Munis: A Less-Taxing Alternative

By Richard Moroney, Editor Dow Theory Forecasts

When comparing muni bonds to taxable bonds, we typically adjust the stated yield based on the highest individual income-tax rate (39.6%) to compute a tax-equivalent yield comparable to the stated pretax yields of taxable bonds.

Even without their tax advantages, munis look better than usual relative to other bonds. As of May 29, The Bond Buyer's 20-Bond Index of municipals yielded 4.26% (equating to a tax-equivalent yield of 7.05%), down from 4.73% at the start of the year, but roughly in line with the five-year average of 4.25%.

The current yield lags the 20-year average of 4.91%, no surprise given the Fed's anchoring of the yield curve at the short end.

At the moment, municipal bonds look somewhat expensive relative to their 20-year average yield. However, Treasury and corporate yields have fallen more sharply from long-run averages, making munis appear cheap in comparison.

Our take: We prefer stocks to bonds for the year ahead. But if bonds make sense for you, municipals look like a wise choice—assuming you keep your bonds in a taxable account and can take full advantage of munis' tax protection.

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The D2 Capital Management Tax Free Income Portfolio is currently yielding 4.84% (Trailing 12 month Tax Equivalent Yield at 28% Tax Bracket, as of 11 June 2014).

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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