When to Buy Municipal Bonds

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Welcome to Something More with Chris Boyd.

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Chris Boyd is a certified financial planner, practitioner,

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and senior vice president and financial advisor at

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Wealth Enhancement Group, one of the nation's largest

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registered investment advisors.

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We call it Something More because we'd like

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to talk not only about those important dollar

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and cents issues, but also the quality of

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life issues that make the money matters matter.

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Here he is, your fulfillment facilitator, your partner

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in prosperity, advising clients on Cape Cod and

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across the country.

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Here's your host, Jay Christopher Boyd.

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Welcome to Something More with Chris Boyd.

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I'm here with Jeff Perry and Brian Regan,

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all of us of the AMR team at

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Wealth Enhancement.

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And glad to have you joining us today.

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We're going to talk a little bit about

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municipal bonds.

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Jeff, we get these questions a lot, don't

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we?

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We do, yeah.

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Clients will often think about why not use

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tax-free bonds?

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Why am I paying taxes?

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Boy, I've got a lot of taxes as

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it is.

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Maybe I'd be better off avoiding some of

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the tax in my non-IRA accounts, that

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kind of thing.

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Well, we've seen them in IRA accounts before.

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That's true.

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And actually- I've put them in IRA

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accounts before.

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During extreme circumstances, but that was like during

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the pandemic or something extreme like that.

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But I think that's what we want to

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talk about today.

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Why or why not use municipal bonds?

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And to help us navigate that, we've got

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Brian Regan, our team senior portfolio manager, talking

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with us today.

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So Brian, let's start by explaining which kinds

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of bonds pay what kind of tax.

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So when it comes to, for example, and

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maybe we'll even back up further, what's a

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bond?

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A bond is when I lend my money

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to a corporation or a government with the

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expectation that I will get it back at

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some point at the end of the term

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of that bond.

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And I get consideration for that.

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There's actually more types than that, because sometimes

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I get my principal back over time and

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sometimes at the end and so forth.

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But let's just think of it simply similar

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to the way I might think of a

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certificate of deposit with the bank.

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I decide, do I want a one year

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term or a five year term or longer

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in the case of a bond?

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I pick the term I want.

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I lend my money.

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I'm going to get back my principal at

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the end.

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And I get some consideration for that.

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And the things that might factor into how

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much consideration I get might be how much

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risk am I taking?

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Is this a corporation that is very stable

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or one that's not so much?

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Is this a government entity that's very stable

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or one not so much?

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Is this a bond that is tied to

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a specific occasion, a specific project, or is

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this tied to the taxing authority of a

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municipality or a state or whatever it might

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be?

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So all of these factors will impact how

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the bond is priced, the interest rate I

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might get.

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Similarly, how long I commit my money will

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play a role in this.

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And typically as an investor, I think, well,

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if I'm going to commit my money longer,

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I want more consideration for that.

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I want to get a little better deal.

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And that's when we start talking about the

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yield curve, that's looking at how much more

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consideration do I get or not because of

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expectations of what might happen with interest rates

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over time.

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Well, we're not going to focus on the

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yield curve today, but we are going to

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talk about some of these other considerations.

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So that's maybe what a bond is, essentially.

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Generally, we think of bonds as being more

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predictable and less volatile, a little bit less

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risk, depending on the credit quality of what

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we're buying.

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And when it comes to the taxation of

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bonds, if I have a corporate bond, the

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interest that it generates, the income that it

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generates, all of that is subject to taxation,

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whether it's on the federal level or on

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the state level.

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And if I sell it before it's maturity

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and it is worth more or less than

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what I bought it for, well, then I

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might entertain whether I have a capital gain

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or a capital loss.

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But if I just buy it at inception,

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wait till it matures, I've put in my

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amount, I get that amount back, and the

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interest is the tax I'm going to deal

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with.

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Now, in the case of a treasury, which

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is a bond issued by the federal government,

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that has some tax benefit that is not

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taxed by the state.

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It is tax-free on the state level

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for income tax.

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However, it is potentially, and is generally, taxed

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by the federal government.

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Whereas a municipal bond, something issued by a

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state or municipality entity, can be tax-free

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on both levels, but it avoids the federal

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tax.

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And if it is from my state, I

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get taxed in for income, it can avoid

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that tax as well.

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However, I live in Massachusetts.

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If I bought a New York municipal bond,

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I wouldn't pay federal tax, but I might

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still have to pay Massachusetts income tax on

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that bond.

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So that's sort of the basic tax considerations.

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You guys might have things to add because

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I hopefully covered the basics of that.

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But what do we want to add to

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that?

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Oh, well, I would just add that I

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think it almost never makes sense for most

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people to buy municipal bonds.

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It's a very rare occasion where I think

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it makes sense.

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And why do I think that?

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Well, just on the face of it, if

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you were to compare, on average, seven-year

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municipal bond to a seven-year taxable bond,

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the yield will be significantly lower.

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The yield will be significantly lower because the

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market's taking into account the respective tax savings.

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So one way or another, you are going

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to essentially pay that tax.

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You can get the muni bond and get

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a lower rate, or you could buy the

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taxable bond and get a higher rate and

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pay taxes.

