Minibond security vs. mutual fund flexibility

May 12, 1991|By David Conn

To muni or to mutual? That is the question.

Whether 'tis nobler, and smarter, to suffer the fees and commissions of a mutual fund that invests in municipal bonds, or to take arms against those costs by buying the bonds directly.

It ain't exactly Shakespeare, but it's still a valid question if you're trying to choose between the security of municipal bonds and the flexibility of a mutual fund.

For years, your decision probably has been affected by one important factor: Maryland general obligation bonds, tax-free instruments backed by the full credit of the state, tend to cost at least $5,000 each. And not everyone has that kind of cash lying around.

Maryland Treasurer Lucille Maurer has an answer. On Wednesday, the Board of Public Works, on which Mrs. Maurer, the governor and the state comptroller serve, approved the second annual sale of "minibonds," state municipal bonds that sell for a mere $500 apiece.

"The whole purpose is to give Marylanders who don't have $5,000 to put away in core savings the opportunity to buy what the BondBuyer [newspaper] called the 'gilt-edged' Maryland bonds," Mrs. Maurer said.

The sale will take place May 27 through May 31, and applications are available in various state offices, including Motor Vehicle Administration branches, or by calling 1-800-535-6464.

But before you sign over your latest paycheck to the state, it's important to consider the fine print on the minibonds, and how they mesh with your investment objectives.

To broaden the number of possible buyers, the state will limit the amount of investment per person to $2,500, or $5,000 when bonds are purchased jointly. There are more restrictions:

* The minibonds cannot be sold or transferred to another owner.

* There will be a $25 penalty per $500 bond for early redemption.

* The state will pay a lower interest rate in the first few years and a higher rate in the later years.

That adds up to a serious incentive to hold the bonds to maturity. "These are basically for people who are not depending on this for cash," Mrs. Maurer explained. "People should look at them as savings for retirement or college, for a down-payment on a house, but not as a money-market account."

As with U.S. savings bonds and other "zero coupon bonds," owners of Maryland minibonds will not receive any interest payments until the bonds are redeemed. Investors will pay $500 for each bond and receive the original investment plus the compounded interest when the bonds mature.

The five-year bonds will pay an average annual interest rate of 5.6 percent, and the 10-year bonds will pay 6.1 percent. Assuming it is held to maturity, a five-year bond will return $659.02; a 10-year bond will pay $911.86 at maturity.

The bonds are "double tax-free" -- no federal or state taxes are incurred by Maryland residents. For an investor who pays 35.5 percent combined state and federal taxes, the comparable yields on taxable securities are 8.68 percent and 9.46 percent for the five- and 10-year bonds, respectively, according to Mark Sherno, an investment counselor with CIGNA Individual Financial Services Co. in Columbia.

Those comparable taxable bond rates may seem like a pretty good deal, unless you believe interest rates are due to climb any time soon, said William I. Kissinger, a CPA and certified financial planner who heads Kissinger Financial Services in Timonium.

"In the short term these look like good deals," he said of the minibonds, especially since the Federal Reserve Board seems intent on lowering interest rates. "But in the long term, I believe interest rates will go up. So even five years is a long time to lock in these rates," especially for the small investors who would be attracted to the minibonds, Mr. Kissinger said.

Further, the comparable rates for taxable bonds look best for those in the highest federal tax bracket of 28 percent. If you're among those in the 15 percent federal tax bracket, the comparable yield is much lower, Mr. Kissinger noted.

With state and federal taxes combined, a five-year minibond would be comparable to a 7.23 percent taxable yield for those in the lowest tax bracket. The 10-year minibond would be worth 7.87 percent from a taxable bond.

"It becomes a marginal investment for someone in the 15 percent [federal] tax bracket," Mr. Kissinger said.

By contrast, the highest certificate of deposit rate listed in the Maryland interest rates chart inside this section is 7.53 percent for a $1,000 five-year CD offered by Eastern Savings Bank. Eastern Saving's deposits are insured by the Federal Deposit Insurance Corp., while the state bonds enjoy the triple-A rating Maryland shares with fewer than 10 other states.

The experts agreed that prospective Maryland minibond purchasers should share some or all of these attributes:

* A desire for a relatively risk-free investment.

* A high tax bracket.

* No immediate need for the cash used to buy the bonds.

* A belief that interest rates will not rise substantially in the next five or 10 years.

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