It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong.Markets are designed to allow individuals to look after their private needs and to pursue profit. It's really a great invention and I wouldn't under-estimate the value of that, but they're not designed to take care of social needs.
Wednesday, April 6, 2011
Municipal Mess or Opportunity
Death and taxes are inevitable. You can't really do much about the former but you can certainly do a lot about the latter. As the tax filing deadline approaches I often take the opportunity to plan a little for the current year.
Looking at my tax return is not very exciting especially when I look at the interest income, or lack thereof! If you're lucky you can make about 1.25% on your money at places likeEverbank. Your regular bank is paying a quarter of that if that. You can invest in bonds, but the returns on short term corporates are running below the inflation rate and then you have to pay taxes on any interest received. Dividend paying stocks are an option. Companies like Walmart are paying north of 2% and some of the pharmas are paying north of 5%. But that also puts you at risk for a market correction.
The alternative that I like is the Municipal sector, specifically closed-end municipal bond funds, but only the type that meet the following criteria:
- They must invest in higher quality bonds - No use of leverage...many muni funds try to increase their returns by using leverage thereby owning more bonds and also putting themselves at increased interest rate risk - They must be insured. Insured muni funds give you the added protection against default by the issuer. These funds pay a lower yield but they are less likely to get hurt as well.
Dividends from closed end muni funds are usually paid monthly and are not subject to Federal or state taxes. Right now some of the top funds are paying close to 6% which works out to over 9% if you are in a higher tax bracket since the dividends are not subject to tax - of course you should always consult a tax adviser to make sure any strategy including this one is appropriate for you.
The reason that munis are paying so much is because there is a lot of negative news in the press about the potential for default. Listen, defaults are going to happen as local municipalities run into hard times because of economic conditions. But, mass defaults - very, very unlikely. Even during the Great Depression, wither crises like the 1973 bear market, muni default rates were less than 2%. With the economy recovering in many states, the risk of default decreases even in the extreme situations.
So, if you're looking to park some cash, take advantage of the muni correction and pick up some high quality muni funds and not only keep more of your money, but make more on the money you have. Otherwise you will likely be paying more tax and earning a lot less at a time when returns from fixed income is abysmal.
Oil and Gold
Both resources are rising to new highs as a perfect storm of energy issues and political instability grip the globe. Events in Libya are forcing energy traders to bid up the price of oil in anticipation of more upheavals to come. Besides Mexico, Canada, Norway and the USA, most of the oil is held in countries and regions that are in the crosshairs of popular revolutions. What we are seeing right now is small change...what would oil do if one of the bigger producers like Venezuela or Iran becomes unstable. That is what is sending oil higher, not the old news...but what may yet come.
Gold is acting as it should during periods of crisis. Crisis this time is not limited to countries foreign to us. Gold's rise is a harbinger of bad news on the inflation front as the world's largest debtor, the USA, cannot get its fiscal house in order. Congress is bickering over a hundred billion dollars in cuts...yet 44% of the budget is earmarked for entitlements that no one is willing to talk about. A one billion dollar cut in a debt that exceeds 14 trillion dollars is much like you or I debating about spending an extra dime at dinner.
Both oil and gold will move much higher unless we see concrete action in Washington, and a cessation of violence in the Middle East. Problem is that there is a greater probability of the Easter Bunny being declared real than either of those situations changing.