Municipal Bonds (not fund)

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DangerDad
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Municipal Bonds (not fund)

Post by DangerDad »

My brother is in his 60’s, retired and doing well financially. He recently shared his financial plan w me—it’s not a typical Boglehead style plan to say the least. However I recognize that personal finance is very personal, different strokes for different folks, etc. That being said, I’d appreciate a reality check from you fine folks. I have only a rough outline—here’s what he told me: 72% municipal bonds (individual bonds, not a bond fund) and 28% stocks, mostly individual stocks. His portfolio is managed by a Money Guy who charges “less than 1% AUM.” He said his municipal bonds pay slightly over 4% which supplies way more than his monthly expenses. I asked him what he does with the excess funds from these bonds and he said he buys additional municipal bonds. There are various aspects of his plan that concern me, including the AUM fee and the big bet on individual stocks. My biggest concern is the 72% allocation to individual municipal bonds—but this is also my biggest area of ignorance. I’m very familiar with bond funds but I have zero experience investing in individual bonds. Does his plan seem reasonable to you folks? Does that large allocation to individual municipal bonds create risk via inflation? Thanks in advance for your input.

DangerDad
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David Jay
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Re: Municipal Bonds (not fund)

Post by David Jay »

His current bonds are paying 4%, but the bonds he is purchasing now are paying far less. This will continue to be the case if interest rates remain at the current low level, with his “income” falling from year-to-year as he redeems high-interest bonds and replaces them with low-interest bonds.

If I were him, I would look at his reinvestment strategy (buying more bonds) because he is locking in very low rates on the new bond purchases - rates that likely will not even keep up with inflation.
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MahoningValley
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Re: Municipal Bonds (not fund)

Post by MahoningValley »

I am also not well versed on Municipal Bonds, but I do know they require an extraordinary amount of due diligence. Also, you need quite a large sum of money to invest to build a proper muni bond ladder. I would not fault the adviser his paycheck if he is doing a good job of providing return for your brother.

With regard to percentages, I am reminded of Groucho's response to "bonds don't make you much money". *

I personally own MuniBond CEFs in my taxable portfolio and the tax free dividends are reliable month after month. I used the dividends to make the monthly payments on my wife's last two cars.






* "They do if you have enough of them"
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Elric
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Re: Municipal Bonds (not fund)

Post by Elric »

Agree with previous poster. My municipal bond allocation in taxable is also in individual bonds, in a ladder. When I reinvested those that rolled over in the past year, yes, of course I got far less interest, as is true for bonds in general.

Being 28/72 is quite conservative. On the other hand, maybe he's "won the game" and chosen to bow out. Without knowing a lot more about his investments and his overall situation and finances, it's not possible to say. When you've "won the game" you have a lot of viable options, from becoming quite conservative, as your friend seems to be, to being more aggressive than others, since you can afford to take bigger risks. Or anything in between.

Rolling over the interest into more bonds may or may not be a good thing. Money is fungible, and one really needs to look at what his overall asset allocation is, whether or not it's changing, and if so, by design or not. You say that the bond income more than covers his expenses. Does this mean that all of his stock gains (dividends plus growth in share value) stays in stocks? If that's the case and his stock portfolio is keeping up with the overall market, over time his stock allocation would be increasing unless he's rebalancing. So not enough information to judge.
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retired@50
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Re: Municipal Bonds (not fund)

Post by retired@50 »

It's likely that the new municipal bond purchases are better for the "Money Guy" than for your brother. He's likely getting a commission or a markup on every bond he sells to your brother. The trouble with the municipal bond market is that it's huge and opaque. Individual bond holders typically get mistreated, unlike the big players like Vanguard.

My father in law was in a similar situation and would have been better off owning a Vanguard municipal bond fund (which is the current situation, since we rescued him).

I'd also be curious about how many individual stocks make up his 28% equity portfolio. If it's like 30 stocks, somewhat equally divided, it may not be all that bad, but if all the money is in only a few companies, then the risk is heightened.

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Re: Municipal Bonds (not fund)

Post by backpacker61 »

It sounds to me as if he's doing okay. I would wonder about the credit quality of his municipal bonds. The approach your brother is taking is not how I would choose to do things, but it sounds as if it's working okay for him. "1% AUM" for a financial advisor is pretty typical, assuming he's not also getting commissions. If he is a fiduciary, I would be okay with it, but still not how I would choose to do it.
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Re: Municipal Bonds (not fund)

Post by orklc »

Is the slightly more than 4% for the muni bonds the coupon yield (no surprise), or is it the actual return (would expect to be much less than 4%)?
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DangerDad
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Re: Municipal Bonds (not fund)

Post by DangerDad »

Thank you for the responses thus far.
I don’t know any details re the credit quality or duration or coupon yield of the municipal bonds.
It appears this is just one (probably) valid approach after winning the game, even though it isn’t what I would choose.

