investing in municipal bonds

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Investing in Mutual Funds: The Best Pick to Protect from Interest Rate Volatility

investing in mutual funds

Right now investors should be investing in mutual funds that provide stability - not ones that chase yield.

A case can be made for the Fed doves who want to see rates stay low for a while, or the Fed hawks who want rate hikes now.

The bottom line: no one knows when rates are going up. And here's how to avoid the uncertainty and interest rate volatility...

This Could Shake Muni Bonds to the Core

Editor’s Note: Detroit is more than a sideshow. What’s at stake here is bigger than most investors realize. It could take a Supreme Court decision to determine the viability of many municipal bonds. Regardless of whether you’re a muni bond investor or not, what happens in Detroit will affect you. Shah Gilani has the whole story.

Detroit went bankrupt, but so what?

Its own decades-long gross political mismanagement, corruption and incompetence pushed the city over the cliff into bankruptcy.

Why should we care?

It could change the way investors look at muni bonds. And not for the better.

The largest Chapter 9 filing in U.S. history will reverberate well beyond this once-bustling city and its creditors.

What’s most threatening to muni bond investors, and in fact all investors, is whether the city’s general obligation bonds are secured or unsecured issues.

General obligation bonds, backed by a city’s ability to levy taxes to pay interest and principal, are thought to be the safest of all munis.
Detroit is putting this to the test. Read how this will affect all investors...

Municipal Bonds: While Others Bail, It Might Be a Good Time to Buy

Everything runs on liquidity. Unless you know something I don't, that dollar bill in your pocket is just as likely to buy a can of Pabst Blue Ribbon today as it was yesterday, and will be tomorrow.

Or you could sell 1,000 lbs. of gold - if you have that lying around - without fear of completely scuttling the global gold market. Your bank has to have cash, liquidity, lying around somewhere in the back if it wants to stay in business.

And in many cases, it's easy to see or verify this liquidity. It helps everyone feel better about doing anything.

But there are markets where this liquidity is kept off the open exchanges, where it can be used to juice up huge deals. Or it can prevent these huge deals from having the impact that they "should" have, keeping the hands of large traders hidden.

These are the sinister-sounding dark pools of liquidity.

Dark liquidity is generated and stored in a variety of ways, most of which are possible due to the huge variety of trading venues, electronic and traditional.

With dark pools, neither the size of the order nor the entity making that order can be known until the order is completed. Rosenberg Securities Inc. estimates that fully 15% - trillions of dollars - of all trades occurring on American exchanges, every day, utilize dark pools.

Not Playing Straight Poker

And the markets, like nearly everything else, operate on the wide availability and transparency of good, reliable information. A poker game gets its lurid thrills from the partial presence of that information, or the possibility that the information could be faulty. You wouldn't want to play with all your cards face-up. You just don't know, and that's why it's fun to play poker.

But the markets, despite some inkling to the contrary, can't function with true optimum efficiency if good information isn't available to the widest possible group of participants.

It's not that a player has to have the information, but it should be available to the player if things are going to work the way they should. One is a vying, gambling game, and the other is a free market. We should be able to tell the difference.

And there are nowadays big incentives and compelling reasons for large traders, for high-frequency traders, to maintain this half-plentiful supply of good information. Why? It's simple. They're making a killing off of arbitraging market inefficiency.

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Money Morning Exclusive: Meredith Whitney on Muni Bonds and Red State-Blue State Migration

In 2010 Meredith Whitney made an earth shattering statement during a CBS's "60 Minutes" interview that rocked the municipal bond investment world.

"There is not a doubt in my mind that you will see a spate of municipal-bond defaults,"said Meredith Whitney on Dec 19. She continued, "You could see 50 sizable defaults, and 50 to 100 sizeable defaults, more. This will amount to hundreds of billions of dollars' worth of defaults."

The muni bond market fell far short of Whitney's prediction. But many today feel she was merely ahead of her time.

Recently Detroit has defaulted on its muni bonds leaving investors hoping to get 10% return on their original investment, but there are no guarantees.

As Detroit moves closer to bankruptcy California has 10 cities facing the same fate. The cities of Atwater, Azusa, Compton, Fresno, Hercules, Mammoth Lakes, Monrovia, Oakland, San Jose and Vernon are ready to file for bankruptcy following the now bankrupt Stockton's lead.

Money Morning's Shah Gilani recently talked to Whitney in an exclusive interview about her new book, The Fate Of The States:
The new Geography of American Prosperity

She believes that wealth and opportunity are moving away from the coasts and toward the central corridor. The states of California, Florida and Nevada benefited from the housing boom. However instead of budgeting wisely, local governments spent their windfall profits as fast as they came in on pay increases for public employees, pension increases and pay hikes.

When the housing boom ended, the money stream became just a trickle of new capital. The states were left with pensions they couldn't pay and employees they couldn't afford. They were forced to raise taxes for schools and essential public services.

In contrast a much different scenario was developing in the interior states: N. Dakota, Texas, Indiana. These states avoided the housing crisis. Because foreclosure was not a serious problem they found themselves rich in capital with money to offer tax incentives to companies to relocate and retrain new employees.

These central states are also positioned to reap the massive benefits of from the oil and natural gas boom.

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Investing in Bonds: How to Build a Bond Ladder

With interest rates at near-record low levels it appears that the only way for rates to go is up.

As the U.S. economy moderately strengthens, that means the bond bubble will begin to leak. Even darker, the bubble might just burst altogether.

The prospect of yet another bursting bubble makes investing in bonds difficult. The same is true for stocks.

After all, stocks tend to underperform when rates head north, while gold will certainly drop back once interest rates begin to rise ahead of inflation (which may take a considerable time.)

However, there is one strategy that enables you to prosper even in this tough environment.

It is called the bond ladder. It works like this...

Bond investing in a rising rate environment can be a terrific way to lose money.

If you buy short-term bonds, the yields may well be less than inflation, causing you to lose money in real terms.

And if you invest in long-term bonds, your immediate yield will generally be higher, but you run a large risk of losing part of your principal as rates rise and bond prices decline.

These losses can be a large multiple of your interest payments.

For example, if 30-year bond yields rise from their current 3.11% to 5.11% over the next year, your principal loss on a 30-year T-bond will be $30 on every $100, far more than the $3.11 you will have received in interest.

Of course, if you hold the bond for the next 29 years you will get your principal back at maturity.

But meanwhile you will have spent 30 years locked into an investment at interest rates below the market, and probably below the level of inflation. Not a wise choice.

Investing in Bonds: Building a Bond Ladder

The problem of investing in bonds then is one of reinvestment. You really don't know at what rate you will be able to reinvest your money when the time comes.

This problem is solved by buying bonds in a range of maturities, from short to long, and reinvesting the proceeds of each investment as it comes due.

For example, you could invest 10% of your money in each Treasury bond maturity from 1 to 10 years.

Then when the first bond came due in year 1, you would reinvest the proceeds in a 10-year bond, so you would again have 10 equal bond investments coming due in years 2 through 11.

Here's a concrete example.

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