In case you’re interested by holding particular person municipal bonds as a protected and liquid supply of funds, assume twice. Proudly owning highly-rated municipal bonds is low threat. Nonetheless, promoting particular person municipal bonds will be extremely costly and cumbersome.
Not like shares, which now have $0 buying and selling charges and ample liquidity, municipal bonds have a a lot much less liquid market. Because of this, in case you ever wish to promote municipal bonds, you may need to promote them for means beneath market worth.
The important thing takeaway from this publish is that in case you plan to put money into particular person municipal bonds for tax-efficient passive revenue, you need to plan to carry them to maturity. Don’t depend on particular person municipal bonds as a simple supply of liquidity if an emergency comes up or if you wish to purchase a big ticket merchandise like a home.
Please word I’m differentiating between proudly owning particular person municipal bonds and shares in a bond fund, which often has far more liquidity, however no maturity date.
Counting On Municipal Bond Proceeds For A Home Down Cost
The nearer you’re to purchasing a home, the higher the share of your down fee ought to be in money and low-risk investments similar to Treasury payments. While you discover the house you wish to purchase, you typically have to put down at the very least 20% to be aggressive.
Given the excessive worth of houses lately, 20% down is often some huge cash. It will be unwise to gamble your down fee within the inventory market given its volatility. The extra it’s a must to stretch to give you a suitable down fee, the extra conservative you have to be together with your home down fee investments.
A few of you may need thought-about investing in particular person municipal bonds as a substitute of money or Treasuries resulting from their tax benefit. You do not have to pay federal or state revenue tax in case you are shopping for municipal bonds issued by your state of residence. Due to this fact, the upper your marginal tax price, the extra engaging the asset class.
Nonetheless, regardless of a possible increased web yield, I would not park your down fee in particular person municipal bonds. You won’t have the ability to promote them as a result of there might not be a marketplace for them. And in case you do promote them, you’ll probably must promote them at a steep low cost.
Bond Desk Sorted By Period
Earlier than I share with you my municipal bond-selling expertise, let me rapidly share why somebody would favor proudly owning munis as a substitute of Treasuries or different bonds. Check out this bond desk beneath.
You will get a two-year Treasury bond yielding 4.91% and a two-year Aaa-rated municipal bond yielding 3.98%. In case your marginal revenue tax price is 37%, the online yield in your Treasury bond is 3.09% because you pay federal revenue tax on bond revenue.
Given 3.09% is decrease than 3.98%, an individual within the 37% marginal revenue tax bracket might choose to personal a two-year Aaa-rated municipal bond as a substitute. On this instance, the breakeven level is in case you are within the 19% marginal revenue tax bracket, which there’s at the moment no such factor.
The marginal revenue tax price jumps from 12% to 22%. Due to this fact, anyone paying a 22% marginal revenue tax price or increased would profit from shopping for the municipal bond in the event that they maintain to maturity.
Holding particular person bonds to maturity protects you from principal loss in case rates of interest rise in the course of the holding interval.
Since early 2022, all varieties of bonds have gotten pummeled since inflation and rates of interest have surged increased. Due to this fact, if it’s a must to promote bonds now it isn’t an optimum time.
First Unanticipated Downside Holding Municipal Bonds
Once I submitted an supply with contingencies for a home, I assumed round $400,000 of the proceeds would come from municipal bonds I’ve held for over six years. Though I might take a loss on the bonds, I wanted some losses to offset some features I might have from promoting shares.
What I did not anticipate was not with the ability to promote about $200,000 out of the $260,000 municipal bonds I held at my Citibank brokerage account! My wealth supervisor tried for 2 weeks to promote a few my massive municipal bond holdings to no avail. There have been merely no bids, even at decrease and decrease costs.
Uh oh. How on earth was I going to give you the $200,000 shortfall on this account?
Motive #1 for not relying on particular person municipal bonds for liquidity. You actually won’t have the ability to promote them!
When you have no different sources of funds to give you your own home down fee, you would possibly fall out of contract. You would possibly even lose your earnest cash deposit in case you launch financing contingencies earlier than realizing you’ll be able to’t liquidate your municipal bonds. Beware.
Second Unanticipated Downside Holding Municipal Bonds
I then went to my Constancy brokerage account, the place I additionally held some municipal bonds. Anticipating I might have a troublesome time promoting my municipal bonds right here as properly, I gave the rep a name to see what he may do.
He walked me by the method of promoting a municipal bond, which required a number of steps. Step one was to click on the person bond holding, then click on the Promote button. Then I needed to scroll all the way down to get a Bid Request.
The Bid Request was not instantaneous. It takes the system about one hour to find out whether or not there’s demand for the variety of municipal bonds I wish to promote. I might get notified both by textual content message, e-mail, or each.
This was inconvenient as a result of I so occurred to be on the seashore with my daughter. As well as, the Constancy cell app did not have the performance to promote municipal bonds. I needed to name Constancy again as soon as I obtained my bid request alert.
If I did not evaluation and settle for the bid requests inside 5-10 minutes after they got here, they might expire. I might then must undergo the whole course of once more. What a ache within the a$$!
Instance Of Muni Bond Bid Request Outcomes
Beneath is a snapshot of my Bid Requests, most of which expired as a result of I wasn’t paying quick consideration an hour later.
Therefore, my second unanticipated shock from attempting to promote particular person municipal bonds was that after I discovered a brokerage that might promote them, the method was extraordinarily cumbersome. I needed to dedicate at the very least an hour of my time to promote a municipal bond in comparison with promoting a inventory instantaneously by a cell app.
