can you be too safe w/ muni bonds? - municipalbonds.com
Can You Be Too Safe With Muni Bonds?
Most investors are aware that they can risk too much, but few realize that playing it too safe also has its own set of risks. By taking on less risk, an investor may compromise their ability to achieve their target performance goal, such as a retirement goal, for their portfolio.
Municipal bonds are widely regarded as a safe-haven asset class since government backing provides better credit ratings than most corporate bonds. Exemptions from federal, state, and local income taxes further create a higher after-tax yield than comparable private-sector bonds. These attributes have helped muni bonds perform extremely well over the past couple of years as investors sought out safe-haven asset classes amid the drop in equity prices.
Muni Bonds vs. S&P 500 Figure 1 – Muni Bond v. S&P 500 Returns in 2015 – Source: StockCharts.com
Below, MunicipalBonds.com takes a look at a few common ways investors may be playing it too safe with muni bonds and some key changes they may want to consider.
Overallocating Muni Bonds
The first mistake that investors often make is overallocating their portfolio to municipal bonds during troubled times in order to reduce their risk.
A number of research studies have shown that investors sacrifice between 1.2% and 4.3% of their returns due to attempts at market timing – also known as the behavior gap. According to Betterment’s analysis, investors trying to time the market over 20 years risk losing out on $117,700 in aggregate value for every $100,000 invested over the time period. This calculation was made using one of the more conservative estimates of 1.56%.
Betterment Estimated Growth Figure 2 – Estimated Cost of Timing the Market – Source: Betterment
Investors may be tempted to overallocate their portfolio to muni bonds during an economic downturn, but doing so could cost them money over the long run. Often times, it’s a much better idea to keep a steady allocation that is set up to meet a target goal over time rather than trying to time the market and avoid losses. Research suggests that few people are able to do the latter successfully over the long term.
Short-Duration Mistakes
The second mistake that investors often make is focusing on short-duration municipal bonds during troubled times in order to reduce their risk.
Duration is an important measure of risk when it comes to all types of bonds, including muni bonds. It’s a measures of how long, in years, it takes for the price of a bond to be repaid by internal cash flows. Bonds with longer durations carry greater risk and experience more price volatility than bonds with shorter durations. After all, longer durations mean that bondholders are tied to the bond’s interest rate over a longer period of time.
Interest Rate Effect on Bonds Figure 3 – Impact of Interest Rate Changes Based on Duration – Source: Blackrock
The problem with moving into short-duration as a safer investment than longer-duration muni bonds is that there’s an increased reinvestment risk. In other words, an investor may not be able to reinvest the proceeds of a short-term bond into a comparable bond when it matures. Longer-duration muni bonds have lower reinvestment risk because there’s a longer period of time before the bond matures and the interest rate differential may be minimal.
The Bottom Line
Most investors are aware that their portfolio can be too risky, but playing it safe has its own costs. Often times, investors purchase short-duration municipal bonds as a safe-haven asset. Market timing has a long-term cost known as the behavior gap, while short-duration bonds may pose a reinvestment risk. Investors should carefully consider these risks when evaluating muni bonds – especially during an economic downturn.
Best Online Brokers: Fidelity Wins In Barron’s 2016 Survey I have an account with TD Ameritrade and think for MF investors it is not a good choice.
1. For NTF funds it requires holding for 6 months to avoid fee.
2. For transaction fee funds you pay $50 twice when you buy and when you sell the fund.
3. Research information for MF is much worse comparing with Fidelity and Schwab.
4. You never know whether a load is waived for MF until you enter transaction.
5. Portfolio analysis is really bad.
6. The choice of NTF ETF is very limited.
I am thinking about moving to another brokerage but have not decided yet which one.
Q&A With Joel Tillinghast, Manager, Fidelity Low-Priced Stock Fund
Guggenheim Total Return Bond Fund Crushes Peers FWIW: Load waived at Schwab. $100 mini for regular and IRA. Also available as an ETF, viz., GTO but thus far with very low volume.
American Funds Says Low Fees, Manager Ownership Can Save Actively Managed Funds C shares are called "level load" for a reason. They charge higher expenses that are used to compensate the broker.
In addition, " American Funds Distributors pays 1% of the amount invested to dealers who sell Class C shares", which is why they'll also impose "A contingent deferred sales charge of 1% ... if Class C shares are sold within one year of purchase." That's from the typical American Funds prospectus.
However, unlike most C shares, those sold by American Funds ultimately convert to the noload F-1 class of shares.
Speaking of F-1 shares, they should be available via a fee-only advisor. (In the 90s, you could buy them without an advisor via some of the smaller discount brokerages.) Going through a fee-only advisor to gain access to noload shares isn't unique. You have to do that for DFA funds also.
Old_Skeet is correct - loads (other than level loads on C shares) don't get charged over and over, at least so long as one exchanges within the same fund family. (There used to be a measure of reciprocity, where a load family would waive loads if the purchase was an exchange from a load fund of any family, but that's nearly nonexistent now.)
That's a strong argument for keeping (not adding) money in a good load family. The load is a sunk cost. No additional load, and access to a variety of funds.
