPS fund at Fidelity, FINPX, that is up 25.8%.  I suspect those TIPS funds will give back some when rates normalize, but rates probably won't normalize without a significant inflation component so I expect they will do better than bond funds not indexed to inflation.

Many of the stocks in "Kirk's Newsletter Explore Portfolio" are paying a great dividend while selling at very low price to earnings multiples.  My portfolios are up significantly over the past 10 years while the index funds are down.   I expect equities to significantly out perform bonds and probably CDs over the next decade and my "core plus explore" portfolio approach should do even better.

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VCAIX, VCITX, iShares S&P California Municipal Bond Fund CMF & CA GO Bonds

Bob Brinker recommended California general obligation (GO) bonds on his show last year. Last weekend a caller said he purchased the Vanguard California Municipal Bond Fund (probably VCAIX or VCITX) and it is down about 2%. He wanted to know if Brinker had any advice now for him.

CMF is the iShares S&P California Municipal Bond Fund.

Brinker said he did not own that fund but he does own General Obligations issued by the State of California which he is holding on to. Brinker said he thinks the great state of California is too big to fail and the federal government will step in to guarantee payment on bonds like it did for New York in the 1970s.

Many investors are in a panic about California's financial crisis. Some Californian municipal bonds are paying an unprecedented tax equivalent rate more than three times as much as Treasuries.

See US Treasury Rates at a Glance

This chart shows the 10-year Treasury is paying about 2.5% now while the table below shows the Vanguard intermediate and long-term CA tax exempt funds are paying 4.15% and 4.64%, respectively.

This could turn out to be the mother of all buying opportunities, or the mother of all muni defaults. Obviously, Bob Brinker is betting on the former. As a California taxpayer, I sure hope Brinker's advice does not turn out to be another bust like his QQQ advice to buy the ETF for the NASDAQ-100 back in late 2000 before it fell from the $80s to the teens.

Table of Vanguard California Tax Exempt Funds and Rates

Name	Symbol			YTD Returns as of 01/06/2009
		Yield
S&P 500 Index Fund Inv	VFINX	2.84%		3.53%
CA IT Tax-Exempt Investor	VCAIX	4.15%		1.04%
CA LT Tax-Exempt Investor	VCITX	4.64%		1.46%
CA Tax-Exempt Money Mkt	VCTXX	0.74%		0.01%

I must admit that 4.64% tax free is a very attractive yield. I have not been inclined to take risk with my fixed income investments but I may reconsider this . One reason for optimism is president elect Obama will be much friendlier to spending addicted, democrat controlled California than president Bush who let Enron screw us by manipulating our energy prices before Enron failed.


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						10 Years
Kirk Lindstrom's Newsetter		2007	2008	Combined		Through 12/31/08
80% Core Aggressive + 20% Explore		6.31%	(29.90%)	(25.47%)		40.95%
95% Core Conservative + 5% Explore (50:50 Balanced)		6.54%	(17.13%)	(11.72%)		49.60%
Brinker Marketimer
Model Portfolio #1 - Aggressive		9.17%	(39.71%)	(34.18%)		49.25%
Model Portfolio #2 - Moderate		9.04%	(37.45%)	(31.79%)		43.08%
Model Portfolio #3 - Balanced		7.94%	(23.86%)	(17.81%)		46.42%
Vanguard Index Funds
VTSMX - Wilshire 5000		5.49%	(37.04%)	(33.58%)		(6.90%)
VFINX - S&P500		5.39%	(37.02%)	(33.62%)		(14.06%)

(Brinker Marketimer 10-year performance includes effect of QQQ advice.)

Bob Brinker on California Municipal Bonds

October 13-14, 2007 Moneytalk with Bob Brinker Commentary by David Korn (newsletter excerpt)

LEGAL DEVELOPMENT FOR MUNICIPAL BONDS

Caller: This caller owns some California municipal bonds and asked Bob whether he should make any additional investments in the municipal bond market pending a decision by the Supreme Court on the case that is testing the taxability of municipal bonds issued by other states. Bob said if you are a California resident and purchase a municipal bond from another state you are going to get hit over the head with up to a 9.3% tax depending on your tax bracket. Bob said we may have to wait until spring before we get a decision, which means May or June of 2008. Bob said we don't know what the court decision will be, or the impact of the court's decision. There are a lot of unknowables. The one thing we do know is that if you go out of state right now, you are going to have to pay the tax.

David Korn: Bob didn't seem too enthusiastic about making such purchases before the Supreme Court weights in on the issue. Here is an article out this month discussing the case entitled, "Municipal bonds making big wages."

- David Korn

More articles by David Korn:

• Bob Brinker Biography, Part 1
• You missed the Buy Signal in 2003, what should you do?
  Excerpt from David K's Interpretation of Moneytalk (Bob Brinker Host) March 23, 2003 Newsletter

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