If you think this market
getting too exciting, this might be a good time to slow things down
and focus on generating steady income while minimizing risk.
And it would be really nice if that income were
You can do all three by adding
municipal bond funds to your portfolio. Cities, counties, states,
and other government agencies sell municipal bonds to raise cash to
finance the construction of capital projects such as schools and
About Municipal Bonds
Municipal bonds pay dividends, and
even better, those dividends are federal tax-free. While you could
buy muni bonds individually through your stockbroker, it’s easier
and potentially more profitable to hold bond funds instead. While
many mutual funds and
funds (ETFs) focus on bonds, a category that you probably haven’t
paid much attention to, closed-end funds, is usually your best
About Closed-End Funds (CEFs)
Closed-end funds are similar to
conventional (open-end) mutual funds, but with one major difference.
Rather than selling and redeeming shares as needed, closed-end funds
sell a fixed number of shares when launched. After that, the fund
trades just like a stock. Buyers purchase from existing
shareholders, and shareholders must find a buyer when they sell.
Many closed-end funds use leverage
(borrowings) to enhance shareholder returns. Basically, they borrow
at, say, 1.5%, and invest the borrowed funds in bonds paying 3% or
so. Consequently, many muni closed-end funds pay monthly dividends
equating to 4% - 5% dividend yields vs. 2.5% to 3% for conventional
mutual funds. Here’s one more thing you need to
know about closed-end funds.
Because they create and redeem
shares as needed, conventional mutual funds always trade at their
net asset value (NAV), which is the per share value of the fund’s
assets. But, not closed-end funds. Because their share prices
reflect the balance of supply and demand, they typically trade
either above (premium) or below (discount) their NAVs.
Tax Math: 5% = 7.7%.
Most muni funds pay monthly dividends equating to
4.5% to 5.5% dividend
yields. But, a 5.0% non-taxable yield is equivalent to a 7.7%
taxable payout (assuming 35% tax rate).
Pay Attention to CEF Premiums
While many investors seek out
funds trading at 10% or higher discounts, in my experience, the
highest returning funds typically trade in the range of 5% discounts
to 5% premiums. That said, some well known funds trade at 20% or
higher premiums. Avoid them.
Three CEFs Worth Considering
Here are three municipal bond
closed-end funds worth considering. All pay monthly federal-tax-free
BlackRock Investment Quality
Municipal Trust (BKN): Recently traded at $17.69 per share, about a
2% premium to its net asset value (NAV). About 80% of its portfolio
consists of investment grade bonds. The balance are unrated or less
than investment grade (junk). Last year’s total return (dividends
plus share price appreciation) was 16% and returns averaged 13%
annually over the past three years. Monthly dividends equate to a
4.7% annual yield.
MainStay Defined Term Municipal
Opportunities (MMD): Recently traded at $22.39 per share, about a 4%
premium to its NAV. About 75% of portfolio is investment quality.
Last year’s total return was 9% and total returns averaged 11%
annually over the past three years. Dividend yield is 4.6%.
Nuveen Municipal High Income
Opportunity (NMZ): Recently traded at $14.60 per share, a 1% premium
to its NAV. About 50% of portfolio is comprised on investment
quality bonds and the balance are either junk rated or unrated.
Returned 7% last year and averaged 10% annually over three years.
Dividend yield is 5.2%.
The main risk in holding these funds would be sharply rising general
interest rates. As always, do your own due diligence. The more you
know about your holdings, the better your results.