CNNMoney’s well-respected senior editor-at-large, Allan Sloan, has a warning for municipal bond investors ? look out below, because even investment grade municipal bonds are mega-inflated by lighter-than-air interest rates and are sure to pop when interest rates (and tax rates) rise. Repeat: high grade munis, he says, are at risk (“Municipal bonds: A train wreck waiting to happen,” Allan Sloan, CNNMoney).
Investors should be especially wary of municipal bond funds trading at a premium above face value, according to Mr. Sloan.
The problem facing municipal bond investors is a double whammy. First, an investor who buys a municipal bond at a premium over face value (which is common in this price-inflated environment) only gets back face value at maturity, and the difference reduces the total return of the investment.
Second, municipal bonds are callable by the issuer (unlike U.S. Treasury securities and many corporate bonds). When a bond is called, it is redeemed prior to the maturity date and the stream of interest payments is cut short. That reduces the yield that would be expected if the bonds were held to maturity. In muni bond lingo, the measure of this double whammy is called the “yield to worst.”
Mr. Sloan advises investors considering a municipal bond mutual fund to find out what the yield-to-worst is of the underlying bond portfolio and compare that to the stated yield. He predicts that we will be unpleasantly surprised.
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