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Now, the formula to determine whether or not

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it's worth it for you is what we

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call the tax equivalent yield.

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The yield on the municipal bond in question

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divided by one minus the tax rate.

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The textbook version will tell you that you

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should use a marginal tax rate.

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I don't think there's anything wrong with doing

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the effective tax rate, and there's a few

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reasons why I think that.

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The effective tax rate's actually what you pay.

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And unless you're committing a lot of capital

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towards the municipal bonds, it's likely that the

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marginal rate won't highly impact what you're going

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to pay in the following year.

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Secondly, if you do end up paying a

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capital gain, so let's say that the stars

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align and it makes a lot of sense

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for you to buy municipal bonds, and then

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the market corrects, and you want to take

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a capital gain, well, you're going to end

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up paying taxes on that capital gain.

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And I think that using the effective tax

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rate rather than the marginal tax rate might

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take into account the effects of that possible

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capital gain that you might take in the

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future.

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So I think you can use either one.

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The marginal tax rate is a much more

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conservative way to do it because it's a

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higher rate.

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The effective tax rate's probably going to be

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a lower rate.

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So let's stop for a second, Brian, because

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I think you threw a lot there to

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start with.

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Let's just go back for a minute.

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You're getting into the differences between a marginal

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rate and an effective rate.

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Let's explain what that means to our listeners

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in case they're not clear about what that

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is.

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So if you have an income of a

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certain amount, whether you're married or filing jointly,

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right, there's thresholds.

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You land in different tax brackets based on

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that.

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So when you talk about the marginal rate,

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it's the, oh, I have this much income,

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I'm landing in the top tax bracket of

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that amount of, let's say it's 24%, something

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like that.

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Well, not all of that income is paying

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24% because you've gone through other tax

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rates before that last dollar of income is

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getting taxed at that 24% rate, let's

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say.

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I'm making up the number in this case.

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But you've also paid some 10%, some 15%,

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and so on, 22%.

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So your effective tax rate might be lower.

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Oh, it was 20%.

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I'm, again, making up numbers.

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But whatever that figure is, you had a

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lower effective rate.

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And so, Brian, you're arguing that when one

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tries to do this calculation, which we're going

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to come back and explain a little, because

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you went through that very quickly, I want

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to make sure people understand how that works.

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But when you try to do this calculation

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of how do I compare a taxable versus

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a tax-free environment, which rate should I

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use?

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My top tier, that marginal tax rate?

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Or should I use that effective tax rate

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with the average, if you will, of the

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rates I've used?

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And your argument was to use the effective

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rate, Brian?

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Yeah.

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I mean, I'm at a step with the

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textbook definition.

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The textbook definition would tell you to use

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the marginal tax rate.

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I think that gets people into municipal bonds

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that likely shouldn't be in municipal bonds.

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Because like I said, if the stars align

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and you're in a municipal bond, and then

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the market cracks, you might end up taking

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a capital gain anyways.

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So for these reasons, unless you're committing a

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huge swath of your capital towards municipal bonds,

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I think it makes just as much sense

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to use the effective tax rate, which will

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give you a lower tax equivalent yield and

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probably keep you out of municipal bonds more

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often.

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But if you wanted to use a marginal

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tax rate, I wouldn't fight you on it.

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I think either one you use, the math

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almost never works out to make municipal bonds

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a better deal.

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So let's elaborate on that a little bit.

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Yeah.

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Before you, let's explain the math a little

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bit more closely.

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Give us an example of this formula in

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use.

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And let's say, what's a yield I might

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get from a tax-free municipal bond?

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3%?

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00:11:40,720 --> 00:11:42,200
What's a realistic number?

275
00:11:42,640 --> 00:11:44,720
Let's just say, hypothetically, you live in California.

276
00:11:44,720 --> 00:11:47,060
And in this case, and you make a

277
00:11:47,060 --> 00:11:48,160
lot of money, let's say you make a

278
00:11:48,160 --> 00:11:48,960
million dollars a year.

279
00:11:52,580 --> 00:11:54,780
And I'm guessing these tax rates, but I

280
00:11:54,780 --> 00:11:56,680
think they're probably fairly accurate, right?

281
00:11:56,740 --> 00:11:59,880
Let's say that your marginal tax rate between

282
00:11:59,880 --> 00:12:03,280
federal and state is close to 50%.

283
00:12:03,280 --> 00:12:05,760
And let's say that since you live in

284
00:12:05,760 --> 00:12:09,180
California, municipal bond rates are probably lower because

285
00:12:09,180 --> 00:12:10,660
this is one of those states that you

286
00:12:10,660 --> 00:12:12,540
would want to buy a municipal bond in

287
00:12:12,540 --> 00:12:13,280
more likely than not.

288
00:12:14,200 --> 00:12:16,260
Let's say the yield is 2%.

289
00:12:16,260 --> 00:12:19,300
So you take 2% divided by 1

290
00:12:19,300 --> 00:12:23,120
minus, let's just use the marginal tax rate

291
00:12:23,120 --> 00:12:24,560
to be conservative, 50%.

292
00:12:24,560 --> 00:12:26,060
What number do you get?

293
00:12:26,140 --> 00:12:28,260
You get a tax equivalent yield of 4%.

