April has arrived, spring is in the air and, oh yes, taxes are on our minds! One way to cut your investment tax burden is to utilize tax exempt interest provided by municipal bonds. With that in mind, I thought I would talk about municipal bond investing and why I believe municipal bonds, and specifically California municipal bonds, remain an attractive and tax smart investment despite the budgetary crisis that continues to plague our federal government, most states, many municipalities and in particular California.
Undeniably, California is not in great shape. The great recession has been particularly tough on California. Some have suggested that our problems here are worse than in Greece. But are things really as bad as all of the media reports would make you think? More importantly, as investors, does California’s budget crisis mean we should stay away from owning California munis?
Despite all of the negative headlines, California is not a “junk” credit. California is a major economic power, the world’s eighth-largest economy. We have a diversified economy with an industry mix similar to a country as a whole. There is no comparison to Greece. California’s economy dwarfs that of Greece. California’s total economic output (GDP) is nearly 5 ½ times larger than the Greek economy. California’s debt as a percentage of GDP is 5.1% compared to Greece at 111.5%. Greece’s deficit as a percentage of GDP is 12.7% compared to California’s at 1.1%.1
As a bond holder you want to make sure you get your interest payments and avoid default. In that regard, munis have been a pretty safe bet. Historically municipal bond default rates have been extremely low. Muni default rates have been a fraction of similarly rated corporate bonds. Here in California, our constitution mandates that the two highest priority payments are number one to provide funding for K-12 education and next to service the debt. During the budget crisis of 2009, California issued $2.6 billion in IOUs to many taxpayers, private businesses and local governments. California bond holders, however, continued to receive their payments in cash, on time and in full.1
Taxes are high here in California and most likely are going up both on the state and federal level. This makes municipal bonds all that more attractive. Many California munis yield north of 6%. For a California taxpayer paying a combined 40% federal and state tax rate, a 6% yield on a double tax exempt bond would be the equivalent to a 10% yield on a taxable bond. Given where interest rates are right now, that kind of return alone warrants giving California munis a look.
1. Capital Markets Perspectives, Focus on Global Fixed Income, Oppenheimer Funds, March 2010
Damien helps individuals invest and manage risk. He is a Certified Financial Planner™ professional and an Investment Adviser Representative of, and offers securities and investment advisory services through, Financial Network Investment Corporation, Member SIPC 1850 Mt. Diablo Blvd., Suite 170 Walnut Creek, CA 94596. These are the views of Damien Couture, CFP® and should not be construed as investment advice. The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Not all recommendations are suitable for all investors. Each investor must consider their own goals, time horizon and risk tolerance. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or dcouture@jbcfg.com.