Word: munis
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...Investors are worried--especially with tobacco-bond income imperiled--that states won't be able to service their other bonds. Meanwhile, the Bush Administration's push to cut taxes on stock dividends could make tax-free bonds less attractive. As a result, yields on the best-quality tax-free munis have reached a rare parity with those of taxable Treasury bonds. In both cases you can get about 4% on a 10-year issue. A T-bond would have to yield 5.7% to generate the same after-tax income as a 4% muni for anyone in the 30% tax bracket...
...upshot: if tax-free income is what you savor, this is a great time to buy munis. Altria is just blowing smoke about bankruptcy; indeed, at the urging of a large number of states, Illinois has dramatically reduced Altria's appeal bond so that it can keep making settlement payments. Even in bankruptcy, the payments would probably continue as an operating expense. And even in the unlikely event that the tax on stock dividends is erased, there will be no massive flight from munis toward stocks. The typical muni investor values stability above...
...states' overall budget troubles are the biggest danger for muni investors, and ample reason to be very selective. No state has defaulted on its general-obligation bonds since the Great Depression, so stick with these "GOs" or with "essential service" bonds issued by water, sewer or even school authorities. Medium-term maturities of about 10 years are the bond market's sweet spot today; prices here are less vulnerable to rising interest rates--a certainty at some point--than are those of longer-term bonds...
...portfolio of munis up to about $100,000, the most cost-effective route to safety and diversification is a well-run, low-cost mutual fund. Some good choices are in the box at left. For bigger portfolios, it pays to buy (and therefore control) your muni bonds directly. Your best bet is to work through a financial adviser...
Finally, a word on munis for the growing ranks of investors who must pay the hated alternative minimum tax (AMT): income from "private use" bonds, like those used to fund many stadiums and airports, becomes taxable under the AMT. Muni-bond funds will tell you their AMT exposure if you ask, and any good personal portfolio adviser should watch out for them as well...