Attractive Investment For Yield
There are times when speculators over do it.
This is a great time to take advantage of an investment with low downside and big income potential.
Today's top idea is municipal bonds.
US Cities and States need financing just like corporations and these debt instruments are called municipal bonds (or "munis"). The loans fund education buildings, utility facilities and roads.
The incentive to investors is the income is federal tax free. With a 24% tax bracket, a 5% yield is really like buying other bonds paying 6.6%. You risk is also very low with historical default rates at 0.15%.
An attractive way to own Municipal Bonds is through a "closed end fund." Instead of issuing and withdrawing shares when investors buy and sell like an open fund, closed end funds issue a fixed amount of shares and they trade on the market at a discount or premium to NAV (Net Asset Value).
The best opportunity rises when closed end funds trade at a discount where you can buy a $1 worth of assets for say $0.90.
Take a look at Nuveen AMT-Free Quality Municipal Income Fund (NEA) which is yielding a safe 5%. Right now the fund is trading at a rare almost 12% discount.
This is one of the largest discounts in NEA's history. Investors are currently worried about rising interest rates which will make current bonds less attractive. However, with most expecting higher long term rates it is likely that long term rates stay suppressed or even decline over the next year or so.
NEA currently trades near a 4 year low.
This allows us to take advantage of multiyear price low, a discount to NAV and an attractive yield in today's low interest rate world.
Buy NEA up to $13 with a stop loss at $12.40. It is best to only risk about 4% on this investment given that it is a yield play and not a capital appreciation play.
Happy yield hunting.
Disclosure: I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.
I have a question, @slider2990. You suggest that we should risk no more than 4% on NEA because it's a yield play rather than a capital appreciation play. How much do you normally suggest risking on a capital appreciation play?
If I am purchasing common stock for a long term hold I will typically follow a 25% trailing stop to give the stock room to fluctuate.
Also to limit risk I will place no more than 5% of my portfolio in any one individual stock or bond investment. In this case with a 25% trailing stop loss I only risk 1.25% of principal if this participial position turns for the worse.
Thanks for reading and asking questions. Cheers!
Thanks for the detailed reply! Just to be clear, in the case of NEA, are you recommending 4% as a trailing stop-loss or as a position size?
Trailing stop.
A nice, succinct explanation of the case for municipal bonds as well as for closed-end funds. I would add a few points. First, if you (readers of this post) choose to invest in munis (whether through NEA or some other means), you should do so in a regular taxable account, as opposed to a tax-sheltered account like an IRA, Roth IRA, or self-directed 401(k). (In fact, your brokerage might not even allow you to invest in munis inside a tax-sheltered account.) The reason is that tax-sheltered accounts only allow you to contribute so much each year, and so you want to use those precious dollars for investments that will serve you but don't come with any inherent tax advantages. Whereas if you have an account that's not tax-sheltered, that's a good place for investments that do come with inherent tax advantages! Second, I want to make sure readers don't miss the point that @slider2990 makes that it's the income from munis that are exempt from federal tax; if you sell an individual muni or a muni fund like NEA, any profit from the sale will be taxable. And third, if you're investing from outside the U.S., check the tax laws where you live, because even if income from U.S. munis is exempt from federal taxes in the U.S., there are countries, such as Canada, where income from U.S. munis are taxable.
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