THE TAX ATTIC with Jerry Coon

Municipal bonds, yea or nay?

Jerry Coon

The Coon family made a trip to Nashville, Indiana recently. Nashville is a larger version of Rockford with lots of shops that is located in Brown County, about 75 miles south of Indianapolis. They have an Ace Hardware that looked like it sells everything; just like Pete’s Ace does for us. They have the Big Woods Brewery located downtown with several nice brews; just like Rockford Brewing Company will provide when it opens next month. They have many, many shops just like Aunt Candy’s, Kimberly’s Boutique, and Great Northern. They had a festival going on just like our Harvest Festival and the town was packed. What Nashville has that Rockford doesn’t is a log cabin on the side of a mountain with a wonderful view of the surrounding valley. What a view it was, too. It’s very hilly around Nashville. We toured the Brown County State Park that contains over 15,000 acres. It has a few places with such steep grades that the signs warn bike riders to get off their bikes and walk them down the slope. That doesn’t quite jive with my thoughts of Indiana. I have spent most of my time visiting the relatively flat northern and central Indiana counties. However, after spending the weekend in the Nashville area, I have adjusted my thinking. It’s a beautiful area. It’s still Indiana, but it is beautiful.

There have been many articles published recently about the fiscal state of municipalities. Across the United States, here and there, municipalities have either declared bankruptcy or have defaulted on municipal obligations. Earlier this year, Stockton, California initially defaulted and then declared bankruptcy. According to Kiplinger’s Personal Finance magazine, up to 341 million dollars of investor money could be lost in the process. In 2011, Jefferson County, Alabama filed for bankruptcy. It is thought likely that up to 3.47 billion dollars could be lost. Before these poor economic times, it was almost unheard of for a municipality to not pay its debts. The instances of default could be counted on one hand. It’s a different world now it seems.

When times were good, some cities over-spent on capital assets. Stockton sold millions of bonds to finance a marina, a stadium, a sports arena, a new city hall, and several parking garages. Jefferson County sold over a billion dollars of bonds to finance a county-wide sewer system. I doubt if either Stockton or Jefferson County had a five-year capital asset budget in place like we do here in Rockford. They just presumed that good times would beget good times. How wrong they were. Unfortunately, there will be other municipalities that will sadly follow suit by defaulting or bankruptcy. So the question arises, should investors continue to buy municipal bonds? The answer seems to be yes.

Over-all, according to the research firm, Municipal Market Advisors, only .3% of municipal bonds have gone into default in the past three years. That’s an extremely small amount of non-payment and indicates that most municipal bonds are safe. Presuming they are still a viable product to buy, there are two ways to buy municipal bonds. The first way is to buy the actual bond. You receive the interest payments directly from the issuing municipality and, if you hold the bond to maturity, you turn in the bond and the municipality pays you the face amount in full. If you are buying the actual bonds, it’s very important to do your homework. Buy bonds from municipalities like Rockford with a great history of making every payment. There are a number of rating agencies and scales. It’s best to stick to those highly rated municipalities that will be the best bet to pay your money back.

The second way to buy municipals is to purchase a municipal bond mutual fund. Experts manage the fund; do the picking; and you buy their expertise. They purchase a basket of municipal bonds and you purchase a portion of that basket. The mutual funds are more liquid than owning a bond because the mutual funds are required to make a market for their shares. If you want to liquidate your entire portfolio or just a few shares, you just call up the mutual fund and inform them of your intent. Within one day, it’s sold. When you want to sell an individual bond, someone else has to want to buy that individual bond. It’s an all or nothing issue with that particular bond. Finding that person and having them buy the bond for what you want to sell it for is sometimes an issue.

Beyond being a relatively safe investment, municipal bonds carry the distinct advantage of distributing tax-free income. Going forward, tax-free income might be particularly valuable, regardless of which candidate wins our presidential race. With a 15 trillion dollar debt and climbing by the second, it’s inevitable that taxes will go up. Tax-free income could be difficult to beat. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent and Registered Tax Return Preparer. He owns Action Tax Service on Northland Dr. in Rockford. Contact Jerry through www.actiontaxservice.com

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