The Alchemist: Municipal Bonds

Posted in Money Matters on September 23, 2002

The following is this week’s installment of The Alchemist, a column by Mensan Al Thomas, author of If It Doesn’t Go Up, Don’t Buy It. Click ‘Read More’ below for this week’s article, “Municipal Bonds.”

Municipal Bonds

by Al Thomas


Because there are so many stocks that are NOT paying dividends
and also going down people are looking for a safe investment that will pay a
decent return and also won’t lose money. Slowly folks are beginning to think
about bonds of which there are all kinds.


Cities and counties have been issuing bonds. There are the school bonds for
building new school buildings and the local district issues these. How about
building a new sewage plant? Yes, a special bond could be used. If you live
in a big city there could be bonds for that new stadium or maybe an aquarium
or a huge theme park. Toll roads are a big money maker, aren’t they?
The businessmen who want to build these attractions get the permission of
the local government to issue them and they have the blessing of the city
council or whoever and then go out and collect your money. These are not
what are called investment grade bonds. They rank below the A classification
and as a result you, the bond buyer, get a much higher rate of return.
Remember this – the higher the rate of interest the riskier is the bond. Of
course, if your municipality says this has their blessing than it should be
O.K. Right?


The citizens of Denver popped for a new aquarium to the tune of 1.2 million.
It was supposed to bring in more tourists and pay for itself with tickets. A
fraction of those visitors showed up and now it looks like the project might
default. They do not have enough money coming in to pay for the fish food
and service the debt. And many toll roads are not getting enough traffic.
The spending spree of local governments has sponsored (not guaranteed) bonds
equal to more than $320 billion this year. There are $1.6 trillion in
municipal bonds. When the projects don’t pay out the local governments can
raise taxes to pay the shortfall, can’t they? Sometimes they can, but many
times they won’t. The present default rate is running 10 times its historic
norm.


Bonds can be as risky as stocks. You must be careful where you invest your
hard-earned cash. If you buy any bond other than a U.S. treasury you insist
a reputable insurance company insure the bond. Just because the mayor says
it is good doesn’t mean anything.
One of the safest ways to buy bonds in a no-load bond mutual fund and there
are hundreds of them. You can buy as little as $1,000 increments. Your
broker will not tell you about them.


If you insist on buying individual bonds you want to know the true net
yield, is it investment grade and is it insured. Bonds can be as dangerous
as stocks. That is why a mutual fund bond manager is important, but you
still must be in an investment grade fund.


Copyright Albert W. Thomas. All rights reserved. Author of “If It Doesn’t Go Up, Don’t Buy It!” www.mutualfundmagic.com. Comments to al@mutualfundmagic.com.