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Five Reasons to Buy Munis
10/10/2014 9:00 am EST
Many people realize that rising interest rates affect yields and prices, but what others might not know is that if you stick closely to short-term, investment-grade debt securities, the impact of such a rate hike is not as dramatic as some investors might think, explains Frank Holmes in US Global's Frank Talk.
US Global’s Near-Term Tax Free Fund (NEARX) has been a steady grower over the years, in times of rising and falling interest rates as well as extreme market downturns.
Although short-term bonds might not be sexy, they play an important role in any serious investor's portfolio. Below are five reasons why investing in municipal bonds makes sense now more than ever.
1. Short-term, investment-grade municipal bonds are less volatile in a climate of rising interest rates.
Interest rates are currently at 50-year lows but they can't stay near zero forever. And when rates do rise, bond prices will fall. At first glance, this inverse relationship might seem illogical but it makes sense. If newly issued bonds carry a higher yield, the value of existing bonds with lower rates fall.
The farther out the maturity date and higher the rate hike, the more your security would be affected. Remember, these are Treasuries, not municipal bonds, but munis could be similarly affected.
As you might guess, what this indicates is that investors should take advantage of short-term bonds, which are less sensitive to rate increases than longer-term bonds that are locked into rates for greater periods of time.
2. Investment-grade munis have a low default risk.
In 2013, your chances of investing in a reliable, secure municipal bond from an issuer that wouldn't default were roughly 99.9%. That's according to the number of bond issues in the S&P Municipal Bond Index that defaulted last year.
Out of more than 21,000 bonds in the index, only 23 failed to meet their payment obligations. There's a greater likelihood that an issuer won't default the higher its rating and the shorter its maturity. Bottom line: these securities are relatively safe.
3. Municipal bonds are tax-free at the federal level.
As you might already know, munis are typically exempt from federal income taxes and often from state and local income taxation as well.
This fact is especially appealing to high net worth individuals who want to minimize the tax impact on their investments. That means more money stays in your pocket and can be reinvested.
4. Munis help diversify your portfolio.
It's prudent to have a diversified portfolio of both equity and debt securities, not to mention cash and commodities such as gold. Stocks can offer you growth and capital gains while bonds provide income and can help protect your assets during more volatile times.
Even within the bond portion of your portfolio, it's important to diversify the types of debt securities you're investing in. NEARX, for instance, holds a wide range of municipal bonds, from school districts to transportation to utilities.
5. Municipal bonds help make America strong.
Speaking of schools, transportation, utilities, and other projects, bonds help state and local governments build, repair, and maintain much-needed services. This is one of the most compelling reasons to invest in short-term, investment-grade munis.
Not only do they have an attractive risk-reward profile and offer tax-free income, they also do precisely what they're designed to do, namely, fund projects such as hospitals and roads that benefit all citizens, young and old, rich and poor.
The Near-Term Tax Free Fund recently received the coveted 5-star rating from Morninginstar for the three-year performance period in the Municipal National Short-Term category and it's been rated four stars overall for many years.
The turnover of NEARX is very low and it has performed well against its peers. Additionally, the fund seeks preservation of capital and has a floating $2 net asset value (NAV) that has demonstrated minimal fluctuation in its share price.
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