HOW TO SHOP FOR A MUNICIPAL BOND by John Sadeghi

While municipal bonds tend to be good investments for high-taxed investors, their wide range of benefits have attracted a large array of investors. Some of these benefits include:

• Attractive rate of return free from federal, state and local taxes
• Predictable stream of income
• Wide range of choices with regard to quality, maturity, and type of bond
• High degree of safety with regard to payment of interest and principal

Now that I’ve convinced you that municipal bonds are a good investment I want to touch on how to shop for one. Always remember the most important rule of investing - diversify. Buy insured bonds as well as non-insured. Out of a misplaced aversion to risk, all too many investors are demanding the safety of insured bonds. This is an overreaction since historically the municipal bond default rate is 1%. In addition, the insurance is not free. It cuts into your rate of return. Buy some A rated bonds, BBB bonds and even some special tax bonds that are non-rated to spice up your portfolio. My simple point is that since you should always diversify your investments, avoiding non-insured municipal bonds is foolish. If you build a portfolio divided among 20 bonds from different issuers with different income streams backing them (general obligation, sewer, hospital, etc.) you have diversified away much of the risk of default.

If you buy insured bonds, make sure no more than 20% of them are covered by a single insurer. The reason again is diversity. A big disaster could mean trouble for a single insurer. Thankfully we haven’t tested an insurer in a meaningful way. But it is a possibility that you should always consider.

Buy premium bonds. These are bonds that are offered at a higher price than par or $1000 per bond. Why? Because they generally pay a higher current income that you can reinvest. Also, bonds that offer a higher coupon or yield usually hold up better in price when rates rise. These bonds are called “cushion” bonds. Contrary to common perception paying more than par for a bond is a good idea.

My last and most important rule of investing in municipal bond is that it pays to have a seasoned bond professional help you build a good portfolio. Work with a bond specialist that knows how to find a good value and makes you aware of opportunities in the market.