Last month, one of the market’s best high-income opportunities got a little cheaper.
If you take action right now, you can earn a safe 5 percent interest, tax-free.
The opportunity is in municipal bonds.
As you may know, municipal bonds are loans made to State and municipal governments. To encourage folks to invest in the government, interest received from “munis” is exempt from Federal income tax and, in many cases, State and local income taxes. These bonds are one of the great friends to the income-seeking retiree. And despite some mindless bearish forecasts over the past few years, “munis” have been a terrific income investment.
They still are. And last month, they went on sale.
In March, the biggest municipal bond fund and the largest exchange-traded fund tracking municipal bonds fell sharply — losing 1.5 percent and 2.5 percent, respectively — in less than three weeks. This may not sound like a big move, but for “boring” bonds, it is.
The decline was the result of a report from Moody’s, a credit-rating agency. Moody’s said the default rate for municipal bonds has doubled in the past two years relative to the average default rate from 1970 to 2009. The ratings agency also said it expects more local governments to default on bond payments.
I don’t pay much attention to what ratings agencies like Moody’s have to say. These are the same agencies that gave pristine ratings to the worthless mortgage bonds that helped cause the 2008 credit collapse.
Remember: The municipal bond market is huge; it’s over $3 trillion. Since 2010, defaults totaled close to $6.4 billion. The average recovery rate is nearly 70 percent. Even now, with higher defaults, only 21 have defaulted (compared to 28 this time last year). But most of the bonds are priced as if they’re expecting 10 percent to 14 percent default rates. To put that into perspective, in 2011, defaults totaled $2.8 billion — less than 1 percent of the total market. So even if defaults doubled (to $5.6 billion), that is still less than 1 percent of the market — and a long way away from 10 percent to 14 percent.
I expect prices to rise as the U.S. economy slowly improves. After falling 1.7 percent in 2009, State personal income rose in 2010 and 2011. And tax revenue has climbed for the past eight quarters. More tax revenue means more secure interest payments and lower default risk. Last month’s muni selloff was a huge overreaction by skittish investors.
Also, keep in mind that we saw a similar overreaction back in April 2011. My Retirement Millionaire subscribers have made a super-safe 23 percent because of it.
That overreaction was due to banking analyst Meredith Whitney. On 60 Minutes, Whitney claimed the municipal bond market was facing “hundreds of billions of dollars” in defaults. At the time, I wrote:
In my investing lifetime, 2008 was the record for muni defaults, but only a tiny $8.5 billion defaulted. And last year, 2010, it was only $2.8 billion.
Remember, the muni bond market is gargantuan: more than $3 trillion in outstanding municipal bond debt. You would think we’d have seen a lot of defaults by now. But we haven’t. It seems things are getting better, not worse.
When Whitney made her prediction, $30 billion exited municipal bond funds in just three months. The biggest muni bond fund is the Vanguard Intermediate-Term Tax-Exempt Fund (VWITX). Shortly after Whitney made her claims about massive defaults, VWITX plunged below $13 a share (from close to $14 a share).
But Whitney couldn’t have been more wrong about munis. In 2011, defaults totaled just $2.6 billion. That’s a hair less than the $2.8 billion defaults in 2010 and hardly the disaster industry “experts” were expecting.
And last year, the Barclays Municipal Bond index returned 10.7 percent, while the S&P 500 returned only 2.1 percent. And one of my Retirement Millionaire picks — the Invesco Insured Municipal Income Trust (IIM) — returned 23 percent. But earlier this month, after the Moody’s report, it fell an absurd 13 percent.
Just like last year’s overreaction, this one is an opportunity.
Right now, IIM is trading at almost a 3 percent discount to its net asset value (NAV). This fund is the equivalent to holding a long-dated (15 years to maturity) municipal bond paying around 5 percent in tax-free interest — which means you’re making safe, steady income for years.
The payout is all from real income and is tax-free at 5.82 percent. That equates to a taxable dividend of almost 9 percent for those in the top 35 percent tax bracket. Many other muni funds are offering similar deals.
In summary, many people are scared of the sector, but the numbers and facts just don’t support such a stance. And just like last year’s muni selloff, this one presents a great buying opportunity for folks seeking retirement income.
Here’s to our health, wealth and a great retirement,
–Dr. David Eifrig
Editor, Retirement Millionaire
P.S. In addition to muni bonds, I’ve recently recommended a handful of very safe investments you can make right now — all of which pay a high yield. Instead of depending on government programs and conventional Wall Street investments, many retirees are using these investments to get all the income they need for the rest of their lives. I think you’ll be surprised at what these investments are and how simple they are to use. You can learn about them right here.