Muni Bond Insurance : About as Useful to your Investment as a Kids Comfort Object

Our society has come to value insurance in the same way little tikes value their baby blankets and teddy bears. As children we loved our teddy bears because they would protect us were anything to happen through out the night that the good 'ol night light couldn't take care of. As adults we pay up for insurance because it's supposed to protect us against any unforeseen financial boogie monsters. The majority of the time insurance serves its purpose when dealing with types of insurance like life insurance and car insurance but a teddy bear (insurance company) can only protect a certain number of people (securities), if it's spread too thin, or protects someone who lives in a ghost and ghoul ridden house (junk), it's protection powers fade to nothing. Basically in the Fall of 2008, nearly every municipal bond insurance company had its ratings lowered from AAA down to at least Aa, in most cases a lot lower than that. The reason for this is that they were insuring other types of securities aside from municipal bonds such as the CDOs that we've all heard about that started our economy to tumble. Once these securities went bad, so did the insurance companies.

The difference is that while the CDOs actually were poor investments, the municipal bonds that the same insurance companies were insuring were fine. Of course the ratings were lowered on these bonds because they could not show the insurance company's AAA which in some cases is now CC but the true quality of the bonds stayed the same insurance or none.

Municipal bonds have been known as one of the safest securities you could buy for over 100 years now, bond insurance came about in the late 1980s and shortly after that nearly 75% of all munis were rated AAA. The underlying quality of munis never changed, municipal insurance companies just came up with an easy way to make a profit. Basically as investors we love to hear that our investment is insured (comes with a teddu bear) so we'll pay more for an insured security than one that doesn't have insurance (EVEN WHEN THE SECURITY IS STRONGER THAN THE INSURANCE COMPANY). Now that the insurance companies are not worthy insurance to pay for, nearly all the municipal bonds that these companies insured are doing fine without the insurance. The moral of the story is, don't pay up for a bond that has insurance.

So how do you tell a municipal bond's true quality if you can't depend on the insurance? First off, look at what is paying the bond (ask your broker) specifically who is holding your principal and how are they going to afford to pay your interest? If it makes sense to you such as, a general obligation bond (payable from property taxes) or a essential service revenue bond (water, sewer, gas, electric) which are payable from everyone's bills, then these are reliable sources of revenue to pay off your bond. You want sources of revenue that people don't have the option to pay such as taxes, bills of an essential service, and tolls. Another factor to look at is the bond's rating without insurance. Usually this will give you a good idea of the security's quality but not something you should always depend on. Most important is what is paying your bond.

While there are some types of insurance in our society that can give great comfort such as car insurance, municipal bond insurance is just not in the security blanket category. Don't fall for it.

Taxes are Going to be Hiked higher than a Pair of Tights One Size too Small

In America everyone likes to consider themselves middle class but the fact of the matter is 2 peoples' incomes can vary in the hundreds of thousands and both will declare themselves in the middle. I'm not concerned with changing peoples ideas of where they fit in our economical scale, but more with informing them what type of bond would be the best investment for their tax bracket. While taxes already eat a big chunk of our paychecks, that meal is about to get supersized. Now that our economy is not spiraling out of control, we are going to have to pay for our nice little bailout package that helped put the breaks on. And the way we're going to pay for it is through our taxes being raised, by a lot. Most people don't even know what tax bracket they're currently in and your tax bracket is probably a lot higher than you think. I wish I had better news, but it's only going up. Just to give you an idea, in 2009 a single person who makes $34,000 a year is already in the 25% federal bracket. That doesn't even take into account people who live in states and cities that have additional taxes (most states do). The higher a person's bracket is, the more sense it makes for him or her to invest in tax free bonds. Once your paycheck is already taxed at that high rate, you don't want your investment income to be taxed there too!

A general rule of thumb to go by is if your bracket is 25% or above, you should be looking for tax free bonds. If you live in a state such as NY, CA, MA, MD or MN that have higher state income taxes, you should really stick to buying tax free bonds within the state you live in to get the added bonus of your investment income not being subject to state tax. Just as an example, if you buy a 5% tax free bond and are a NY resident in the 25% bracket, if you buy a NY bond, that's another 6.85% you avoid having to pay on your interest. To get your taxable equivalent, you add your state and federal bracket, subtract it from 100 and then divide that number into the yield you bought the bond at. (25% + 6.85%= 31.85%, 100-31.85=68.15, and 5/68.15=7.34%) Basically you would have to get a taxable investment yielding a 7.34% to equal your net income on a tax free 5% bond.

If your bracket is below 25% (right now less than 34k a year) you should be buying taxable bonds. While many people buy corporate bonds as taxable investments because we want to support our favorite companies, we've all seen what has happened to a lot of corporations in the past year. Once upon a time bond holders had first claim to the company's assets when it went under, now with all these different type of bankruptcies bond holders end up getting screwed. To be safe, and still get a higher yield you should look for taxable municipal bonds. These bonds have the safety of a municipal bond with the yield of a taxable entity, if you're in a bracket lower than 25%, these bonds are great! To get your post tax yield multiply your bracket by the yield you're getting and then subtract that number from your bond yield. For example if your taxable bond yields 6% and you're in the 15% bracket, to get your true yield you 15%*6%= .9 then 6-.9 = 5.1%

Basically, while we're all in the middle class, we're not all in the same tax bracket so get out there, try on some bonds and see what fits!

The Skinny on our Anorexic Interest Rates

I'm sure everyone at some point in the past six months has read an article discussing how interest rates are at record lows. What does this mean? Basically that the Fed is keeping rates low to encourage us to spend more. Think about it if it were a credit card, the lower your rate, the more likely your are to to splurge on those shoes on that card as opposed to another card with a higher rate essentially making your shoes more expensive.

A year ago when this entire economic catastrophe hit, people were scared of everything from the very riskiest of stocks to the very safest of bonds. Now that things have settled down, everyone's new fear is inflation and interest rates sky rocketing. I don't believe that's going to happen and here's why. While our government is printing and spending money like a bunch of drunken sailors, you and I aren't seeing any of it. This money is going to all of the large institutions that put us in this mess to not create any more turmoil than they already have. We're all aware that we're not seeing any extra money and the money that those of us who still have jobs make, we're tucking away to pay off our credit card bills from last year's shoes. Basically, the American consumer is not ready to pull us out of this mess like the Fed is hoping. Since we're not ready to spend our hard earned cash, and it will probably take most people at least 3 more like 5 years to pay off their debt, interest rates will most likely not turn around for at least another 5 years. Also, when they do, our economy will not shoot up in a straight line, it's going to be an uphill climb and not like a steep black diamond, think bunny slope.

So basically if you're going to invest in a bond and you like to look short term, look at least 5 years out because if you buy something just 3 years out, your bond is going to mature, rates will still be low, possibly lower and you will have to reinvest at a low or even lower rate. Moral of the story is lock in a bond yield to weather out this storm because right now interest rates seem to be stuck on a prepetual cleansing diet.