Muni Bond ETFs and the Tax-Free Coupon

January 22nd at 1:00pm by James Colby -- Market Vectors

If there is one certainty that I believe municipal bond investors can lean upon as we fully commit to writing 2013 in our check registers, it is the seemingly perpetual uncertainty regarding the political deliberations about to resume in Washington, which again could include discussions about capping the benefit of the tax-free coupon.

Ask yourself, “What has changed since the November elections?” and you’ll probably answer, “Nothing.” However, with the adjusted personal income tax rates now at higher levels, this statement is not entirely true; the market has been living with this cloud of uncertainty going on five months or more. [No Cliff for Muni Bond ETFs]

Armed with facts and figures that demonstrate the relatively small benefit to deficit reduction this tax plan would potentially create (only 2%-4% of revenues needed), state and local treasurers and industry proponents appear to be standing ready to once again defend small local issuers and taxpayers who would likely bear the incrementally and disproportionately higher costs of capital under this plan. [Muni ETFs Keep Tax-Sheltered Status ... For Now]

Since March seems to be the legislative deadline, we have nearly three months to endure this uncertainty. The danger, in my opinion, is that investors can become indecisive. Holding onto cash with rates as low as they are can be costly. If you invested $100,000 in a money fund from the beginning of the year to the end of March and it was yielding 25 bps, $62.16 would be the income received, but at what cost? Fees can eat away that income while one waits.

Municipals have benefited marginally from the new higher personal income tax rates, but I believe there is little about the near future to suggest that investors, despite the uncertainties, should not participate in current markets.

As we watch this drama play out before us, portfolio managers and individuals face a continuing dilemma: in this low interest rate environment, to invest or not to invest? That is the question.

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James Colby is a portfolio manager and senior municipal strategist at Market Vectors ETFs.

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