Published June 14, 2012
When there are fears around the world, investors flock to buy U.S. Treasuries for safety. With the fear of a contagion spreading today, this is happening at an alarming rate.
Investment 101 classes teach us that when prices on bonds go up, yields go down, and when prices go down, yields go higher. The 10-year Treasury is at historic lows. It makes for good headlines, and the unintended positive result of this is that municipal bond prices have soared relative to what they will mature at in the future.
Investors in these vehicles need to look at their latest statements and look at the unrealized gains. If you see municipal bonds with maturities from 2015 onward above 104 to 105, you should consider having a yield to maturity calculation done. You most likely will realize that although you are getting a good tax- free yield in the form of income, from this day forward the total return (yield plus or minus growth) is possibly less than 1% per year until maturity.
Why? When rates drop, the value of municipal bonds with higher yielding coupons increases, but will ultimately drop in price as they get closer to maturity. They all mature at par or 100. So if you look at your current value and it says 105, it will eventually be at 100 by maturity date.
Bottom line: Look today and possibly capture the gains that you have been given as a result of the fear from Europe. Although I believe the problems will persist in Europe for years, rates at these low levels won't. Take the gift from the fear today. It will be gone soon.