294
00:12:29,620 --> 00:12:32,520
I can go buy a treasury today for

295
00:12:32,520 --> 00:12:35,480
the same length of time and get 4

296
00:12:35,480 --> 00:12:39,520
.5%. So I would be giving up a

297
00:12:39,520 --> 00:12:42,160
half a percentage point or 50 basis points

298
00:12:42,160 --> 00:12:45,720
worth of value by buying a municipal bond

299
00:12:45,720 --> 00:12:49,080
rather than buying the taxable bond and paying

300
00:12:49,080 --> 00:12:49,640
my taxes.

301
00:12:49,980 --> 00:12:53,020
So I have the sense of satisfaction that

302
00:12:53,020 --> 00:12:56,440
I didn't have to pay that tax, but

303
00:12:56,440 --> 00:13:01,680
in reality, I gave up some interest even

304
00:13:01,680 --> 00:13:06,000
after tax that I would have still made

305
00:13:06,000 --> 00:13:09,340
a little bit more by paying the tax

306
00:13:09,340 --> 00:13:13,840
and having the treasury in your example, where

307
00:13:13,840 --> 00:13:16,380
I end up with a little bit better

308
00:13:16,380 --> 00:13:18,900
outcome than avoiding the tax.

309
00:13:19,700 --> 00:13:21,980
So that's not to say we haven't run

310
00:13:21,980 --> 00:13:23,860
into people that would be willing to take

311
00:13:23,860 --> 00:13:26,320
that deal because they just were sick of

312
00:13:26,320 --> 00:13:27,100
paying the taxes.

313
00:13:27,400 --> 00:13:29,100
Or in that example, they pay a lot

314
00:13:29,100 --> 00:13:31,420
of taxes at a million dollars of income.

315
00:13:32,140 --> 00:13:35,500
But as a math equation, it doesn't work

316
00:13:35,500 --> 00:13:36,260
in this example.

317
00:13:38,060 --> 00:13:40,480
Now, let's think about it more commonly.

318
00:13:40,700 --> 00:13:42,540
Most people don't make a million dollars a

319
00:13:42,540 --> 00:13:42,820
year.

320
00:13:43,700 --> 00:13:46,440
So let's say someone's in the 22 or

321
00:13:46,440 --> 00:13:48,460
the 24% tax bracket.

322
00:13:48,780 --> 00:13:50,800
And a lot of our clients are in

323
00:13:50,800 --> 00:13:51,420
Massachusetts.

324
00:13:53,720 --> 00:13:55,980
Unless you do make a million dollars a

325
00:13:55,980 --> 00:13:59,920
year, then you're paying 9% state income

326
00:13:59,920 --> 00:14:00,540
tax rate.

327
00:14:00,680 --> 00:14:04,620
But most people would pay 5% state

328
00:14:04,620 --> 00:14:05,800
income tax rate.

329
00:14:06,520 --> 00:14:08,420
So let's say, you know, we're all in

330
00:14:08,420 --> 00:14:11,880
we're under 30%, you know, 27, or something

331
00:14:11,880 --> 00:14:15,300
like that, in our tax rate.

332
00:14:15,880 --> 00:14:16,520
Right.

333
00:14:17,120 --> 00:14:21,900
So that equation, if I, what's the rate

334
00:14:21,900 --> 00:14:25,100
in Massachusetts, for example, Brian, for a muni

335
00:14:25,100 --> 00:14:27,460
bond fund that one might typically get or

336
00:14:27,460 --> 00:14:32,480
a municipal bond example?

337
00:14:33,120 --> 00:14:35,100
Am I in the ballpark saying 3%?

338
00:14:35,420 --> 00:14:37,080
Three and a quarter, something like that?

339
00:14:37,460 --> 00:14:38,800
I think three would be generous.

340
00:14:38,960 --> 00:14:39,960
I don't have it in front of me

341
00:14:39,960 --> 00:14:40,680
right now.

342
00:14:41,220 --> 00:14:43,380
So let's just use that as an example.

343
00:14:43,400 --> 00:14:46,480
Let's say 3% at a 23%

344
00:14:46,480 --> 00:14:46,980
tax rate.

345
00:14:47,020 --> 00:14:47,640
Is that what you said?

346
00:14:47,640 --> 00:14:51,400
I said, you're 22 in the federal five

347
00:14:51,400 --> 00:14:56,020
on the state, you know, so that's 27,

348
00:14:56,280 --> 00:14:56,440
right?

349
00:14:56,540 --> 00:14:57,640
22 and 27.

350
00:14:57,780 --> 00:15:01,800
So that gives us 73% we're gonna

351
00:15:01,800 --> 00:15:03,140
divide.

352
00:15:03,680 --> 00:15:05,780
You would get 4.1% under that

353
00:15:05,780 --> 00:15:08,040
scenario, which still doesn't, you know, make the

354
00:15:08,040 --> 00:15:10,300
treasury less appealing.

355
00:15:10,600 --> 00:15:12,000
You're still better served.

356
00:15:12,440 --> 00:15:15,160
Here's the added caveat to this, right?

