It always boggles my mind when people think the stock market is the best way to make money. I know some people who throw every single penny they have into the stock market hoping that they will make a return on investment. I understand their reasoning completely, all they’ve ever known is “Buy Low, Sell High.” The movies make stock trading look sexy and with IPOs from Facebook and Twitter hitting headlines it’s hard to avoid the idea that you should be jumping into stocks as well.
But what if I told you there was an easier, low risk way to compound your wealth?
What if I told you with this type of investment you could sleep well at night?
What if I told you there could be a complete market crash and your investment would be completely safe?
You’d probably call me crazy, a liar, or stupid. Heck you might just call me all three! But it’s the absolute truth and I want to tell you about this awesome opportunity.
What are Tax Free Municipal Bonds?
When a local government needs to build a new toll road, school, or facility it borrows money. Specifically the local government raises the money by taking out a loan from the public (selling municipal bonds). As with any other loan there is a set amount that is borrowed, an interest rate is set, as well as a payback date. The government then promises to pay back the money it borrows through revenues from the municipality or state. The revenues may come from the taxes of residential real estate, businesses or tolls. As the lender you can now consider yourself “The Bank.”
But it gets even better…
In order to attract and allure investors to lend money to local governments, the U.S. government made a tax law stating investors don’t have to pay federal income taxes on the interest they earn on their municipal bonds. To makes things EVEN better most U.S. States do not tax bonds issued from their state. For this reason very wealthy individuals in high tax brackets absolutely love municipal bonds. They simply buy them and hold until maturity while they collect tax free income.
So why haven’t you ever heard of municipal bonds?
Probably because it doesn’t give investors 100% profits overnight. Or because it is such an incredibly “boring” investment. Think about how boring your car payment is, or your mortgage payment, or your student loan. You make that payment EVERY SINGLE MONTH and nothing changes. It’s so mundane, predictable, and downright boring!
But guess what… imagine if you were the bank collecting those steady interest free payments. Now you have something to be excited about right?!
Real World Example
“The” Ohio State University recently issued a $350 million municipal bond. The funds will be used for the purpose of paying cost of the acquisition, construction, improvement, and renovation of certain student housing, dining, and student recreation services at the university.
This project will add approximately 3,200 new beds, replace approximately 675 existing beds, and add new dining facilities, new social study – group work areas – meeting rooms, and additional indoor & outdoor recreational facilities. Completion of this project ensures that the University’s future policy to require all freshman and sophomore students to live on campus by the 2015-2016 academic year can be achieved.
Here are the key takeaways from this Municipal Bond
- They are raising money to expand
- The expansion will bring more revenue to the university
- In order for the university to default on this bond they would have to go bankrupt and shutdown their campus… which was founded in 1870. (EXTREMELY UNLIKELY)
I’m telling you this is all possible but you still might be skeptical. I understand, but take a look at the following quantifiable facts about this type of investment opportunity.
From approximately 1871 to 2001, the stock market has returned an average of 8.8%. For everyone in my tax bracket, this translated to a net return of 6.6% a year. Municipal bonds during the same period gave approximately a 5% tax-free yield with absolutely no risk. If you ask me the 1.6% difference isn’t worth the extra “stock market” risk and worrisome nights to me.
|Tax Rate||Stock Market Return||Realized Return||Municipal Bond Return|
PIMCO, a huge bell weather bond firm that manages approximately three-quarters of a trillion dollars in bonds stated from 1970 to 2006 the default rate for munis has averaged 0.01% annually.” In other words, only one out of 10,000 municipal bonds defaulted. If you need even more convincing, PIMCO reported that during the Great Depression, the default rate was 1.8%, with 97% of the defaulted principal eventually being recovered.” So approximately two out of 100 bonds defaulted during the Great Depression, but investors recovered a full 97 cents on the dollar.
|10 Yr U.S. Treasury||3.81%||Yes|
|5 yr CD||1.50%||Yes|
Municipal Bonds in Your Portfolio
Since Municipal bonds give an almost guaranteed return and offer 5% annually tax free, you could gradually double your wealth every 14 years without worrying about ups and downs in the stock market. The only thing you need to do is reinvest the profits into more bonds.
Heck you don’t even have to study them, just insure they are rated triple-A and the odds are in your favor.
When the stock market crashed in 2008, municipal bond owners didn’t lose a penny to the crisis. While all their friends and family were panicking and frightened by their retirement outlook, these investors were sleeping well at night.
Let’s be blunt. This opportunity shouldn’t even exist once you factor in the two golden rules of investing.
- If you take no risk, then you earn no reward
- If you take risk, then you earn a reward
Isn’t that the conventional financial wisdom we have received in the past?
As you’ve surely seen in the news, local governments across America are experiencing severe cash-flow problems. Detroit recently filed bankruptcy! These municipalities are not seeing growth in their revenues, in fact some revenues are shrinking while their expenditures are not.
Long time Wall Street darling Meredith Whitney who predicted the 2007 crash of Citigroup stated that there would be significant defaults in the municipal bond market totaling billions of dollars. Her estimation was approximately 50-100 municipalities would go bankrupt. But if you took a quanitifiable look at those numbers and you believed what she said was true that’s still 100 municipalities out of tens of thousands.
Here’s the thing: Although there has been frightening news reports and horrific predictions. Municipal bonds are paying higher interest rates than any other investment vehicle that offers the same amount of risk. This type of investment may not be the “no brainer” investment it was 20 years ago, but if you conduct the proper research, invest in only AAA bonds, then you can still have one of the safest retirement investments in the market.