Are municipal bond funds a safe haven now?

[Jack Sprat]

With interest rates so low as they are now, would buying into a state municipal mutual fund be a bad idea now? States like NY, California, and Florida have tax exempt bond funds at Vanguard. Anyone with advice who is in the know about investments for currrent income. Bank CDs and traditional savings accounts rates are horrible right now.

[A HERETIC I AM]

1. If by "safe haven" you mean you can't lose money, then no...

however this might just be about the best time to buy any bond mutual fund, be it municipal or corporate. (Treasury Bond funds are a different matter in this environment)

A couple of things you should keep in mind about Muni Bond Mutual Funds;

If you live in a state with a state income tax, interest income from municipal bonds issued by other states may not be tax free to you. Your profile does not mention where you live, but if you live in say, Florida or Arizona (or any of the other states without a state income tax) you don't have to worry about it. You can buy any one of those types of funds and have no concern about the tax ramifications. If you live in California or New York, for instance, you are better off buying a CA or NY specific fund as interest payments are therefore tax-free.

Capital gains realized by the holder of a Municipal bond are subject to capital gains taxation. If you own a Mutual Fund that has such gains, you will possibly be subject to such taxation.

Most bond funds, be they Corporate or Muni, have historically seen their share prices valued in a fairly narrow range, say between $12.00 and $14.00 a share. Many, many stalwart, long existing bond funds have seen their share prices plunge over the last 18 months in an unprecedented fashion. This happened because the value of the bonds held in a given fund portfolio have had their values bid down on the open market and as a result the share price of the fund had to follow suit. Having said that, there quite likely exists a state of mis-pricing of many issues held by fund managers and the opportunity to buy into bond funds at what are either all time or multi year lows certainly exists. Lowered fund share prices often mean higher yields (depending on the individual fund, of course) so if you are looking for a vehicle to provide an income stream, this is as good a time as any to carefully step into that pool.

But...

The risks involved are by no means mitigated. S&P recently placed Florida's General Obligation bonds on a negative credit watch. There was an article recently that mentioned both S&P and Moody's ratings agencies have issued a blanket credit watch for every state and municipality in the country. This is not altogether surprising given the state of the economy but credit downgrades often affect bond prices negatively. The bond Mutual Funds may not have seen a complete bottom. Continued stress in the bond markets in general could further depress fund prices or at least stagnate them for some time. Again, if you are simply looking for an income producing security, this becomes less of an issue.

The Morningstar website has an excellent fund screening tool that can help you narrow your search. Morningstar has a massive database and has information and ratings on almost every Mutual Fund available.

I would suggest you also look into an Municipal Bond Exchange Traded Fund (ETF). Here's an article that briefly discusses these.

However you decide to proceed, you should THOROUGHLY read the prospectus of any fund you are considering and read the Morningstar reports and any other research you can find on a particular fund.

Hope that helps.

[Jack Sprat]

2. That's a huge help.

You gave the most thorough description of municipal bond funds. I thank you for your kindness and the time you took informing me.