357
00:15:16,220 --> 00:15:18,260
Even in a state like California or state

358
00:15:18,260 --> 00:15:21,580
like Massachusetts, where the credit, the credits are

359
00:15:21,580 --> 00:15:23,680
usually pretty good, you know, but they're not,

360
00:15:23,840 --> 00:15:25,520
they're not guaranteed by any stretch of the

361
00:15:25,520 --> 00:15:27,540
imagination, especially when it comes to, you know,

362
00:15:27,560 --> 00:15:28,300
like specifics.

363
00:15:28,500 --> 00:15:30,700
Sometimes you can buy a hospital, which is

364
00:15:30,700 --> 00:15:31,860
considered a municipal bond.

365
00:15:32,640 --> 00:15:34,500
And, you know, we've seen here in Massachusetts,

366
00:15:34,520 --> 00:15:36,160
some hospitals go belly up, right?

367
00:15:36,280 --> 00:15:40,060
So these are not riskless like a treasury.

368
00:15:40,460 --> 00:15:41,400
So you would have- Would you elaborate

369
00:15:41,400 --> 00:15:44,320
on the idea so that just what you're

370
00:15:44,320 --> 00:15:50,320
talking about is the difference between a general

371
00:15:50,320 --> 00:15:51,920
obligation, right?

372
00:15:52,820 --> 00:15:57,640
Something that's tied to a particular entity versus

373
00:15:57,640 --> 00:15:59,960
something that's tied to the taxing authority.

374
00:16:00,240 --> 00:16:01,700
Talk about these distinctions.

375
00:16:02,320 --> 00:16:02,620
Sure.

376
00:16:02,760 --> 00:16:04,680
So a general obligation bond is tied to

377
00:16:04,680 --> 00:16:05,580
the taxing authority.

378
00:16:05,720 --> 00:16:07,160
So that means if you were to buy

379
00:16:07,160 --> 00:16:10,940
a bond in the state of California, the

380
00:16:10,940 --> 00:16:14,060
revenues from the state of California, the taxing

381
00:16:14,060 --> 00:16:15,920
authority from the state of California is on

382
00:16:15,920 --> 00:16:18,320
the hook for paying the bond.

383
00:16:18,780 --> 00:16:20,520
There's also something called a revenue bond.

384
00:16:20,800 --> 00:16:22,520
Now a revenue bond is tied to a

385
00:16:22,520 --> 00:16:23,340
specific project.

386
00:16:23,740 --> 00:16:25,520
So let's say, you know, you're building-

387
00:16:25,520 --> 00:16:27,360
Talking about the hospital example, or they're going

388
00:16:27,360 --> 00:16:28,940
to- Yeah, you're building a hospital or

389
00:16:28,940 --> 00:16:30,640
toll booth or something like that.

390
00:16:31,300 --> 00:16:35,660
The revenues of those projects need to support

391
00:16:35,660 --> 00:16:39,240
the interest payments and- It's specifically tied

392
00:16:39,240 --> 00:16:42,660
to that limited revenue capacity.

393
00:16:43,440 --> 00:16:43,640
Yeah.

394
00:16:43,920 --> 00:16:48,740
So there is credit risk in some of

395
00:16:48,740 --> 00:16:49,040
these bonds.

396
00:16:49,140 --> 00:16:50,640
So comparing it to a treasury, even though

397
00:16:50,640 --> 00:16:52,220
the math did not work against the treasury,

398
00:16:53,440 --> 00:16:55,520
is not an appropriate comparison.

399
00:16:55,740 --> 00:16:58,220
You have to compare it to, let's say,

400
00:16:58,260 --> 00:16:59,540
an A-rated bond, right?

401
00:16:59,580 --> 00:17:01,120
Which will get a spread over treasury.

402
00:17:01,120 --> 00:17:02,840
So you're really looking at something, you're comparing

403
00:17:02,840 --> 00:17:05,200
it to maybe five and a quarter, five

404
00:17:05,200 --> 00:17:07,819
and a half percent, which- It's maybe

405
00:17:07,819 --> 00:17:10,740
even a harder equation to overcome and say,

406
00:17:10,859 --> 00:17:13,200
oh, there's value and benefit in getting that

407
00:17:13,200 --> 00:17:14,260
tax-free rate.

408
00:17:14,640 --> 00:17:18,119
Because for a credit equivalent, you really should

409
00:17:18,119 --> 00:17:19,920
be looking at something that pays even more

410
00:17:19,920 --> 00:17:23,700
in the corporate or in the taxable setting

411
00:17:23,700 --> 00:17:27,900
than what that tax-free bond will yield

412
00:17:27,900 --> 00:17:32,540
you in comparison, in an after-tax equivalent

413
00:17:32,540 --> 00:17:33,760
comparison.

414
00:17:34,280 --> 00:17:37,360
So let's say that hypothetically that the math

415
00:17:37,360 --> 00:17:40,380
works out, which for very few people it

416
00:17:40,380 --> 00:17:42,940
does, for very few occasions it does.

417
00:17:43,740 --> 00:17:45,320
But let's say you live in New York

418
00:17:45,320 --> 00:17:47,860
or California, you make a ton of money.

419
00:17:48,480 --> 00:17:49,100
Good for you.

