While stocks can supercharge a portfolio, getting income out of an all-stock portfolio is difficult. Withdrawing at the wrong time can cause an investor to sell at a significant loss, hurting long-term returns. Then there is the tax issue: With long-term capital gains taxes of up to 20%, many retirees will find themselves being squeezed by the IRS as they try to live off their life savings.
There is a solution to these problems: municipal bonds, and municipal bond funds.
“Munis” have been favorites of American retirees for generations. That’s not only because they provide tax-free income, but because their low volatility and high yields mean selling at a loss is very hard to do.
“Muni bonds are a good way to provide consistent income, and the tax angle can also provide additional value,” says Ben Barzideh, Wealth Advisor with Piershale Financial Group. “Also, bonds tend to fluctuate much less than stocks, so it brings a level of diversification and safety for the overall portfolio.”
But how do you buy municipal bonds? After all, they’re not easily traded on exchanges such as the NYSE or Nasdaq. And most new muni bond issues are reserved for the largest municipal bond buyers – firms like BlackRock (BLK), whose $7 trillion in assets under management puts it in the front of the line, miles ahead of retail investors, when a municipality wants to sell a bond. Because the big guys have already swallowed up the lowest-risk, highest-yielding bonds on their own, individual investors just can’t get their hands on them …
… unless they buy municipal bonds through the big guys. You can do this via municipal bond funds, which are issued by the major bond buyers, who in turn use your cash to go and buy more muni bonds.
If you’re going to buy municipal bond funds, consider buying closed-end funds (CEFs). For one, because of how they’re constructed, CEFs can trade at a discount, allowing you to buy their net assets for less than if you bought those bonds outright. According to CEF Insider data, the average muni bond CEF has a discount of about 7% right now. That also means CEFs can afford to pay higher dividends. A discounted fund’s yield on market price will be higher than on its actual net assets; for instance, a fund with a 7% discount that earns a 4.5% yield from a muni bond portfolio can pay out a yield on market price of 4.8%.
The payouts are even bigger when you consider they’re tax-advantaged. If you consider just federal taxes alone, at the highest tax bracket, you’d need a roughly 7.6% yield on a normally taxed bond to bring home the same amount of income as a 4.8% yielding munibond. That number is even higher if state or local tax breaks come into play.
