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I know the best protection would be treasury bonds but, do municipal bonds provide an effective shield against most bear markets? It is rare to see a reasonably sized wealthy city go bankrupt and their tax free status makes them very tempting especially since I want to keep my money far away from the IRS.
many times like 2008-2009 credit down grades made them a poor choice. if you want protection from bear markets nothing beats long term treasuries. muni's do not have to default but it is just fear ,greed ,and perception that can move them.
2008-2009 saw long term treasuries soar 45% while corporates and muni's fell. muni's fell around 10% on average.
IMPORTANT:
there is another issue with muni's that amateurs do not realize since we have been in a bond bull market for almost 40 years.
many muni's can be called. so that means when rates are falling THEY ARE PRICED LIKE 10 YEAR BONDS. odds are they will be called.
however in rising rates they revert back to what they really are 25-30 year bonds and are priced as such.
most of the time gains and losses are limited when rates fall but losses can increase by alot when rates rise.
basically it means you will likely buy at a premium today but sell at a discount when rates rise . it isn't a question as to if they rise , only when .
Last edited by mathjak107; 12-25-2014 at 04:17 AM..
I know the best protection would be treasury bonds but, do municipal bonds provide an effective shield against most bear markets? It is rare to see a reasonably sized wealthy city go bankrupt and their tax free status makes them very tempting especially since I want to keep my money far away from the IRS.
In a real crisis, everyone freaks out - and the bonds would plummet in value. However, they would probably recover in 1-2 years to their previous value, while stock might take 4-5 years to do so. There is partial protection in the bonds, but not liquid since you have to wait a year or two. Also, I doubt munis do much better than a volatility-adjusted equivalent mix of stocks and Treasuries.
the biggest issue is the fall they will take if callable if rates rise. you would be buying based on a 10 year and valuing them when rates rise as a 25 year. you will get hammered.
most muni's are callable.
if you are buying for protection you are buying for the ability to appreciate and not the small income stream.
if thats the case my vote is go treasuries , you are playing with fire with muni's if downside protection is your goal.
this dual pricing issue has not come to light and not been an issue in our lifetime since interest rates only went down as long as most of us have been investors. but that is on the edge of changing.
the biggest issue is the fall they will take if callable if rates rise. you would be buying based on a 10 year and valuing them when rates rise as a 25 year. you will get hammered.
most muni's are callable.
if you are buying for protection you are buying for the ability to appreciate and not the small income stream.
if thats the case my vote is go treasuries , you are playing with fire with muni's if downside protection is your goal.
this double pricing has not been an issue in our lifetime since interest rates only went down as long as most of us have been investors.
The key is to stick with intermediate term munis, not long term ones.
they will not provide enough oomph to protect a portfolio. you would have to hold so much of an allocation to them to over come a drop in stocks it would be silly.
the long term treasury fund TLT saw a 35% rise in 2008-2009 . that offset MUCH OF STOCKS stocks losses in a 50/50 mix. the zero coupon 30 year was up 45%.
intermediate term was up 10% . that would not really have offset a whole lot of drop,
muni's lost 10% , corporate bond funds alost about 8%. so while not offsetting losses they just did not fall as much .
it depends what you call " downside protection" true downside protection can only be either the long term treasury or if you want to commit less dollars zero coupon long term treasuries. they can be one wild ride but in any flight to safety you will get a big bang for the buck. but the flip side is true and they can drop quite a bit when we go up.
you may want to consider changing what you use for protection as the big picture changes with rates.. that is what i do.
i used to use the benham capital 30 year zero's years ago when i did the permanent portfolio. the gains were amazing with just a 1% drop in rates.
Last edited by mathjak107; 12-25-2014 at 08:26 AM..
the fed's interest rate moves via the fed funds rate or discount rate have nothing to do with rates on bonds. the fed controls only short term rates when we speak of the fed raising rates..
investors control longer term bond rates not the fed.
in fact the last 36 years the fed has raised the feds fund rate 1/2 as many years by 1% or more yet in those years bonds went down only in one of them ,1996.
the feds short term rate adjustments are supposed to send a symbolic wish to the worlds bond investors as to their wishes. but it is a coin toss as to whether investors follow the fed.
more often than not a raise by the fed in short term rates is looked at as good for bonds since it is holding down inflation.
Last edited by mathjak107; 12-26-2014 at 02:41 AM..
I completely get that Treasuries have lower volatility and more protection than munis in stock market crash and decreasing rate environment, but I think we have a much higher risk these days of interest rate hikes than a broad U.S. stock market crash. With that being said, do treasuries offer any advantages over munis in a rising rate environment, or are both pretty much toast?
read what i wrote above about muni's being a poor choice at the junction of any rate reversal trend.
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