Here’s your “Slap in the Face” Award for this week. And it’s a wake-up slap for people looking for income in all the wrong places.
The recent dip in Treasury yields is driving record numbers of people to search for higher yields in tax-free and municipal bonds, or munis. Unfortunately, a big part of the buying in munis is in a part of that market that you do not want to own.
If you follow my work in Oxford Bond Advantage, you’re familiar with the term “rate pig-itis.” This is a condition that affects income buyers and causes them to look at only the yield of a bond or a bond mutual fund. Essentially, they look for the highest yield they can find and ignore all the other variables associated with an investment.
Nothing could be further from the truth.
If a municipal bond is going to default, it is going to be a high-yield one. Municipal bonds that can’t earn an investment grade aren’t even rated. There are no BB- or B-rated municipal bonds. It’s BBB- and higher or nothing.
If you own investment-grade muni bonds, which are paying far less than their high-yield counterparts, you do have a 99.9% success ratio to bank on. The default rate is about one-tenth of 1%. That’s the reliability investors assume they’re buying.
And the buying has been unbelievable. Through the end of May, investors have poured $8 billion into high-yield or junk municipal bond funds. That’s the most money that’s gone into these types of funds since 1992.
Add up all the problems associated with bond funds that I have talked about for years, add the riskiest investments of the municipal bond market, add illiquidity and below-average returns for the risk associated with them, and you are asking for trouble.
High-yield municipal bonds default 25 times more often than investment-grade munis. That should say it all.
If you want to avoid a big, big slap in the face down the road, avoid the rush for yield in junk munis.
Don’t let rate pig-itis destroy your retirement nest egg. The extra few percentage points you can earn with these things are not worth the risk.