In this episode of “Investment Management Foundations,” Gary Quinzel, Wealth Enhancement Vice President of Portfolio Consulting, discusses the potential benefits of including municipal bonds in investment portfolios and the features that may make them a worthwhile consideration for investors.

VIDEO TRANSCRIPT BELOW

Hello, everyone. Welcome to another edition of “Investment Management Foundations.” My name is Gary Quinzel, VP of portfolio consulting at Wealth Enhancement Group. Today's topic is why you should consider municipal bonds as part of your investment portfolio. So, first off, let's talk a little bit about yield. On an absolute basis, municipal bonds, like all bonds, are trading at much higher yields than they have in decades. A big part of that is the recent rate-hiking cycle that the Fed has embarked upon as part of its effort to stem inflation, which of course was at 40-year highs. So, we have a much different yield environment overall, which creates tremendous opportunities for fixed income investors that can just buy bonds and clip coupons over the long run. The timing is still quite uncertain, but the current messaging from the Federal Reserve suggests that the next rate move is expected to be down and not a hike. While we don't know for sure, that seems to be the current outlook, which would be a positive for bond investors of any type, whether it's a taxable or tax exempt bond fund.

Now, why consider municipal bonds, as opposed to other types of bonds? Well, for one, you just double bonds, payout income, that is tax free. Most investors that are looking for ways to negate their overall tax bill find the tax-free income of municipal bonds very compelling. And as you may know, back in 2017, the Tax Cuts and Jobs Act enacted legislation which brought down overall tax rates. That legislation is set to expire at the end of 2025, which has really lifted the demand for investors as ways to find tax-free investments. There's also been a number of states that have changing tax laws, especially those high-income-tax states, where corporations are now getting into the game and looking for tax-free income as well. So, there's incredible demand out there for these tax-free municipal bonds.

So, when we think about what drives the price of a stock, or a bond, or any investment, it's often driven by supply and demand, and supply has not been as much as demand lately. This expected to see around 400 billion in issuance in 2024, which is up slightly from last year. However, it's not expected to be net negative overall. So, we're expecting to see higher demand, which has helped push the price of municipal bonds to multidecade highs. As we can see on the screen, we have a graph that demonstrates the ratio of the yield that investors get from municipal bonds relative to that of the broader Bloomberg Barclays Aggregate Bond Index. When that graph gets really high, basically what that means is that municipal bonds are attractive relative to taxable bonds. When it gets really low, we can see that on a relative basis, the relative yield that you're getting in comparison to what you're getting on a technical bond isn't quite as attractive, as we know yields and prices move in opposite directions. So, when prices are high, yields are low. And so on a relative basis, we're not seeing a ton of extremely attractive opportunities.

But there's a really important consideration when thinking about when you should invest in municipal bonds, because it's not what you make on a bond—it’s what you take home. And of course, I talked about the tax-free impact. So, we have what we call the tax equivalent yield, which is really what investors should be thinking about when considering whether or not they should invest in municipal bonds. We have another chart here, which demonstrates what the current yield you can get in the broad Bloomberg Barclays Municipal Bond Index, and then it demonstrates what the taxable equivalent yield would be out to all the different current federal income tax brackets. And as we can see, the further you go out for tax brackets, the higher the taxable equivalent yield it can become. So, we can see even relative to what you can get from taxable bonds, the textbook seven deals becomes that much more compelling. So really, there's a case to be made that any investor should consider adding municipal bonds because of the after-tax impact.

Another important consideration, as with all portfolios, is diversification. Municipals offer a lot of compelling features that are differentiated from other securities such as stocks and bonds. They have different credit features, they have different liquidity features, and there's really a number of opportunistic ways that investors can include actively managed municipal bonds, as well as a ladder on a portfolio that can be created for income purposes. So, we hope you found this useful, and hopefully you can join us again in our next edition of “Investment Management Foundations.” Thanks, and have a great day.

This information is not intended as a recommendation. The opinions are subject to change at any time and no forecasts can be guaranteed. Investment decisions should always be made based on an investor's specific circumstances. Investing involves risk, including possible loss of principal.

There is no guarantee that asset allocation or diversification will enhance overall returns, outperform a non-diversified portfolio, nor ensure a profit or protect against a loss. Investing involves risk, including possible loss of principal.