Motive #2 for not relying on particular person municipal bonds for liquidity. The method isn’t instantaneous.
Last Unanticipated Shock Promoting Municipal Bonds
I by no means deliberate to promote my municipal bond holdings earlier than maturity, not to mention in the course of the worst bond bear market in latest historical past. Nonetheless, when my dream home reappeared a 12 months later at a cheaper price, I made a decision to go for it. The low cost I would get from the home would greater than cowl the loss from promoting the bonds.
Once I lastly obtained to evaluation my bid requests, I used to be shocked by how a lot decrease the bid worth was in comparison with the market worth. We’re speaking a bid / ask unfold ranging between 1% – 4%, with the common hovering round 3%.
In different phrases, if I wished to promote $10,000 price of municipal bonds, I needed to pay between $100 – $400 / settle for between $100 – $400 much less. At first, I held my nostril and offered some bonds as a result of I used to be initially so relieved to search out out I may really promote a few of my bonds by Constancy.
However then I took a step again and paused. Paying 1% – 4% to promote my municipal bonds felt like freeway theft! I might somewhat simply maintain them to maturity and discover different sources of capital that did not have such egregious promoting prices.
Beneath is an instance of a bid worth of $59.801 for a zero-coupon municipal bond at the moment buying and selling at $61.643. The distinction is $1.812 for a diffusion/charge of two.94%. Not low cost!
Motive #3 for not relying on particular person municipal bonds for liquidity. If it’s a must to promote, you could have to promote at a steep low cost.
Some Brokerage Homes Are Higher Than Others
It seems that Citibank is not an incredible platform to promote municipal bonds. Not solely is its buying and selling platform expertise inferior to Constancy’s, it additionally by some means cannot faucet the identical pool of municipal bond liquidity Constancy can.
Given I could not promote $200,000 price of municipal bonds at Citibank, I spotted I may merely switch my Citibank portfolio over to Constancy. This course of would take about 7-10 days whole. I’ve executed it earlier than.
Given I’ve a lengthy escrow interval with contingencies, ready 7-10 days to port my Citibank portfolio over wasn’t an enormous deal. However in case you want the liquidity sooner, then this resolution will not work. As a result of after you promote a municipal bond, you will not get the proceeds for 2 days (T+2). Therefore, plan forward.
Looking back, I am grateful I could not promote $200,000 price of municipal bonds at Citibank. Promoting them would have price me $4,000 – $8,000.
I additionally do not plan to promote $200,000 price of municipal bonds in my Constancy portfolio both as a result of charges. Actually, I wish to construct a bigger bond portfolio to lock in increased rates of interest for extra passive revenue.
Discovering New Capital To Make Up For The Shortfall
How will I give you the capital shortfall if I do not promote my municipal bonds?
One concept is to ask for a bridge mortgage paying a 5.5% rate of interest to the Financial institution of Mother & Dad. However I am uncomfortable asking for extra money as a result of I am presupposed to be serving to them, not borrowing from them.
One other supply of funds may come from my rollover IRA. Supposedly, I can use funds from my IRA as long as I return the funds inside 60 days. That is referred to as the 60-day rollover rule from the IRS web site. Fortunately, my rollover IRA has sufficient funds to cowl the whole shortfall. The issue with this resolution is paying again the cash inside 60 days. Extra on this in a future publish.
One other supply of funds is to get a job or do some consulting work. I am going to couple this lively work with chopping our bills aggressively. However these actions will not even make up for 10% of the cash that is wanted since I solely have a month left. However I ought to attempt anyway.
The ultimate supply of funds is to ask my spouse to faucet into her taxable retirement portfolio. We purchase every part collectively. However we additionally earmark sure funds particularly for retirement to remain disciplined. In any other case, we may be tempted to spend an excessive amount of cash on too many luxuries we do not want. Corresponding to this nicer home!
We do not plan to use for a mortgage. The excessive rates of interest, time it takes, and value to use isn’t price it.
Do not Depend On Your Municipal Bonds To Pay For A Home
In conclusion, do not consider municipal bonds as a liquid different to money. It’s not resulting from its excessive promoting charges and issue of promoting. The longer the period of the municipal bond, the extra worth it can lose if rates of interest go up.
Therefore, if you wish to park your own home down fee in bonds, purchase 3-month or 6-month Treasury payments. In case you do, the impression of upper charges, in the event that they occur throughout your holding interval, might be negligible. Additional, the Treasury bond market is very liquid, in contrast to the municipal bond market.
Once I used to work in finance, bond merchants had been a few of the wealthiest staff at my agency. Now I’ve a transparent understanding why. The mounted revenue bid-ask spreads are so massive, bond merchants are capable of make a killing if they will efficiently meet market calls for.
In case you plan to put money into particular person municipal bonds, attempt to maintain them to maturity in case you can. Provided that rates of interest plummet and the worth of your bonds skyrocket, must you take into account promoting them earlier than maturity.
Reader Questions and Suggestions
Have you ever ever needed to promote a person bond resulting from liquidity wants? In that case, why? In case you are an skilled bond investor, what are another issues we ought to be privy to when shopping for and promoting bonds, not simply municipal bonds? Anyone shopping for bonds now to make the most of excessive rates of interest?
Pay attention and subscribe to The Monetary Samurai podcast on Apple or Spotify. I interview consultants of their respective fields and talk about a few of the most attention-grabbing matters on this website. Please share, price, and evaluation!
For extra nuanced private finance content material, be part of 60,000+ others and join the free Monetary Samurai publication and posts through e-mail. Monetary Samurai is among the largest independently-owned private finance websites that began in 2009.
