Harry Domash's Winning Investing

Check Out Tax-Exempt Muni Bond Funds

Do you enjoy paying income taxes? Me neither. You can legally avoid paying federal income taxes by investing in tax-exempt municipal bonds.

Muni bonds are debt instruments issued by public agencies such as cities, states, water districts, etc., to finance public projects.

You could buy individual bonds, but not all bonds are equal in terms of risks and returns. So, unless you have the time to do the analysis, it’s better leave that job to the experts. You can do that by investing in bond funds rather than individual issues.

Instead of the more familiar conventional (open-end) mutual funds, I recommend closed-end funds. Here’s why.

Why Closed-End Funds?

Open-end funds create new shares when you buy and redeem your existing shares when you sell. So, fund managers must deploy new cash when more investors are buying fund shares than selling (usually in an up market). Conversely, they must sell existing holdings to raise cash to redeem fund shares when more fund holders are selling than buying (usually in a down market). Thus mutual fund managers are forced to “buy high” and “sell low.”

By contrast, closed-end funds have a fixed number of shares permitting fund managers to better execute their strategies. Unlike open-end funds that always trade at the per-share value (net asset value) of their holdings, closed-end fund shares prices vary with supply and demand, and typically trade at a premium or discount to their net-asset value.

Tax Math: 5% = 7.7%.

Most muni funds pay monthly dividends equating to 5% to 6% dividend yields. But, a 5.0% non-taxable yield is equivalent to a 7.7% taxable payout (assuming 35% tax rate).

All else equal, it’s best to stick with closed-end funds trading at discounts to their net asset values. However, muni funds are in demand and most are trading at premiums, in fact, many at double-digit premiums.

Five Funds at Low Premiums.

Here are the five highest returning (past five years) funds trading at a 2% or lower premiums to their net asset values.  

Eaton Vance Municipal Income Trust (EVN): Portfolio holds primarily (87%) bonds credit-rated investment quality. The fund has returned 16% over the past 12-months, and 15%, on average annually, over the past five years. Its current dividend yield is 5.3%. EVN recently traded at a 2% premium to its net asset value (NAV).

Nuveen Municipal High Income Opportunity (NMZ): Holds roughly 50% bonds rated investment quality and 50% below investment quality (junk) or unrated bonds. It returned 8.5% over the past 12-months, and 13%, on average annually, over the past five years. Its dividend yield is 6.4%. The fund recently traded at a 1% premium to its NAV.

BlackRock Investment Quality Municipal (BKN): Holds primarily (94%) investment quality bonds. Returned 12% over the past 12-months, and 12%, on average annually, over the past five years. Dividend yield is 5.2%. Recently traded even with its NAV.

Nuveen Municipal Market Opportunity (NMO): Holds primarily (91%) investment quality bonds. Returned 10% over the past 12-months, and 11%, on average annually, over the past five years. Dividend yield is 5.1%. Recently traded at a 6% discount to its NAV.

Nuveen Enhanced Municipal Value (NEV): Holds mostly (83%) investment quality bonds. The fund returned 9% over the past 12-months, and 11%, on average annually, over the past five years. Dividend yield is 5.9%. Recently traded at a 1% premium to its NAV.

I used two websites, CEF Connect (www.cefconnect.com) and Closed-End Fund Center (www.cefa.com) to find the funds mentioned in this article. Both allow you to screen for closed-end funds meeting your selection requirements.

As always, consider the funds listed to be research candidates, not a buy list. The more you know about your investments, the better your results.

Published 5/16/16

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