Do you know what bonds are? Bonds are where you’re kind of like the bank lending somebody money. When you buy savings bonds, you lend money to the federal government. With corporate bonds, you lend money to companies. And when you buy municipal bonds, you’re lending money to cities, counties and states.
Municipal bonds have been particularly attractive to a lot of investors because you don’t have to pay federal income tax on your earnings. Muni bonds can be good for families earning $100,000 or more.
But here’s the problem. The Securities and Exchange Commission has issued a warning that local governments are lying to people who by muni bonds by not telling them about their locale’s financial troubles.
Look at the turmoil with government workers in Wisconsin; the fight in Illinois about that state’s massive deficit; the governor of California proposing moves to deal with his state’s massive deficits; and even Texas, which has long prided itself on low cost government and low taxes, now facing huge multi-billion dollar deficits.
And that’s just at the state level, which is to say nothing of what’s happening at the county and city levels across the country!
So what’s the best way to protect yourself when buy bond? I recommend you stick to bond funds, not individual bonds. The companies that offer muni bond funds evaluate each individual bond and really dig in to get the dirt before you get that bond. They do research that you as individual probably couldn’t figure out on your own. Having a bond fund manager put together a well-researched bond fund lowers the risk of facing down a government default, in which case you could lose all your money.
Vanguard is the giant in muni bonds and really the only company you should look at because they own this territory. With any bond fund, I want you to opt for shorter maturities because bond values are in a funny place right now with interest rates being so low. When those rates rise, the value of your bonds will go down, not up. So short-term maturities are the only safe choice right now.
Note: This segment originally aired February 2011