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INVESTMENTS-
JUNE 2003 by Claude Hammond Rock Steady For many investors, the past two-and-a-half years in the stock market has pretty much been a crapshoot. The big, heady returns of the dot-com market of the 1990s turned into stomach-wrenching losses in the dot-bomb market of the early 21st century. Still, there are instruments of investment than are solid and safe, yet provide a nicer return than a bank’s certificate of deposit. And, if you make the right investment, you won’t have to pay taxes on its returns. “If you buy municipal bonds in the same state in which you live, you generally don’t have to pay state, federal or local taxes on the returns on your investment,” explains Logan Foster, investment counselor at Dupree & Co., a Lexington firm with more than $950 million of municipal bonds in total management. The firm runs the second-oldest tax-free bond mutual fund in the U.S. and has tax-free bond funds available for Kentucky residents. “They’re one of the last true tax shelters left,” Foster says. They’re not to be confused with tax-deferred investment – they’re tax-free, totally and completely. Particularly where the bond market is right now, this can be a very smart investment. “In today’s bond market, there’s very little difference between tax-free and taxable yields. Normally, municipal bonds will earn about 85 percent of what a comparable treasury bond yield might be. Now, they’re almost identical.” According to Foster, the large returns offered by various stocks and stock mutual funds in the 1990s taught many people bad habits on what to do with their money. “We saw the market take thousands of investors and turn them into speculators,” he says. “We’ve had all too many people come in here who were invested entirely in stocks and were over 65 years old. To me, that is entirely inappropriate. Now, I’m in the bond business, so you can expect me to say that. But I have sort of an old-fashioned view. I hear these guys on TV saying things like, ‘Get into stocks to get into the market bounce now that the war’s over.’ “That’s nonsense. Going back to the 1940s, ’50s and even ’60s, most trust departments were heavily into bonds. Many of them have moved 180 degrees since and are into stocks almost completely. Most people and institutions need more balance in their portfolios.” Foster ascribes to the old investor adage that one’s age should equate to the percentage of their investments that are in bonds. “So, if you’re 40 years old, about 40 percent of your investments need to be in bonds,” he says. “It just makes sense. When you’re about to retire, you’re going to need a much more stable and safe investment environment than when you were 20.” The reason for the safety of municipal bonds is a relatively simple one, Foster says. “Municipal governments aren’t getting out of the tax collecting business,” he explains. “Municipal bonds are the major funding sources for taxes. The reason an investor would want to get into a bond fund – rather than buying the bonds directly – would be instant liquidity. If you buy a bond outright, it’s a buy-and-hold proposition. A bond fund allows you to get in and out pretty much at your own discretion. “Roughly, the yield on the main Kentucky tax-free income series bond fund we offer is 4.5 percent. Someone in the 30 percent tax bracket would have to get a taxable yield of more than seven percent to get comparable yield. In the world of bonds, seven percent isn’t out there anywhere. Your net yield with tax-frees is so much higher. All of Dupree & Co.’s tax-free bond funds are no-loads. “These funds offer instant liquidity and diversification. As far as mutual funds in general, we believe people should buy no-load funds.” The boom years of the 1990s were hard times for the bond industry. “To your average clients of five or six years ago, we looked pretty boring when they were getting 15 to 40 percent returns on their stocks,” Foster recalls. “There are a lot of people who got pulled into the 20-40 percent yield thing and the whole Internet technology bubble. But stock prices are based on earnings and earnings weren’t worth a darn for a lot of those stocks. A company has to make money.” Many of those who maligned the bond industry a few years ago are now having to eat their words. “If you’re looking at 10-year average returns, as of December 2002, one of the more popular S&P Index funds averaged 8.4 percent,” Foster notes. “Our company’s Kentucky tax-free income series averaged 5.9 percent for that same period of time. When you figure in the tax-free angle, it’s the equivalent of 8.2 percent prior to taxes. “Our Kentucky tax-free income series did much the same as the S&P index with significantly less risk and stress on the investor. If you look at the three- and five- year numbers, the tax-free fund beats the S&P. That’s just not us, but it’s other tax-free bond funds as well.” According to Foster, using both stocks and bonds within an investment portfolio is an old habit that still works. “I think people need considerably less stocks in their portfolio than they think they do,” he adds. “In my mix of investments, I’m about 80 percent bonds and 20 percent stocks. If you’re willing to do your own research on yields and dividend, you’re probably better off. I’m more of a buy-and-hold investor and I’m in for the long-term. “Look at what Warren Buffett’s guidelines are for stock purchases: Buy good companies at a good price and leave them alone. That’s a hard thing to do. “If you’re going to buy stocks, buy a good stock with a good dividend yield. In other words, it’s going to behave like a bond if you hold it for a good 10-15 year period. Buy it and hold it – weather the tough times and watch it grow steadily. I think investors need that sort of philosophy.” Claude Hammond is a writer
for The Lane Report. |
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