420
00:17:49,180 --> 00:17:49,700
Congratulations.

421
00:17:50,200 --> 00:17:51,180
I'm happy for you.

422
00:17:51,420 --> 00:17:55,200
And this equation works out for you.

423
00:17:57,180 --> 00:17:58,100
What do you do?

424
00:17:58,320 --> 00:17:59,760
Well, or what are the problems?

425
00:18:00,140 --> 00:18:02,060
Well, if you're in California, you really only

426
00:18:02,060 --> 00:18:03,600
want to own California municipal bonds.

427
00:18:04,120 --> 00:18:05,560
If you're in New York, you really only

428
00:18:05,560 --> 00:18:07,840
want to use New York municipal bonds.

429
00:18:08,980 --> 00:18:10,240
So what does- Because of what I

430
00:18:10,240 --> 00:18:12,260
mentioned earlier, just because you own a municipal

431
00:18:12,260 --> 00:18:16,240
bond, if it's not your state that you're

432
00:18:16,240 --> 00:18:18,500
taxed in, it still could be taxed.

433
00:18:19,140 --> 00:18:19,580
Right.

434
00:18:19,740 --> 00:18:21,300
So you don't necessarily just want to buy

435
00:18:21,300 --> 00:18:22,920
an ETF of diversified bonds.

436
00:18:23,760 --> 00:18:25,620
So diversification becomes a real problem.

437
00:18:25,860 --> 00:18:27,320
It becomes a real challenge.

438
00:18:27,500 --> 00:18:28,900
And why do I say California and New

439
00:18:28,900 --> 00:18:29,060
York?

440
00:18:29,140 --> 00:18:31,060
Those are typically the highest taxed states.

441
00:18:31,160 --> 00:18:33,900
They're typically the states where this math might

442
00:18:33,900 --> 00:18:34,380
make sense.

443
00:18:34,660 --> 00:18:34,780
Yeah.

444
00:18:34,800 --> 00:18:36,960
Remember in New York, you can be taxed

445
00:18:36,960 --> 00:18:41,480
not only on state, but municipality level as

446
00:18:41,480 --> 00:18:41,680
well.

447
00:18:41,760 --> 00:18:43,340
There could be income tax implications.

448
00:18:43,780 --> 00:18:46,520
So yeah, it works more effectively.

449
00:18:47,040 --> 00:18:47,140
Yeah.

450
00:18:47,160 --> 00:18:49,460
And the more money you make, the more

451
00:18:49,460 --> 00:18:52,220
that marginal tax rate makes sense and the

452
00:18:52,220 --> 00:18:53,760
less the effective tax rate makes sense.

453
00:18:53,840 --> 00:18:56,700
So there's more opportunity for this to make

454
00:18:56,700 --> 00:18:59,140
sense for you individually.

455
00:18:59,800 --> 00:19:03,300
But going back to my point, it's really

456
00:19:03,300 --> 00:19:04,120
hard to get diversified.

457
00:19:05,200 --> 00:19:08,360
Now, here's some other things that people should

458
00:19:08,360 --> 00:19:08,660
know.

459
00:19:08,660 --> 00:19:12,840
Only the interest is tax deductible.

460
00:19:13,140 --> 00:19:13,980
So what does that mean?

461
00:19:15,480 --> 00:19:17,560
You have to buy bonds at a premium.

462
00:19:18,500 --> 00:19:21,240
So most municipal bonds are priced at a

463
00:19:21,240 --> 00:19:21,520
premium.

464
00:19:21,700 --> 00:19:22,460
So what does that mean?

465
00:19:23,280 --> 00:19:24,540
If at the end of maturity, you get

466
00:19:24,540 --> 00:19:26,800
a hundred dollars, most of the bonds are

467
00:19:26,800 --> 00:19:28,220
priced over a hundred dollars.

468
00:19:29,120 --> 00:19:30,980
Sorry, Brian.

469
00:19:31,420 --> 00:19:34,280
If I'm not buying the bond at inception,

470
00:19:35,000 --> 00:19:36,800
but I go out and buy it on

471
00:19:36,800 --> 00:19:39,860
the marketplace after it's already been issued from

472
00:19:39,860 --> 00:19:42,740
someone else who bought it previously, that's when

473
00:19:42,740 --> 00:19:45,800
I'm facing this issue of premium that you're

474
00:19:45,800 --> 00:19:46,440
talking about.

475
00:19:47,180 --> 00:19:47,660
Yeah.

476
00:19:47,780 --> 00:19:49,260
If you can buy a premium bond, that's

477
00:19:49,260 --> 00:19:51,000
actually a good thing because then all your

478
00:19:51,000 --> 00:19:54,700
interest expense will be shielded from tax.

479
00:19:55,240 --> 00:19:56,440
But if you have to buy a bond

480
00:19:56,440 --> 00:19:59,060
at a discount, so rates go up since

481
00:19:59,060 --> 00:20:01,760
it's been issued and you buy the bond

482
00:20:01,760 --> 00:20:06,620
at a discount, that amortization towards par is

483
00:20:06,620 --> 00:20:08,180
going to be taxable because it's going to

484
00:20:08,180 --> 00:20:10,260
be considered a realized gain when it matures.

