3 Reasons Your Municipal Bonds May Not Be as Safe as You Think
Through our regular analysis and discussions with colleagues and financial industry professionals, we continue to see evidence regarding the lack of proper oversight and expertise required to evaluate the true risks of municipal bonds.
There are three areas of concern you should know more about if you own municipal bonds in your portfolio.
1. 80% of Individual Municipal Bonds Are Flawed
As we enter a new paradigm of rising interest rates, too many individual municipal bond portfolios could be structured to lose significant value.
In a quest for more income, these faulty portfolios have been over-exposed to long-dated municipal bonds that don’t appropriately match the investor’s cash flow needs. So, unless all the bonds are held to full maturity without defaults, the portfolio is exposed to significant principal risk as rates rise.
2. Municipal Bond Insurance Has Virtually Disappeared
Prior to 2008, insured municipal bonds represented, on average, more than 50% of those issued; today, they represent less than 6%. With the demise of municipal bond insurance, rating downgrades have become more common. As these bonds slide below an appropriate “investment grade” rating, investors who aren’t protected by insurance have a much greater exposure to default risk.
3. The New Markup Disclosure Rule
In the past, municipal bond purchases have only shown the final price paid on the trade confirmations received by the investor, with any markup already included in the price and not explicitly defined. After a new rule went into effect in May 2018, retail investors now see a detailed outline of the markup (or markdown) they paid.
This could come as big surprise for some when they realize they paid an extra $1,730*, which is likely significantly higher than the commissions an investor is used to seeing in other markets, such as stocks, where transaction costs are typically minimal flat dollar amounts similar (Schwab’s, for example, is $4.95 per trade). This new transparency rule should hopefully help bring transaction costs down in the future.
[* A 2014 Wall Street Journal article cited a study that revealed individual investors trading municipal bonds in blocks of $100,000 paid brokers an average markup of 1.73%, or $1,730.]
How We Can Help
If your investment portfolio includes municipal bonds, it’s time to assess whether you are paying too much in markups. Are you exposed to the common characteristics of inefficient bond portfolios, like a lack of proper due diligence, over concentration to a particular bond issuer, or infrequent monitoring?
Uncovering these hidden pitfalls and safely restructuring your portfolio for today’s interest rate climate is something GGM Wealth Advisors can assist you with. For a free portfolio evaluation, please contact us.