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Question:
I'm considering investing in a long-term municipal bond
fund. The fee is 3 percent and the estimated long-term
return is 4.15 percent. I have a little over
$200,000
to invest in a non-IRA account. Should I invest the
total amount in this one muni fund or diversify into
more than one?
Answer:
"Run, don't walk, away from this fund," said
Marilyn Cohen
, founder of investment firm
Envision Capital Management
and author of "Bonds Now: Making Money in the New
Fixed Income Landscape."
That's
because the fee is too high. Bonds pay very little
interest, so high fees on bond funds can severely erode
the money you make.
Many
people look past this. They see a number like 3 percent,
and it sounds tiny. But compare that to many municipal
bonds paying only about 3 percent interest in the first
place. Also consider that the fees you mentioned are
just one way you are charged for mutual funds. In
addition to the 3 percent upfront sales charge, or
"load," mutual funds also charge what's called
an "expense ratio."
The load
pays the broker for giving you advice. The expense ratio
pays your fund company for choosing bonds for your
mutual fund, keeping records for your account and
marketing the fund to prospective clients.
Here's
why the fees matter: You plan to invest
$200,000
in a fund with a 3 percent fee. You don't provide the
expense ratio, so I will assume it's 0.5 percent,
although it might be higher. If you keep your money
invested in that fund for 15 years and make 4 percent a
year, you would end up with about
$324,000
.
But let's
say you find a fund without a load. With the same 4
percent return and expense ratio, you'd end up with
about
$334,000
after 15 years. If you found a fund without a load and
an expense ratio of 0.2 percent, you'd end up with about
$349,500
. Just plug your fund's fees into this calculator:
dinkytown.net/java/FundExpense.html.
So what
do you do? You choose a respected diversified municipal
bond fund that does not have a load. And with a bond
fund, your expense ratio should not exceed 0.5 percent.
Cohen suggests a Vanguard fund because it keeps fees
low.
Beyond
fees, also pay attention to the length of bonds in the
fund. You mention a "long-term" bond fund.
This could be vulnerable to losses in the current
environment. If interest rates rise, as many bond
specialists are expecting, bonds that will mature in 15
to 30 years would lose more money than bonds that mature
in less than 10 years. With bonds, the more years you
wait for them to mature, the riskier they are when
interest rates are rising.
This is a
serious threat now. Interest rates have been very low
during the recession and have been creeping up recently.
Here's
why that matters for your fund: Imagine that all the
bonds in your fund are paying 4 percent, but in a few
months interest rates rise, and people can find similar
bonds that pay 5 percent. People aren't going to want
your bonds at 4 percent when they can receive 5 percent
on new bonds. So the value of the bonds in your fund
will fall, and you could encounter a sizable loss.
Some
investors protect themselves from that risk by buying
individual bonds and holding them until they mature. If
you buy a solid bond, you will have your interest paid
routinely and, ultimately, get back the money you
invested. Still, you must be aware that municipal bonds
are not as safe as buying a U.S. Treasury bond or a bank
CD, and selecting them yourself can be difficult. This
is why some people buy municipal bond funds, with a
manager who buys many bonds.
Another
way to protect yourself would be to buy individual
general obligation bonds sold by states. Unlike other
municipal bonds, these are the safest because the states
promise that they will pay you back even if their
finances sour. To do that, they presumably would raise
taxes.
This is a
particularly important time to pay attention to such
promises. States, cities and other local governments are
facing severe financial stresses. With the economy weak,
individuals and businesses are not paying as much in
taxes. In addition, the recession has left governments
with extra burdens.
"I'm
worried sick about what's going on in some states,"
Cohen said. "Legislators do not have the will to
cut back on spending, and state finances in many states
are in shambles."
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ABOUT THE
WRITER
Gail
MarksJarvis is a personal finance columnist for the
Chicago Tribune
and author of "Saving for Retirement Without Living
Like a Pauper or Winning the Lottery." Readers may
send her e-mail at gmarksjarvis@tribune.com.
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