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Timely tips on buying tax-exempt bonds

Consumer Reports News: December 18, 2008 11:32 AM

In an earlier post, we mentioned that tax-exempt, municipal bonds were looking unusually good in the current investment climate. Here, a Q&A on how and what to buy.

In buying individual tax-exempt bonds (as opposed to mutual funds), are there any states you should avoid because of solvency concerns?
Warren Gisser, a senior vice president with JB Hanauer in Parsippany, N.J., a fixed-income brokerage with branch offices in Philadelphia and Florida, doesn’t think so. Naturally, investors might be wary of bonds from issuers heavily exposed to the weakened financial services industry, auto industry, and housing, Gisser points out. But any state’s general obligation (GO) bonds are viewed as relatively safe.

How many bonds need you own to be well diversified?
“Diversification is important, but the higher the quality you are purchasing, the easier it is to be well diversified,” Gisser says. AAA-rated bonds are considered the highest quality. Still, he suggests dealing with a broker who knows the bond market well. “There is significant nuance in municipal bond investing, and all bonds are not created equal.”

What's the minimum you should think of investing?
Although you can buy bonds for as little as $5,000, Gisser says, “I would advise investors to buy in quantities of $25,000 or more. Should they need to sell their bond before maturity, the bid (or price) they will receive will be better.”
    Donald G. Bennyhoff, a senior investment analyst at Vanguard in Malvern, Pa., thinks that to put together a nicely diversified portfolio of individual municipal bonds at reasonable prices, you might need at least a million dollars. Otherwise, he believes, bond mutual funds make more sense.

Should you confine yourself to local bonds or funds, especially if yours is a high-tax state?
If you can get a better after-tax return by shopping out of state, go for it, Gisser says. Even for investors in high tax states like New Jersey and New York, out-of-state bonds often offer comparable or better after-tax rates of returns. “Keep in mind,” he adds, “that the U.S. territories of Puerto Rico, Guam, and the U.S. Virgin Islands are ‘triple tax-exempt’ in all states, with interest free from federal, state, and local taxes.”

The securities industry provides useful information for bond investors at this Web site. —Warren Boroson

Guest contributor Warren Boroson is the author of more than 20 books, including “How to Pick Stocks Like Warren Buffett” (J.K. Lasser).

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