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Muni bonds: It's not what you make but what you keep

Investing in tax-free municipal bonds provides a degree of safety with the added benefit, in most cases, of receiving earnings exempt from federal and state taxes.

However, muni bond performance over the past couple of years is tricky to assess.

Interest rates have generally increased as a consequence of Federal Reserve intervention, which reduce the current market value of fixed coupon bonds and can be reflected as an unrealized capital loss in a portfolio. As a result, bonds can appear, at first glance, to be less attractive relative to other investments, such as large-cap equities.

But for buy-and-hold investors, principal contraction caused by rising rates doesn’t have to be realized. Instead, investors have the flexibility to be patient and let the bond mature rather than sell and realize a loss.

Moreover, rising rates provide an opportunity to reinvest interest payments and principal redemptions at higher rates of return. In other words, a long-term approach to owning individual bonds is rewarded with both greater yield and safety.

As summer winds down, new issue volume is up year over year, even in spite of the record November and December issuance leading up to tax reform.

Rising new issue volume may be the new norm as a national infrastructure policy has failed to leave the station, and local governments, schools, and states can’t wait. Most local and state government budgets have a fiscal year ending June 30.

Local governments prepare their tax rolls for the 2018-2019 fiscal year property tax bills in late summer to be prepared for mailing to property owners in the fall. And muni and school district issuers tend to time their new tax-secured issues for June, July and August to get their first interest payments covered by the new fiscal year’s tax collections.

Fresh money available to invest in muni bonds has increased as a consequence of tax reform as investors have piled into the market and regularly scheduled principal and interest payments have been made on outstanding debt at the beginning of each month.

When thinking about long-term investments in tax-free munis, the old adage “it’s not what you make but what you keep that matters” couldn’t be more apt.

This story is part of a 30-30 series on tax-advantaged investing.

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