Muni Bonds: The New Cash (SHM)

It’s hard to deny we’re in a difficult market right now. Unless you’re in 100% cash – and have been for 6+ months – then you’re feeling the pain. Such is life for an equity investor. Although equities tend to have attractive multi-year growth rates, there is always risk.

That’s why investors have been taking a second look at bonds, specifically municipal bonds. Affectionately called ‘munis’, municipal bonds have enjoyed a resurgence among retail investors. According to the Financial Times, when California offered a $5 billion bond sale last week, mom and pop investors bought a significant portion of the debt.

This event underscores something happening in households across the land. Those with cash don’t want to risk it in the market – they want alternatives. Investors are buying munis for three (3) reasons:

1. Munis Have High Yield & No Taxes in Difficult Markets

   Municipal bonds are unique investment vehicles. They offer yields, but the interest is not taxed by the IRS. That way, the “effective” yield for the muni is often higher than on taxable bonds. Moreover, as prices for munis have been falling, yields have been rising. Barron’s reported one advisor saying, “Yields are staggering.” This makes municipal bonds attractive to many investors.

2. Munis Are Relatively Safe Investments

   When you’re buying a muni bond, you’re actually loaning to a state/local government or their agencies. Although cities can go bankrupt – thus preventing you from receiving back your initial investment – at least we can vote on governors and mayors. As a result, munis are a safer investment than many corporate bonds. Munis are one way for investors to find safety in this market.

3. Investors Want Something Cheap

   Even though cash has been a safe place this year, keeping cash is not always attractive. Psychologically, we know nothing happens when we leave cash in CDs or savings accounts. Interest hardly does anything for you, especially after taxes and inflation. That’s why investors are still looking for places to park their investments. With municipal bonds yielding above treasuries, they seem to be one alternative to do-nothing cash.

After surveying the market, we found a muni bond ETF to be a great candidate for our Pick of the Week. The SPDR Lehman S-T Municipal Bond ETF (SHM) is one of the best places to invest in munis today. One quick note about the name of this ETF: SHM is not a Lehman Brother’s product (Lehman Brother’s filed for bankruptcy last month.) It simply tracks the benchmark established by Lehman. In case you’re wondering, Barclay’s is rumored to be replacing the Lehman benchmark with their own brand.

SPDR Lehman S-T bond has some of the benefits of holding bonds outright and some benefits of holding an ETF. For one, you collect the yield of the bonds. Right now, SHM is yielding +2.7%. Second, price swings on this ETF are not nearly as wild as equities. Although you can still gain or lose, SHM has been relatively stable. Finally, you can buy or sell this ETF at any time. You don’t have to wait for any of the munis to reach maturity or get a penalty for selling early. For a stable investment, go with SHM.

All the best.