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Tuesday, March 25, 2014

A Bond-Buying Pitfall

The pitch is practiced.  The reasoning is flawless.  The graphics are impressive.  You are elderly, wealthy, and seeking to protect a substantive nest egg.

Actually, on second thought, you may not be so wealthy.  You may merely have a six-figure taxable account as part of your nest egg.

Either way, you are walking around with a huge target on your back when you interact with the brokerage and advisor community.  Many in this community see you as an easy mark from which they can extract a significant portion of the nest egg you have built up over many years or inherited.

One way is to invest you in individual municipal bonds.  What, you say?  Aren't these the most conservative, low-risk instruments I can invest in?  If you believe this, go back and try to figure out the return you have actually achieved over the past 5 years on your muni bonds.

Even better, do as New York Times columnist Carl Richards suggests in

"Determining the Markup on Municipal Bonds"

and ask your broker what exactly is the cost of investing in your municipal bonds.  After he or she gives you a gibberish answer, ask "what is the mark-up?"  Another way to get at this is to ask for a bid price on your most recent purchase.

Then compare the mark-up percentage to the yields you are getting on your bonds.

As you read Richard's article, you may want to underline "...instead of seeing which bond would be best for the client, I was supposed to figure out which one had the highest markup...."  Since you've got your pen out, you may want to also underline, "...that most prospective clients didn’t know the markup existed. They said 'their guy' didn’t charge them anything...."

The points Richards brings up don't just apply to the muni bond world but also to corporate bonds. They are the reasons I prefer bond funds over individual bonds.

As an aside, Carl Richards is among my favorite personal finance writers.  I will be reviewing his book

The Behavior Gap

in the near future.


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