Wednesday, February 04, 2009

A Move into Municipal Bonds

We have been making regular investments into the stock market throughout this downturn, both by maxing out my 401(k) - my wife no longer has a 401(k) since she has gone part-time - and through monthly scheduled investments in our portfolio. However, late last year we got some cash that we were not expecting, and this money has been laying in a money market account ever since. Sure, money markets are a safe investment, currently insured by the government, but with interest rates practically at zero, there can be no meaningful talk of yield. It is also clear to me that this is not a long term solution.

Having said this, while I am very optimistic about the long term prospects of the stock market, I have no intention of jumping into the market with a large amount of cash in a lump sum. We are moving into the stock market slowly and in a measured way that will hopefully blunt the trauma of any sudden or dramatic additional decline in stock values. With that in mind, I have decided to make a move into municipal bonds, and I have done so by investing about 25% of the windfall Vanguard's VCAIX. Here is a description of the fund's investment strategy:
"The fund invests primarily in high-quality municipal bonds issued by California state and local governments and regional governmental authorities. It may invest at least 80% of assets in securities that are exempt from federal and California taxes."
California bonds? Isn't California's credit rating really crappy and isn't the state in a huge deficit? Yes, to both questions. However, I don't believe that California will default on its loans. At the end of the day, this is a state with the power to tax the population or to cut services to balance the budget. I think that muni bonds are a pretty safe investment, well in this environment nothing is really safe, but you understand what I mean. Besides, we live in California.

There is also the important matter of the tax exemption. This fund invests in bonds that are tax exempt federally as well as at the state level. And since our account is not a tax sheltered account (such as a 401K or IRA), a regular bond fund would generate a substantial and recurring tax hit. We are in a high tax bracket, so a regular bond fund would need to generate much better taxable returns to match the net yield that is likely with this tax exempt investment.

The way I look at it, munis are a pretty safe investment which offer a substantially better return compared to money market funds, CDs and such. Hopefully, I don't come to regret this decision, but no risk - no reward, right? Right?  :-) 

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