485
00:20:10,680 --> 00:20:13,200
So you might not get the stated yield

486
00:20:13,200 --> 00:20:15,240
to maturity all tax-free in that circumstance.

487
00:20:15,880 --> 00:20:18,300
So that math that I mentioned, that tax

488
00:20:18,300 --> 00:20:20,880
equivalent yield does not work if there are

489
00:20:20,880 --> 00:20:23,200
bonds that are trading at a discount in

490
00:20:23,200 --> 00:20:23,720
the portfolio.

491
00:20:24,320 --> 00:20:26,220
So you got to buy premium bonds.

492
00:20:26,300 --> 00:20:27,540
You got to buy bonds in the state.

493
00:20:28,040 --> 00:20:30,060
It helps if you buy new issued bonds,

494
00:20:30,580 --> 00:20:33,580
you're going to have some credit risks, specifically

495
00:20:33,580 --> 00:20:37,240
from those revenue-oriented type bonds rather than

496
00:20:37,240 --> 00:20:38,380
the general obligation bonds.

497
00:20:41,780 --> 00:20:44,420
Finally, the duration of these bonds, the maturities

498
00:20:44,420 --> 00:20:46,200
are typically longer.

499
00:20:46,820 --> 00:20:49,160
When you buy a fund for sure, you

500
00:20:49,160 --> 00:20:51,880
tend to buy a longer duration within a

501
00:20:51,880 --> 00:20:54,120
fund than you might choose to otherwise.

502
00:20:54,840 --> 00:20:55,600
So what does that mean?

503
00:20:55,700 --> 00:20:58,620
There's some inherent interest rate risks, more inherent

504
00:20:58,620 --> 00:21:00,380
interest rate risks than there would otherwise be.

505
00:21:02,360 --> 00:21:05,880
So you put all this together and are

506
00:21:05,880 --> 00:21:06,940
municipal bonds for you?

507
00:21:07,240 --> 00:21:08,520
The answer is probably not.

508
00:21:09,260 --> 00:21:12,060
I know that people like them and I

509
00:21:12,060 --> 00:21:14,060
always say that they're great for the issuer.

510
00:21:14,480 --> 00:21:15,620
They're great for the state.

511
00:21:15,720 --> 00:21:16,740
They're great for the municipality.

512
00:21:17,820 --> 00:21:21,380
They may not necessarily be great for you

513
00:21:21,380 --> 00:21:22,040
as an investor.

514
00:21:23,120 --> 00:21:24,960
So a lot of complexities to consider.

515
00:21:25,220 --> 00:21:26,660
There's a lot of variations.

516
00:21:26,920 --> 00:21:31,040
It's not purely the interest rate consideration, but

517
00:21:31,040 --> 00:21:34,360
who's the title we gave this episode is

518
00:21:34,360 --> 00:21:36,280
when to buy municipal bonds.

519
00:21:37,260 --> 00:21:39,120
Let's kind of sum that up.

520
00:21:39,260 --> 00:21:41,480
It's when you're in a very high tax

521
00:21:41,480 --> 00:21:44,320
bracket, when you're in a very high tax

522
00:21:44,320 --> 00:21:48,920
state, these might be the circumstances where the

523
00:21:48,920 --> 00:21:51,660
math can work, but you have to be

524
00:21:51,660 --> 00:21:52,380
very selective.

525
00:21:52,580 --> 00:21:55,480
And it's often the case that you're still

526
00:21:55,480 --> 00:21:59,320
better off to buy taxable bonds because you

527
00:21:59,320 --> 00:22:02,360
can net more even after paying taxes.

528
00:22:03,220 --> 00:22:05,200
And you might have less duration risk.

529
00:22:05,380 --> 00:22:08,480
You might have less capital gain consideration in

530
00:22:08,480 --> 00:22:10,200
this, or it might give some of these

531
00:22:10,200 --> 00:22:12,680
things that you're not anticipating can muddy the

532
00:22:12,680 --> 00:22:13,160
waters.

533
00:22:14,280 --> 00:22:14,380
Yeah.

534
00:22:14,460 --> 00:22:16,220
Going back to the effective tax rate versus

535
00:22:16,220 --> 00:22:17,160
marginal tax rate.

536
00:22:17,320 --> 00:22:20,100
If your effective tax rate is approaching your

537
00:22:20,100 --> 00:22:22,080
marginal tax rate, you might want to look

538
00:22:22,080 --> 00:22:22,420
into it.

539
00:22:22,620 --> 00:22:24,080
I mean, you make enough money where the

540
00:22:24,080 --> 00:22:26,240
math will more often make sense.

541
00:22:27,360 --> 00:22:29,340
And that's why I say that we ignore

542
00:22:29,340 --> 00:22:31,140
the effective tax rate and the marginal tax

543
00:22:31,140 --> 00:22:32,360
rates, the textbook reason.

544
00:22:32,660 --> 00:22:36,360
But I think it's fair to consider the

545
00:22:36,360 --> 00:22:39,040
effective tax rate, given that it's so common

546
00:22:39,040 --> 00:22:42,580
for people to inappropriately get into these types

547
00:22:42,580 --> 00:22:43,080
of instruments.

