My column last week about tax-free municipal bonds prompted a good number of questions from readers who wanted more information.
Far and away, the most asked question was about the process of buying muni bonds. Unlike U.S. Treasury obligations that can be purchased directly from the Bureau of the Public Debt (www.publicdebt.treas.gov) for as little as $100, municipal bonds must be purchased through a registered adviser.
When a government agency such as a city, water district or other municipal government needs to raise capital for a public project, they hire what is called an underwriter to handle to sale of the securities.
Let's say Escondido wants to fund a particular project with proceeds from the sale of bonds. You can't walk into Mayor Lori Holt Pfeiler's office and invest in some bonds. She's likely to tell you to contact the various brokerage firms that are part of the underwriting team.
Most munis are sold in multiples of $5,000, and the rate of return on the bonds will depend on the maturity. The longer the life of the bond, the higher the return. Of course, the risk increases as well.
One of the benefits of buying bonds through a new offering is that you do not have to pay a commission. The broker is compensated as part of the underwriting. So, if you invest $10,000 and hold the bond through its maturity you will get back all that you invested.
Be cautious in the secondary market. Unlike stocks, where the commission you pay is printed on your transaction statement, the fee to buy bonds in the secondary market is not revealed. And, unscrupulous brokers can sneak in very high commissions.
One way to avoid that is to check the true value of a bond by using an online service provided by the Securities Industry and Financial Markets Association. The Web site www.investinginbonds.com can provide a real-time quote for any bond with what is called a CUSIP number. Typing this registration number into the site can get you an accurate quote.
Compare that with what your broker is charging and you can see the difference that a commission will make.
The other option is to use mutual funds. Be sure to compare commissions and the annual expense rates that can really eat into your return.
I also received some questions about the safety of bonds issued in this state, considering its well-documented financial problems.
Interestingly, a new report from Standard & Poor's was released last week that states: "Despite tough economic times, the number of municipalities with AAA ratings has more than doubled since early 2008, to 169. A total of 86 communities joined this group in the 18 months through August 2009."
Carlsbad and Del Mar are among the newcomers who qualified for the elite AAA rating.
The point here is that no two bonds are the same and it is a responsibility of the investor to investigate ---- with the help of a trusted advisor ---- the quality of individual issues.
Contact George Chamberlin at geoc1045@gmail.com.
