Double-Edge Sword of Muni Funds

This is an insanely difficult time for investors, average Americans and even the international community. Uncertainty and fear lurking just below the surface risk a full-blown financial panic, as President George W. Bush suggested in a speech last week.

With fear comes the inevitable flight to safe havens. One haven that our models are detecting is municipal bonds. There is always risk, even with U.S. Treasury bonds, and, therefore, municipal bonds. This risk presents itself in the price currently being paid for both types of securities.

Prices have been bid up and yields compressed, so buying these securities for reasons of safety at current prices exposes the investor, eventually, to price risk in the form of falling prices and, hence, capital loss. When this occurs is unknown but will coincide with a bottom in the market and the economy -- this may be some time away.

At a market bottom, there is more certainty, believe it or not, and it is hoped that, at this point, investors would start to move out of municipals, Treasuries and other safe havens and back into other markets including equities. If you are going to purchase these debt instruments, get out in time. Furthermore, any bailout financed by Treasuries will probably lead to falling prices and higher yields across the bond market, representing another price-risk factor.

The securities themselves are relatively safe. Although tax revenue is likely to fall during a downtown, municipalities that have kept a healthy balance sheet will be able to continue making interest payments on their debts. Thus, the risk lies not with the securities themselves, but with current trading levels.