But in today's topsy-turvy market, intermediate-term municipal bonds now yield around 4.2%, vs. 3.3% for 10-Year Treasurys. A tax-free yield of 4.2% is the equivalent of a taxable yield of 6.3%, assuming a 33% federal tax bracket.
In the four weeks ended March 11, the average intermediate-term municipal-bond fund fell 1.8%, with long-term funds down more than 2.8%. Uncertainties about the economy and credit concerns have weighed on bonds, lowering prices and raising yields. Hedge funds have also dumped muni bonds in an attempt to cover trading strategies gone sour.
Municipal bonds deliver dependable returns, losing money only once in the past 10 years--a 2.1% decline in 1999. Bond prices tend to move in the opposite direction of interest rates, and declining rates could boost performance in the year ahead.
Finally, should a new president raise taxes, municipal bonds would become even more attractive.
Very conservative investors might consider a tax-exempt money market mutual fund offered by an investment company. The funds, with share prices fixed at $1, are not insured like bank accounts but are highly liquid and regulated by the Securities and Exchange Commission. The average fund yields 2.6%, putting the taxable-equivalent yield at 3.9% based on a 33% tax rate.
One standout is Vanguard Tax-Exempt Money Market Fund, which yields 3.0% with a taxable-equivalent rate of 4.5%. The fund has a $3,000 minimum investment.
Investors willing to take on a bit more risk in exchange for potentially better performance should consider short-term municipal bond funds. Share prices of such funds fluctuate, meaning they can gain or lose money.
An excellent choice is Vanguard Limited-Term Tax-Exempt, yielding 2.9% with a taxable-equivalent rate of 4.3%. The fund has a 0.15% annual expense ratio and requires a $3,000 initial investment.
Vanguard Intermediate-Term Tax-Exempt, a longtime Dow Theory Forecasts favorite, seeks a higher level of current income with moderate risk. The fund holds mostly intermediate-term investment-grade bonds, with an average maturity of less than seven years, and has declined in only two years since 1993. The fund yields 3.6%, putting the taxable-equivalent yield at 5.4%. The fund charges a 0.15% expense ratio and requires a $3,000 minimum investment.
Excerpted from a recent issue of Dow Theory Forecasts. Click here for more stock analysis and recommendations from editor Richard Moroney.
