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If you have a slug of clients eligible for AARP membership, chances are you spend a fair amount of time fielding the “cake-and-eat-it-too” request: Income! Income! But I don’t want to lose money.”
While that no doubt spurs you to deliver the “we’re in this for the long-term” convo that makes a case for stock exposure, right about now you might be fielding more than a few queries from clients worried about recent volatility. Yes, it’s been mild, and yes, a real correction of 10%-to-20% is overdue, but perspective isn’t what clients necessarily hear. And that may make it hard to suggest sticking with (or adding to) dividend income stocks such as Chevron (CVX), Coca-Cola (KO) and Microsoft (MSFT).
Municipal bonds should get a better reception. The trailing 12-month yield for the Pimco Intermediate Term ETF (MUNI) and the iShares S&P National AMT-Free Muni (MUB) is circling right around the current sub-2.5% payout for the 10-year Treasury, and both ETFs have durations well below 10 years. Those muni ETF yields are also more than what investors got from the iShares Core Total US bond market ETF (AGG).
And that’s before you even get into the taxable equivalent yield part of the equation. A 2.5% yield has a net effective yield of nearly 3.9% for someone in the 35% federal tax bracket. Even at the 28% bracket you’re getting a 3.5% taxable equivalent yield.
SMC Fixed Income Management runs more than $800 million in municipal bond portfolios (the CIO’s resume includes running Merrill Lynch’s $50 billion tax-exempt investment group). In a recent investment note it made the case that munis should continue to deliver as issuance is down and likely won’t grow as states and municipalities typically need to borrow less when stronger economic growth brings in higher tax receipts. SMC also expects cash on the sidelines will increasingly find its way to munis, given the compelling after-tax yield.
From SMC Fixed Income: “A shortage of securities, continued strong investor demand, and plenty of available cash from August bond maturities should combine to keep the municipal market well-supported.”
If you’re met with “What about Puerto Rico and Detroit?” pushback from wary clients, once you mention that those are outlier problems and that municipal defaults -- especially among high grade issues -- are near historic lows, you might trot out this chart:
There is no question that municipal bonds are more volatile than high-grade government and corporate bonds. (No need to mention that the heavy presence of skittish retail investors is part of the reason for muni volatility ;-). But the haircuts are nothing like what dividend paying stocks endure when the stock market sells off. In three distinct downdrafts for the iShares S&P National AMT-Free ETF (2008, 2010 and 2012-2013) the worst haircut was in the vicinity of 9%.
Meanwhile, patient investors who sat tight have earned a long-term return on par with the ishares Core US ETF that tracks the Barclays Aggregate index. While the sell-offs are deeper, so too are the rebounds from what are headline overreactions. And once you add in the tax-free income advantage for the municipal ETF, it delivers more net return than the iShares Core Aggregate.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at firstname.lastname@example.org. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.