With higher tax rates looming (which is the real subtext of all this fiscal cliff hullabaloo), is now a good time to buy tax-free municipal bonds? A lot of people apparently think so. In recent weeks, prices have soared for mutual funds and ETFs that invest in munis.
I’m certainly not griping. I own a truckload of these things, as I imagine you may, too. BlackRock MuniEnhanced Fund (NYSE:MEN) has since rolled up a stunning total return — capital appreciation plus reinvested dividends — of 53%. Eat your heart out, old Daddy Dow!
However, I must add a tiny detail. When I was scooping up munis two years ago, it was in the midst of a panic triggered by the doomsday prophecies of Wall Street analyst Meredith Whitney. 60 Minutes and numerous lesser media outlets were screaming at you to sell tax-free bonds.
A few contrarians, myself included, had the moxie to advise exactly the opposite. My Profitable Investing subscribers have been richly rewarded as a result.
Now the shoe is on the other foot. The crowd, with all the foresight of Mr. Magoo, has belatedly woken up to the fact that, duh, taxes are going up less than a month from now. So, everybody wants to load up on munis.
My advice: Cool it. I suspect you’ll have plenty of opportunities to buy tax-exempt paper at lower prices after the turn of the year.
Lower prices? How?
Well, if the cliff negotiators come up with a tax package that avoids the extreme increases feared by some investors, today’s stampede to buy munis could turn into an equally passionate rush for the exits.
Recommendation: Hold any munis you purchased earlier at lower prices, but DO NOT BUY more at today’s levels.
Instead, I suggest buying high-yield stocks that have been knocked down by worries about a potential (indeed, very likely) rise in dividend taxes next year. Many dividend-rich names have dropped far enough to discount even a drastic tax hike. If Congress enacts a more modest boost (from 15% to, say, 20% or 25%), dividend stocks could rebound smartly.
Recommendation: I’m warming again to Microsoft (NASDAQ:MSFT). The new Windows 8 operating system appears to be gaining traction, and who knows? Maybe Microsoft’s Surface tablet will wrestle a few business users away from the iPad.
In any event, MSFT is cruising toward another year of record profits, having tripled its earnings per share over the past decade. With $67 billion of cash in the bank, Mr. Softee should have no difficulty paying the current dividend — and then sweetening it again in 2013.
Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.