Investing in Municipal Bonds: A Tax-Free Opportunity You Shouldn’t Miss

This holiday season, consider a gift that keeps on giving: tax-advantaged dividends from municipal bonds. The Las Vegas Valley Nevada Water District bonds yield 5% and are exempt from federal taxes. Effectively, this means they could deliver a return of 6% or 7% or even more depending on your tax bracket.

Las Vegas is experiencing significant growth, making these bonds a potentially safe investment, especially with the area’s increasing drought concerns.

If you missed out on these bonds, there is still a great option available. You can easily invest in a fund that boosts that yield to a tax-free 7.9%. Consider this an opportunity to capitalize on the recent market fluctuations.

The Federal Reserve’s recent hawkish approach is also expected to support this bond fund’s value. Currently, it is trading at an 8% discount to the worth of its Las Vegas municipal bonds and other safe investments. This means you are essentially paying 92 cents for every dollar of this bond fund.

Before diving into specifics, it’s important to address the Fed’s recent decisions. Last week, they cut interest rates for the third consecutive meeting, while long-term rates ironically increased by 90 basis points since the easing cycle began.

Initially, when the Fed cut rates in September, the 10-year Treasury yield was at 3.6%. However, after three cutting meetings, the yield jumped to 4.5%. The bond market has reacted with caution, warning of potential inflation, even as the economy remains stable with ample job opportunities.

Federal Reserve Chairman Jay Powell showed a more cautious stance with his latest announcement. This balance could potentially cap the 10-year yield, which would catch many investors by surprise. It is reasonable to expect that long-term rates might increase now that the Fed is adopting a more measured approach.

The current climate is tough for bonds, which have struggled since September. However, as contrarian investors, capitalizing on this dip presents a compelling strategy.

Successful contrarian investing requires a mindset shift—one must be prepared to acquire assets when they’re out of favor. Anticipating a bond market rebound could prove beneficial.

Bond prices are primarily influenced by two factors:

• Duration risk: The risk that rising future interest rates will make existing bond yields less attractive.
• Credit risk: The risk that the bond issuer cannot meet payment obligations.

A cautious Fed can help mitigate duration risk by stabilizing long-term rates, while the economy’s current strength minimizes credit risk.

To eliminate credit risk entirely, investors can turn to U.S. Treasuries. The SPDR Portfolio Long-Term Treasury ETF (SPTL) offers a competitive yield of 4.8%, with the potential for price growth if 10-year rates decrease.

Municipal bonds are another safe option worth considering. Dip rates have been extremely low at under 0.1% since 2013. The largest ETF in this space, iShares National Muni Bond ETF (MUB), holds over 5,600 individual issues.

Investing in MUB is straightforward and offers diversification, but its yield is only 3.1%. Muni dividends are federally tax-free, which increases the tax-equivalent yield to as much as 5.3%, depending on the investor’s tax bracket.

For those favoring higher returns, closed-end funds (CEFs) are appealing. They can offer yields up to 7.9%, and for high-income earners, this amount could effectively reach 13.3% annually.

Nuveen is a leader in the municipal bond market, managing an impressive $429 billion in assets. When municipalities look to issue bonds, they often partner with Nuveen to secure favorable terms for investors.

Investing in these funds is user-friendly, resembling stock transactions. The attractive dividends and tax benefits enhance their appeal, especially given the current opportunity to acquire them at a 92-cent valuation.

This current market condition presents a buying opportunity for bonds. The ongoing indecision from the Fed has led to prices that are notably favorable, making it a good time to take action.

As you enjoy the festive season, keep in mind that these municipal funds pay out dividends monthly. This is not just a one-time windfall, but rather a consistent source of income. The recent Fed announcements have even revealed more monthly-paying bonds that yield over 8% annually, presenting more exciting investment opportunities.

Also see:

• Warren Buffett Dividend Stocks
• Dividend Growth Stocks: 25 Aristocrats
• Future Dividend Aristocrats: Close Contenders

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.