Since 2022, bonds have been offering attractive yields not seen since the rate cuts that occurred following the Global Financial Crisis. Yields on high quality, low risk, tax-exempt, municipal bonds are especially attractive. As you will see, some bonds are offering taxable-equivalent yields of 7% to 10%!
Tax Exempt Municipal Bond Example: CUSIP 57582RMJ2
This is a State of Massachusetts General Obligation bond, meaning it is backed by the full faith and credit of the State of Massachusetts. Massachusetts carries a AA1 credit rating, the second highest credit rating from Moody’s. Not only is the credit rating nearly perfect, it is also important to note that state governments are not permitted to file for bankruptcy.
Face value: $1,000 per bond
Price: $903.83 per bond
Coupon: 4.00%
Yield: 4.7%
Maturity: 12/01/2045
Callable: 12/01/2026 at $1000
This bond is selling at a 10% discount and offering a 4% annual coupon, equaling a yield to maturity of 4.7%. While the difference from the purchase value to face value will be taxed as ordinary income, the 4% coupon will be tax-exempt for all investors.
A 4% tax-exempt income is equivalent to a taxable income of:
5.33% for an individual who pays 25% in income taxes
6.15% for an individual who pays 35% in income taxes
7.27% for an individual who pays 45% in income taxes
Municipal bonds are highly accessible through brokerage institutions such as Vanguard and Fidelity. Most municipal bonds can be purchased in increments as small as $5,000 face value. For the Massachusetts bond referenced above, that would be a $4,519.15 investment providing a $200.00 tax free annual income until the bond matures or is called.
Also incredibly attractive are high quality, low risk, tax exempt, zero coupon municipal bonds. Zero coupon bonds often offer slightly higher yields than traditional bonds as they do not pay any income during the holding period. Zero coupon bonds can be much more accessible to people with smaller capital amounts as they sell at steep discounts.
Zero Coupon Tax Exempt Municipal Bond Example: CUSIP 64704CAM0
This is a revenue bond being issued by the New Memphis Area Building Authority, a committee that oversees an arena in Shelby County, Tennessee. It holds an AA2 credit rating from Moody’s, just one notch down from AA1.
Face value: $1,000 per bond
Price: $402.49 per bond
Coupon: 0.00%
Yield: 5.2%
Maturity: 04/01/2043
Callable: 04/01/2031 at $751.93
Yield: 5.25%
A 5.25% tax-exempt yield is equivalent to a taxable yield of:
7% for an individual who pays 25% in income taxes
8.07% for an individual who pays 35% in income taxes
9.54% for an individual who pays 45% in income taxes
If you are willing to buy and hold a stock for 20+ years and hope for 7-10% annual, taxable, returns, why not buy a high quality municipal bond virtually guaranteeing the same return? The New Memphis Arena bond referenced above would only require an initial investment of $2,012.45 to meet the minimum required investment of $5,000 face value, making it and other bonds of similar quality and yield highly accessible to all investors with some cash on hand.
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The Conservative Investor