• Jim Perkins

Death and Taxes

I can't fix the first inevitable truth but I can help with the second... A thought on how to increase your investment income and potentially lower your taxes.


Now most of you know I'm not a huge fan of bonds. Inflation, business risk, and duration are just the tip of the risk pyramid that bond buyers assume when they purchase fixed income securities. But I'm also a realist and there are times when it makes sense, or can be explained why, that the certainty of payments offered by bonds are more important than some of the inherent risks from general fixed income securities, And frankly, as legendary value investor Marty Whitman once said, you will find me walking in when others are running out. With today's low rates many are running for the hills from fixed income...so perhaps its time to explain how to walk in...


In short: I believe that today Municipal bonds may offer a better return potential and diversification than taxable bonds... for the right person..


One of the great benefits of the current U.S. tax code is its treatment of municipal bonds. Income received from municipal bonds is generally exempt from taxes at the federal level (and even at the state and local level too, if you live in the issuing state). With this preferential tax treatment, for the right person, moving taxable bond allocations into municipal bonds can be a powerful tool when building tax-efficient portfolios. Now it is true that taxable bonds generally pay 'more' interest than municipal bonds...but when you take into account your tax bracket then what you should be looking at isn't how much you make...but how much you keep. 'What is the after tax real rate of return on your investment?'





In Figure 1, we used Morningstar data to measure pretax and after-tax returns for select taxable and municipal intermediate bond and high yield categories. As shown, pretax returns favored taxable bonds across most categories. However, municipal bonds came out on top for after-tax returns. Examining tax cost ratios can also be helpful. Morningstar’s tax cost ratio measures how much an investment’s annualized return is reduced by the taxes investors pay on distributions.





Now most of you know I'm not a huge fan of bonds. Inflation, business risk, and duration are just the tip of the risk pyramid that bond buyers assume when they purchase fixed income securi But I'm also a realist and there are times when it makes sense, or can be explained why, that the certainty of payments offered by bonds are more important than some of the inherent risks from general fixed income securities, And frankly, as legendary value investor Marty Whitman once said, you will find me walking in when others are running out. With today's low rates many are running for the hills from fixed income...so perhaps its time to explain how to walk in f.


So to summarize, even with the low rates we see today there may be value for some investors in the fixed income world. Knowing where to look and what types of bonds to invest in is critical to creating a efficient and sustainable portfolio.


( Thanks to T Rowe Price for the Charts)

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