the same period. The catch? Such yields are taxable so you might wind up with around 2.5%, after-tax, depending on your bracket.
That’s why investors like 37-year-old Dion Graham turned to munis to generate interest income and a tax break at the same time. “I’m happy I have money in municipal bonds,” says Graham, a software company executive in Cerritos, California. “I locked in a 4.8% yield, after-tax; my bonds have appreciated a bit; and I had less money to lose in stocks during the past two years.”
Graham made his move in early 2001 when the economic downturn was becoming apparent. “I found myself having to lay people off and I realized the importance of having a cash reserve,” he says, “so I moved a little more than 10% of my portfolio into municipal bonds as a reserve in case of a future emergency. With two young children [twins who just turned 3 years old], I thought I should be taking less risk in my portfolio, so I shifted some assets from stocks to municipal bonds.”
To receive interest that was exempt from state as well as federal income tax, Graham bought bonds issued in California. “I bought individual issues,” he says, “which I plan to hold until maturity [20 years]. In case I run into a need for cash, though, I can sell them. I realize that there is a chance the bonds might lose value, but bond pr
ices are likely to be fairly stable, certainly when compared with stocks.”
Antoinette Chandler, a financial advisor with Bank of America in San Francisco, says that she’s currently advising clients in high tax brackets to buy municipal bonds maturing in three to five years. “That appears to be the best combination of risks and rewards,” she says. “Yields may be around 3%, tax-exempt, and there’s less chance of a loss of principal, in case interest rates rise.”
Individual municipal bonds may be a good alternative to municipal bond funds, according to Chandler. “Funds have expenses which can eat into your yield,” she says, “however, bond funds are more practical for many investors. If you’re investing through a fund, try to find one with a low expense ratio and a history of doing fairly well when the bond market has been weak.”
REAL ESTATE: PAPER OR PROPERTY
While stocks have sagged, real estate values have risen. One way to put real estate into your portfolio is though real estate investment trusts (REITs) or REIT mutual funds. Equity REITs, the most popular kind, are essentially companies that own many properties and trade like stocks.
During the past three years, REIT funds have gained nearly 13% per year, according to Morningstar. “They’ve had a good run,” says Garry Bridgeman, first vice president-investments at Merrill Lynch in Atlanta, “and they belong in many portfolios. However, investors often rush into asset classes that have done the best recently. Sometimes you’re better off with asset classes that have not performed as well lately.”
As an alternative to REITs, you might decide to own investment