Why this tax-free income investment might be a great diversifier for your portfolio
Investors are in a tough spot with today’s market. Fortunately, in this Digest, we’re going to suggest a specific investment that can help you sidestep this “between a rock and a hard-place” situation.
But first, the challenge …
We’re now 10 years into a bull market that’s feeling long in the tooth. Worries are mounting that we’re closer than ever to a sustained, bear market.
For instance, just this past Friday, we received news that hiring growth slowed sharply as the U.S. added just 20,000 jobs in February. Economists were looking for 180,000. Certain financial talking heads are already talking about whether this is the first sign of the bear that’s to come.
On the other hand, other economic indicators paint a rosier picture. For instance, famed investor and analyst Louis Navellier points out that corporate earnings — which ultimately drive stock market performance — largely held up well for the Q4 earnings season that just wrapped up. While he believes we will see a narrower set of companies producing outstanding earnings as 2019 progresses, plenty of those companies still exist.
But this leaves investors in a challenging position …
If you sit on the sidelines with the goal of avoiding an impending bear market yet get it wrong, you miss out on stock market gains and watch the slow deterioration of your wealth from inflation. And who knows how much longer this bull market could last?
Yet, if you invest in U.S. stocks now to keep your money working for you, yet get it wrong, you watch your wealth vanish before your eyes as the market falls into bear territory.
Neither choice appears all that attractive — fortunately, you have other options.
***Today, let’s discuss a potential middle ground that leaves you less vulnerable to a stock market selloff, yet gives you solid income — and perhaps capital gains too
When is the last time you considered municipal bonds?
To make sure we’re all on the same page, let’s briefly go over the features and benefits of municipal bonds. Municipal bonds — often called “munis” — are issued by state and local governments rather than the federal government. They’re often a way for the municipality to raise money for public works. Think “a new bridge” or “a new wing to a public hospital,” something along those lines. Munis are considered safer than most corporate bonds, while offering higher yields than Treasury bonds.
Now, when you’re investing in bonds, you’re generally doing so for the income. And that points us toward perhaps the biggest benefit of munis — their interest payments are generally exempt from federal income tax, and usually excused from state and local taxes too (usually when the investor lives in the municipality where the bond was issued).
To get a better sense of how great this is for investors, let’s put some real numbers on it.
Let’s say you’re in the 35% marginal tax bracket. And let’s imagine you’re looking at an income investment with a hefty 5% yield. What would be the equivalent yield if you didn’t have to pay any taxes on that 5%? 7.7%.
That’s a huge difference, especially in this low-yield environment.
Below is a chart for a better understanding of the yield benefits from municipal bonds.
Source: AAII
***Now, even though most investors buy municipal bonds for their cash flow, there’s also the potential for capital gains
That’s what we’ve been seeing so far in 2019. From The Wall Street Journal:
Municipal bonds are enjoying their strongest start to a year since at least 2006, defying expectations that President Trump’s sweeping tax overhaul would depress demand in the market.
Investors poured more than $15 billion into municipal-bond funds in the first eight weeks of the year, the most over that period in at least 13 years, according to net inflows tracked by research firm Municipal Market Analytics. Demand stayed strong through the end of February, Investment Company Institute data show.
When you combine the yield from munis with their capital gains, you get total return. And, as you can see below, it turns out the total return from munis has been outperforming both corporate bonds and Treasuries since 2018.
***Neil George, editor of Profitable Investing and our resident income investment expert, sees reasons to continue liking munis right now
Neil has a long track record of winning investments. In Profitable Investing, he specializes in finding overlooked, high-quality income plays — no matter the market conditions. Whether through dividend stocks, REITs, or bonds, Neil helps his subscribers better understand and navigate the income markets.
Let’s start with Neil’s note to subscribers back in January:
Municipal bonds are benefiting from economic growth and state and local tax revenue growth. For the fiscal year, 40 of the 50 states are reporting on-track or better revenues, with personal tax revenues up 7.90%. This is bringing better credit to the bond sector. The portfolios of the closed-end funds are all performing much better than the stock prices. This means discounts of the funds’ bonds net asset value (NAV) are all in the double digits, into the 12% range.
With ample tax-free dividend income, these are truly bargain buys right now at current prices-use taxable accounts, of course.
Now, Neil’s comments came before the $15 billion muni inflows that marked the first eight weeks of 2019. Does that change his views toward munis?
Fortunately, Neil shed light on this in his Profitable Investing update from last week:
As a veteran banker and bond trader, I always follow the hand of the government when looking at the economy, the markets, and the stocks and bonds inside Profitable Investing. Government makes for a massive portion of the economy, from spending and tax policy to regulatory actions and policy initiatives.
It isn’t all about the federal government when it comes to providing a helping hand, however. States are also doing their part to drive a big and attractive market. Over the past year, I’ve been recommending that you capitalize on the positive developments in the $3.9 trillion municipal bond market.
The stronger economy is driving state and local tax revenues, which is resulting in significant improvements in the fiscal and credit conditions of the muni bond issuers. According to the National Conference of State Legislatures (NCSL), 48 of the 50 states are meeting or exceeding revenue expectations for the fiscal year. In addition, the National Association of State Budget Officers is reporting that rainy-day funds are rapidly rising, with gains of $33 billion from 2010 into 2018.
This is really moving the muni bond market now, with the Bloomberg Barclays Municipal Index showing big gains in the past few months.
Bloomberg Barclays Municipal Bond Total Return Index-Source Bloomberg Finance, L.P.
Inflows into the market — particularly into funds — are soaring from investors with high state and local taxes (SALT).
But the muni market still has bargains.
Neil goes on to highlight three closed-end funds from his Total Return Portfolio. They’re still trading at discounts to their net asset values by as much as 8.30%. Meanwhile, on a taxable basis, they’re yielding in the 7% – 8% range.
Out of fairness to Neil’s subscribers, I won’t reveal all of them. But one which you might want to consider is the Nuveen AMT-Free Municipal Credit Income Fund (NVG). At the time of this writing, its forward yield is 8.45% and its discount to its net asset value is over 8%.
If you’d like to read more from Neil on munis as well as other safe income investments, click here.
***Coming full circle, it’s time you considered a muni bond investment
The stock markets are showing some jitters. Depending on your specific investment goals, you might not want to leave all of your wealth vulnerable to whatever the coming quarters holds for stocks. If so, you should look at munis. Tax advantages, solid income, and the potential for capital gains are just three reasons they might deserve a place in your portfolio.
We’ll continue to keep you up to speed.
Have a good evening,
