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Thursday, June 13, 2024

Promoting Municipal Bonds Is Extremely Costly And Cumbersome

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When you’re fascinated about holding particular person municipal bonds as a secure and liquid supply of funds, suppose 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. Consequently, in case you ever wish to promote municipal bonds, you might need to promote them for method under market worth.

The important thing takeaway from this submit is that in case you plan to spend money on particular person municipal bonds for tax-efficient passive revenue, it is best 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 notice I’m differentiating between proudly owning particular person municipal bonds and shares in a bond fund, which often has way more liquidity, however no maturity date.

Counting On Municipal Bond Proceeds For A Home Down Fee

The nearer you’re to purchasing a home, the better the share of your down fee needs to be in money and low-risk investments equivalent to Treasury payments. Once you discover the house you wish to purchase, you usually have to put down at the very least 20% to be aggressive.

Given the excessive value of houses nowadays, 20% down is often some huge cash. It could be unwise to gamble your down fee within the inventory market given its volatility. The extra you need to stretch to give you a suitable down fee, the extra conservative try to be along with your home down fee investments.

A few of you might need thought-about investing in particular person municipal bonds as an alternative 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 charge, the extra engaging the asset class.

Nonetheless, regardless of a possible greater web yield, I would not park your down fee in particular person municipal bonds. You may not be capable to promote them as a result of there is probably not a marketplace for them. And in case you do promote them, you’ll possible need to promote them at a steep low cost.

Bond Desk Sorted By Length

Earlier than I share with you my municipal bond-selling expertise, let me shortly share why somebody would favor proudly owning munis as an alternative of Treasuries or different bonds. Check out this bond desk under.

You may 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 charge is 37%, the web 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 could desire to personal a two-year Aaa-rated municipal bond as an alternative. On this instance, the breakeven level is in case you are within the 19% marginal revenue tax bracket, which there’s at present no such factor.

The marginal revenue tax charge jumps from 12% to 22%. Due to this fact, anyone paying a 22% marginal revenue tax charge or greater would profit from shopping for the municipal bond in the event that they maintain to maturity.

Municipal Bond table

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 kinds of bonds have gotten pummeled since inflation and rates of interest have surged greater. Due to this fact, if you need to promote bonds now it isn’t an optimum time.

First Unanticipated Drawback Holding Municipal Bonds

After I submitted an provide 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 positive factors I might have from promoting shares.

What I did not anticipate was not having 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 giant 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?

Cause #1 for not relying on particular person municipal bonds for liquidity. You actually may not be capable to promote them!

When you have no different sources of funds to give you your 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 possibly can’t liquidate your municipal bonds. Beware.

Second Unanticipated Drawback Holding Municipal Bonds

I then went to my Constancy brokerage account, the place I additionally held some municipal bonds. Anticipating I might have a tough time promoting my municipal bonds right here as nicely, I gave the rep a name to see what he may do.

He walked me by way of 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.

Selling municipal bonds is cumbersome - Bid request example

The Bid Request was not instantaneous. It takes the system about one hour to find out whether or not there may be 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 evaluate and settle for the bid requests inside 5-10 minutes after they got here, they’d expire. I might then need to undergo your complete 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 fast consideration an hour later.

Submit bid request for bonds

Therefore, my second unanticipated shock from making an attempt 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 way of a cell app.

Cause #2 for not relying on particular person municipal bonds for liquidity. The method just 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 current 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.

After I lastly obtained to evaluate my bid requests, I used to be shocked by how a lot decrease the bid value was in comparison with the market value. We’re speaking a bid / ask unfold ranging between 1% – 4%, with the typical hovering round 3%.

In different phrases, if I wished to promote $10,000 value 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 seek out out I may really promote a few of my bonds by way of Constancy.

However then I took a step again and paused. Paying 1% – 4% to promote my municipal bonds felt like freeway theft! I might fairly 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 value of $59.801 for a zero-coupon municipal bond at present buying and selling at $61.643. The distinction is $1.812 for a diffusion/price of two.94%. Not low-cost!

huge bid ask spread for selling a municipal bond

Cause #3 for not relying on particular person municipal bonds for liquidity. If you need to promote, you might have to promote at a steep low cost.

Some Brokerage Homes Are Higher Than Others

It seems that Citibank is not a terrific platform to promote municipal bonds. Not solely is its buying and selling platform expertise inferior to Constancy’s, it additionally someway cannot faucet the identical pool of municipal bond liquidity Constancy can.

Given I could not promote $200,000 value of municipal bonds at Citibank, I noticed I may merely switch my Citibank portfolio over to Constancy. This course of would take about 7-10 days whole. I’ve accomplished 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 answer 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 value of municipal bonds at Citibank. Promoting them would have value me $4,000 – $8,000.

I additionally do not plan to promote $200,000 value of municipal bonds in my Constancy portfolio both because of the charges. The truth is, I wish to construct a bigger bond portfolio to lock in greater 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 thought 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 more cash as a result of I am alleged 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 your complete shortfall. The issue with this answer is paying again the cash inside 60 days. Extra on this in a future submit.

One other supply of funds is to get a job or do some consulting work. I am going to couple this energetic 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 thing 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. Reminiscent of this nicer home!

We do not plan to use for a mortgage. The excessive rates of interest, time it takes, and value to use just isn’t value it.

Do not Rely On Your Municipal Bonds To Pay For A Home

In conclusion, do not consider municipal bonds as a liquid different to money. It isn’t resulting from its excessive promoting charges and problem of promoting. The longer the length of the municipal bond, the extra worth it should lose if rates of interest go up.

Therefore, if you wish to park your home down fee in bonds, purchase 3-month or 6-month Treasury payments. When 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 extremely liquid, not like the municipal bond market.

After I used to work in finance, bond merchants have been among the wealthiest workers at my agency. Now I’ve a transparent understanding why. The fastened revenue bid-ask spreads are so giant, bond merchants are in a position to make a killing if they’ll efficiently meet market calls for.

When you plan to spend money on 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 contemplate promoting them earlier than maturity.

Reader Questions and Suggestions

Have you ever ever needed to promote a person bond resulting from liquidity wants? If that’s the case, why? In case you are an skilled bond investor, what are another issues we needs to be aware of when shopping for and promoting bonds, not simply municipal bonds? Anyone shopping for bonds now to make the most of excessive rates of interest?

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