548
00:22:45,300 --> 00:22:48,520
So yeah, sometimes it sounds better than it

549
00:22:48,520 --> 00:22:50,880
actually is when it comes to municipal bonds.

550
00:22:51,000 --> 00:22:53,300
Who doesn't like the idea of avoiding tax?

551
00:22:54,060 --> 00:22:56,820
But I think most people would say, all

552
00:22:56,820 --> 00:22:59,200
right, I can save you taxes, but you'll

553
00:22:59,200 --> 00:23:03,680
make less money net even after tax.

554
00:23:03,820 --> 00:23:04,640
Is that what you want to do?

555
00:23:05,180 --> 00:23:06,440
Most people would say no.

556
00:23:08,020 --> 00:23:10,420
So anything else to add?

557
00:23:10,560 --> 00:23:12,280
What do you think, Jeff, Brian?

558
00:23:12,360 --> 00:23:13,500
I think we hit it.

559
00:23:13,920 --> 00:23:17,980
That's less frequently desirable for people.

560
00:23:18,140 --> 00:23:18,940
What were you going to say, Jeff?

561
00:23:18,940 --> 00:23:20,680
I was just going to say the analysis

562
00:23:20,680 --> 00:23:23,020
that we're doing today is based upon the

563
00:23:23,020 --> 00:23:24,300
current treasury rates, right?

564
00:23:24,400 --> 00:23:27,940
So if you saw significant changes in treasuries,

565
00:23:28,000 --> 00:23:32,460
that would change the analysis, but have to

566
00:23:32,460 --> 00:23:33,960
be quite a change to make it meaningful

567
00:23:33,960 --> 00:23:35,000
for most people.

568
00:23:35,600 --> 00:23:37,120
If there's a change in treasuries, it's probably

569
00:23:37,120 --> 00:23:38,780
a change in the municipal bond yield curve

570
00:23:38,780 --> 00:23:39,020
too.

571
00:23:39,360 --> 00:23:40,520
I mean, there are opportunities.

572
00:23:40,660 --> 00:23:41,620
I'm not saying it never happens.

573
00:23:41,660 --> 00:23:42,700
I'm just saying it's rare.

574
00:23:43,140 --> 00:23:45,060
Um, Chris, if you have a second, I

575
00:23:45,060 --> 00:23:47,040
mean, I'd love to revisit that.

576
00:23:47,280 --> 00:23:49,140
Yeah, the 2020 or whatever.

577
00:23:49,760 --> 00:23:51,440
Yeah, that was a great experience.

578
00:23:52,320 --> 00:23:54,680
Uh, so that was kind of, as we

579
00:23:54,680 --> 00:23:56,240
all know, it was a wild time though.

580
00:23:56,440 --> 00:23:56,660
Yeah.

581
00:23:56,920 --> 00:23:57,220
Right.

582
00:23:57,300 --> 00:23:59,820
And what I called that was an occluded

583
00:23:59,820 --> 00:24:00,460
event, right?

584
00:24:00,500 --> 00:24:02,060
Like people were just running the doors.

585
00:24:02,180 --> 00:24:02,940
I need cash.

586
00:24:03,000 --> 00:24:03,740
I need cash now.

587
00:24:03,880 --> 00:24:05,200
I don't care what price.

588
00:24:06,100 --> 00:24:07,760
And when people do that, the markets get

589
00:24:07,760 --> 00:24:11,180
really distorted and there's oftentimes really good opportunities

590
00:24:11,180 --> 00:24:12,460
in really strange places.

591
00:24:12,460 --> 00:24:15,700
This was a time when we actually put

592
00:24:15,700 --> 00:24:18,840
municipal bonds across all accounts, regardless of its

593
00:24:18,840 --> 00:24:21,260
tax status, because we weren't in it for

594
00:24:21,260 --> 00:24:22,220
the tax equivalent yield.

595
00:24:22,340 --> 00:24:25,440
We were in it for the likely capital

596
00:24:25,440 --> 00:24:26,620
gains that was going to come from a

597
00:24:26,620 --> 00:24:27,480
wild mispricing.

598
00:24:28,200 --> 00:24:31,940
So, um, at that time you bought treasuries

599
00:24:31,940 --> 00:24:35,340
and sometimes we were using high yield in

600
00:24:35,340 --> 00:24:37,420
place of equities as a place, as a

601
00:24:37,420 --> 00:24:41,120
way to take less risk to get, uh,

602
00:24:41,980 --> 00:24:44,740
tax equity, you know, to get essentially a

603
00:24:44,740 --> 00:24:48,840
risk equivalent of stock returns without having to

604
00:24:48,840 --> 00:24:50,360
take as much risk in the process.

605
00:24:50,600 --> 00:24:50,760
Yeah.

606
00:24:50,780 --> 00:24:51,920
I mean, that's how it ended up.

607
00:24:51,960 --> 00:24:52,200
Right.

608
00:24:52,300 --> 00:24:54,720
So, um, if you guys remember back then

609
00:24:54,720 --> 00:24:57,160
the federal reserve, Jerome Powell, uh, came out

610
00:24:57,160 --> 00:25:00,860
and said, the federal reserve will basically backstop

611
00:25:00,860 --> 00:25:02,360
on municipal bonds at 5%.