Cheers,
DangerDad
MikeG62
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Re: Municipal Bonds (not fund)

Post by MikeG62 »

Did your brother come to you asking for your input? If not, I’d be careful offering any. You say he is retired and doing well so doesn’t sound like he’s got a big problem.

Having said that, I doubt he is correct when he says he has bonds that yield 4.0% “based upon his purchase price”. I can believe he has bonds with a 4.0% coupon (so do I), but unless he bought these bonds over 15 years ago (or he is buying high yield muni’s) it’s very unlikely he bought them at par or anywhere near par. FWIW, I own approximately three dozen individual muni bonds purchased over a long period of time so I’m pretty familiar with them. I don’t know that I have any with a yield of 4.0% based upon my purchase price. I also haven’t bought a single muni bond in over two (maybe three) years. Muni yields have been unappealing low for a long while now.
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Mr. Potter
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Re: Municipal Bonds (not fund)

Post by Mr. Potter »

When my parents passed away in 2011 I inherited about 40 individual muni bonds all paying 4% -5%. The last one matured in 2020 and even though the tax free income was great it wasn’t fun trying to figure out the cost basis every tax season. Upon their death I moved the bonds from Ed Jones to Vanguard. All I can say is keep your own records for taxes. A bond fund is waaaaay less hassle and it’s totally liquid, good luck selling individual bonds on the secondary market, you’ll get taken to the cleaners.
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Elric
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Re: Municipal Bonds (not fund)

Post by Elric »

Oak&Elm wrote: Mon Jul 26, 2021 5:11 pm good luck selling individual bonds on the secondary market, you’ll get taken to the cleaners.
This is true. At the same time, if you buy and hold to maturity, you can pick up some better deals by purchasing small odd lots on the secondary market. Just be sure you don't have to sell them in turn.
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NotSoDaring
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Re: Municipal Bonds (not fund)

Post by NotSoDaring »

We have laddered individual municipal bonds that provides us with triple tax free income in a high income state and city. Originally we were 30% stocks (mix of funds and individual equities) and 70% Munis. All 5% bonds .04% management fee. We stopped buying more bonds in 2019 and have been rolling them into equities as they came due. We are now down to 50/50, with two more coming due between August and the end of the year.

This plan was recommended to us by two different asset management firms, in that we needed the highest return with the lowest risk. 4.6% triple tax free return in NYC gave us the equivalent of about 7.5 - 8% return on taxable.

I would guess your brother has far more in assets than he needs if at even lower rates they are still providing him with enough income.
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Artsdoctor
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Re: Municipal Bonds (not fund)

Post by Artsdoctor »

I'm going to go out on a limb here.

Your brother (and many investors) might believe that the coupon of 4% means he's "earning 4% on the munis." In fact, that often will represent a large misunderstanding. That's the coupon, not the yield. You can still buy munis with coupons of 4% or so but you're going to pay a premium for them. So you might have a bond that matures at 100 but you paid 120 for it, and you're making 4% on the 100, not the 120. All the while, you'll be amortizing the 120 down to 100. So in fact, your 120 investment will pay you 100 at maturity. There are many, many misunderstandings associated with individual munis and this is one of them.
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Re: Municipal Bonds (not fund)

Post by grabiner »

Artsdoctor wrote: Mon Jul 26, 2021 7:22 pm I'm going to go out on a limb here.

Your brother (and many investors) might believe that the coupon of 4% means he's "earning 4% on the munis." In fact, that often will represent a large misunderstanding. That's the coupon, not the yield. You can still buy munis with coupons of 4% or so but you're going to pay a premium for them. So you might have a bond that matures at 100 but you paid 120 for it, and you're making 4% on the 100, not the 120. All the while, you'll be amortizing the 120 down to 100. So in fact, your 120 investment will pay you 100 at maturity. There are many, many misunderstandings associated with individual munis and this is one of them.
And he may have been earning a 4% yield when the bonds were bought. If he bought a bond for $1000 which paid $40 per year, he would have a 4% yield. With interest rates dropping, the bond might now be worth $1200, so he could sell the bond for a $200 capital gain, getting a cumulative return much higher than 4%. That gain will go away as he holds the bond to maturity, with future total returns lower than 4%. (In this situation, it is probably still worth holding the bond, as the capital gain will be taxed, while the coupon payment will not.)

On the other hand, he might have also been advised to buy the bond at a premium, so that the coupon payment came from the beginning with a decline in bond value. (In this situation, part of the coupon is treated as a return of capital, not reported as a dividend, so that there will be no capital loss when the bond matures.)
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