Tax fears put light on municipal bonds

January 03, 1993|By Newsday

The Clinton promise to raise taxes on those with incomes over $200,000 a year is leading a lot of people, including some in lower income ranges, to look at tax-free municipal bonds.

At the same time, between $10 billion and $15 billion worth of bonds will come due this month, because they are maturing, being refinanced or being called by the issuer.

Some investment companies are trying to use the flood of bond money coming due to get you to buy bonds now. Some analysts say there may be barely enough newly issued bonds to meet the demand caused by the January rollover.

The net result of all this may be a decline in bond yields -- the interest they pay -- and an increase in the price of older, higher-yielding bonds, which investment houses may be hawking.

Despite the pressures, though, it may pay to wait to see what new issues come on the market late in January or beyond. Because of the traditionally thin bond supply in January, James Lynch, editor of Municipal Bond Advisory, a New York-based newsletter, said he was advising his clients to wait until February.

The biggest shock will be to those whose bonds are being paid off by the municipalities that issued them after 10 years. Those bondholders had been receiving 8 percent to 11 percent tax-free. Now they will be getting 5.5 percent to 6.25 percent when they reinvest.

Last year was a record year for bond activity, with $233 billion in new long-term bonds issued, including a record $95 billion for refinancing. It was also, Mr. Lynch said, a record year for demand, because municipal bonds are one of the few tax shelters left since the 1986 tax act.

Even given the lower yields, municipals compare favorably, on a taxable basis, with Treasury bonds and most other bond investments, which can be taxed by federal, state and local governments.

Jim Lebenthal, who heads the municipal bond firm of the same name, said that despite the increased demand, he expects bond yields to hold steady, probably in the 5.5-percent range for high-quality municipal bonds, ranging up to 6.25 or 6.40 for lower-quality bonds.

If you are interested in municipal bonds for tax-free income, the question is how do you buy them: individually or through a mutual fund?

For many people, who have neither the time nor sophistication to thoroughly investigate bonds they are considering, the best answer is probably a bond mutual fund. It is diversified, so you are not stuck with bonds in one municipality. It is also professionally managed, so the bonds' credit quality can be checked.

Funds buy and sell bonds at current market rates, keeping the yield current. And in many cases, interest is paid to you monthly, if you choose. In addition, bonds in funds can be sold more easily, and at lower cost, than individual bonds.

The problem with bond funds for some, however, is that there is no maturity date for a fund. Bonds are continually bought and sold. Depending on interest rates, there is no guarantee that you will receive your original investment back when you sell.

If you buy individual bonds and hold them to maturity, you can be sure of getting your money back. If you have to sell an individual bond before maturity, what you get will depend on the market.

In addition, it is sometimes hard to sell an individual bond.

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