612
00:25:02,360 --> 00:25:04,560
We'll refinance any municipal bond at 5%.

613
00:25:04,560 --> 00:25:07,120
So that essentially put a 4 on all

614
00:25:07,120 --> 00:25:09,880
bonds at a 5% yield and the

615
00:25:09,880 --> 00:25:11,660
bonds were trading well above 5%.

616
00:25:12,360 --> 00:25:14,960
Um, it was an incredible opportunity.

617
00:25:15,320 --> 00:25:17,700
So there was an arbitrage there that closed

618
00:25:17,700 --> 00:25:21,960
within two months, um, where, you know, we

619
00:25:21,960 --> 00:25:25,440
could take that excess duration, um, put it

620
00:25:25,440 --> 00:25:28,580
in people's portfolios and know that it would

621
00:25:28,580 --> 00:25:31,040
make a ton of sense for these bonds

622
00:25:31,040 --> 00:25:33,980
to fall, you know, at least 1%, but

623
00:25:33,980 --> 00:25:36,220
likely more than that, um, as they came

624
00:25:36,220 --> 00:25:37,540
into equilibrium with treasuries.

625
00:25:37,680 --> 00:25:39,020
And I think we ended up making like

626
00:25:39,020 --> 00:25:41,820
a 19% return on it within a

627
00:25:41,820 --> 00:25:42,220
few months.

628
00:25:42,520 --> 00:25:44,720
Um, so anomalies happen.

629
00:25:45,060 --> 00:25:46,920
Um, I'm happy to take advantage of them

630
00:25:46,920 --> 00:25:49,080
when they do, uh, but they're few and

631
00:25:49,080 --> 00:25:51,180
far between and usually in some kind of

632
00:25:51,180 --> 00:25:54,600
a unique situation in this case, the pandemic.

633
00:25:55,740 --> 00:25:56,220
Yeah.

634
00:25:56,320 --> 00:25:59,040
So, um, but your point, Jeff was, um,

635
00:25:59,060 --> 00:26:01,880
I think, uh, one that's worth mentioning that

636
00:26:01,880 --> 00:26:03,660
notion that things change, right.

637
00:26:03,820 --> 00:26:06,940
And it's, uh, worth, uh, you know, revisiting

638
00:26:06,940 --> 00:26:08,460
when there are different circumstances.

639
00:26:08,920 --> 00:26:12,240
As it stands today, by and large, we

640
00:26:12,240 --> 00:26:13,980
would encourage people to think more in terms

641
00:26:13,980 --> 00:26:17,140
of taxable bonds because of the net math.

642
00:26:17,840 --> 00:26:20,500
Um, but like you said, you know, it's

643
00:26:20,500 --> 00:26:21,080
not static.

644
00:26:21,200 --> 00:26:22,500
You got to check it out from time

645
00:26:22,500 --> 00:26:23,000
to time.

646
00:26:23,320 --> 00:26:25,160
Hey, this was a good conversation guys.

647
00:26:25,260 --> 00:26:25,860
Thanks so much.

648
00:26:25,860 --> 00:26:28,060
And for our listeners, um, you know, listen,

649
00:26:28,120 --> 00:26:31,420
if you're thinking about your portfolio and maybe

650
00:26:31,420 --> 00:26:33,340
you have municipal bonds in the mix and

651
00:26:33,340 --> 00:26:35,840
wondering, is it the right thing?

652
00:26:36,300 --> 00:26:38,380
Maybe it's something you've wanted to think about

653
00:26:38,380 --> 00:26:40,060
and you want to get a little bit

654
00:26:40,060 --> 00:26:41,040
more into the weeds.

655
00:26:41,480 --> 00:26:43,320
We can look at things in the particulars

656
00:26:43,320 --> 00:26:46,800
of your financial plan and your portfolio and

657
00:26:46,800 --> 00:26:49,500
see if we can help you navigate what's

658
00:26:49,500 --> 00:26:50,860
best for your circumstances.

659
00:26:51,440 --> 00:26:52,620
If you need a little hand with that,

660
00:26:52,720 --> 00:26:54,340
don't hesitate to reach out to us.

661
00:26:54,940 --> 00:26:57,100
In the meantime, thanks for being with us

662
00:26:57,100 --> 00:26:59,780
until next time, everybody keeps driving for something

663
00:26:59,780 --> 00:27:00,120
more.

664
00:27:01,660 --> 00:27:03,480
Thank you for listening to something more with

665
00:27:03,480 --> 00:27:06,060
Chris Boyd, call us for help, whether it's

666
00:27:06,060 --> 00:27:09,880
for financial planning or portfolio management, insurance concerns,

667
00:27:10,100 --> 00:27:12,280
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668
00:27:12,280 --> 00:27:13,720
the money matters matter.

669
00:27:14,080 --> 00:27:16,220
Whatever's on your mind, visit us at something

670
00:27:16,220 --> 00:27:19,460
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671
00:27:19,460 --> 00:27:25,700
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672
00:27:25,700 --> 00:27:30,020
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673
00:27:30,200 --> 00:27:32,160
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679
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