Whether you’re just starting to invest in municipal bonds or are reviewing your current portfolio of municipal bonds, you should consider the following guidelines:

MAKE SURE THAT MUNICIPAL BONDS ARE A GOOD ALTERNATIVE FOR YOUR CIRCUMSTANCES. Because the interest income is exempt from federal, and sometimes state and local, income taxes, the returns on municipal bonds are generally lower than those on taxable investments. Before you invest, you need to determine how a muni bond’s yield compares to the after-tax returns that you would receive on a comparable taxable bond. To do that, you need to calculate the tax equivalent yield for the municipal bond. See the article "Converting Tax-Exempt to Taxable Equivalent Rates" for more details.

CAREFULLY CONSIDER THE MATURITY OF THE BOND YOU ARE PURCHASING. Rather than simply selecting the maturity that offers the highest return, it is important to select a maturity that coincides with your individual goals and objectives.

INVESTIGATE THE CALL PROVISIONS OF THE BOND. While most municipal bonds have provisions that allow the issuer to redeem the bond prior to maturity, the terms of the call provisions can differ significantly.

REVIEW THE CREDIT QUALITY OF THE MUNICIPAL BOND. Fewer than .5% of all municipal bonds have ever defaulted, while the default rate for AAA corporate bonds is 1.4% (Source: Money, November 1995). Yet defaults can occur, as evidenced by the Orange County bonds. Thus it is important to review the credit quality of muni bonds. An investment-grade rating means that the issuer is considered financially stable and appears unlikely to default on the issue. Ratings of BBB or higher from Standard & Poor’s are considered investment grade, while Moody’s ratings of Baa or higher are investment grade. You may want to consider lower rated bonds for additional return, but be sure that you understand all of the risks before investing.

ENSURE THAT YOU HOLD A DIVERSIFIED PORTFOLIO OF BONDS, GENERALLY 7 TO 9 DIFFERENT ISSUES. Since municipal bonds sell in denominations of $5,000, you will probably need $35,000 to $45,000 to adequately diversify in individual bonds. That does not mean that you cannot start out with less than this, but your ultimate goal should be to hold a diversified portfolio of bonds.

DON’T OVER-DIVERSIFY. While it is important to ensure adequate diversification, holding an excessive number of individual issues becomes an administrative nightmare. For each issue, you need to ensure that interest payments are received on time, re-invest that interest, and monitor credit quality, maturity dates, and call dates.

TO FURTHER INCREASE TAX SAVINGS, CONSIDER BONDS ISSUED FROM THE STATE YOU RESIDE IN. By purchasing muni bonds issued in the state you reside in, your interest income will also be exempt from state, and perhaps local, income taxes. However, be careful to match your desire to reduce your income taxes with the need for proper diversification.

SEARCH UNTIL YOU FIND A BOND THAT MEETS YOUR CRITERIA. With over 1.5 million different issues sponsored by over 50,000 municipalities (Source: Money, November 1995), you should be able to find a bond that meets your particular criteria. However, many of these issues are thinly traded, so it may take some searching.

UNDERSTAND THE TERMS OF THE MUNI BOND BEFORE PURCHASING IT. Make sure to review the credit quality, coupon rate, call provisions, and other significant factors.

REVIEW YOUR HOLDINGS PERIODICALLY. Be sure to review the credit ratings of all your municipal bonds at least annually to make sure that the quality hasn’t deteriorated. Check the call provisions so that you aren’t surprised in the coming year by a bond call. Also, review your holdings to ensure that they are still consistent with your overall investment objectives and asset allocation plan.

If you’d like assistance with your municipal bond portfolio, please call us at (800) 878-4036.

Approximately 65% of all 401(k) plans offer loan provisions to participants. While loan procedures and terms will vary by plan, general federal regulations regarding 401(k) loans include:

A loan from your 401(k) plan is not considered a distribution. Thus, you do not have to pay income taxes or the 10% early withdrawal penalty on the proceeds.

The amount of the loan cannot exceed 50% of your vested interest in the plan or $50,000, whichever is less. Although not allowed by most plans, loans greater than 50% can be obtained if you provide collateral to secure the additional amount. Although there is no minimum balance for a loan, plan administrators often impose a limit to reduce administrative costs.

The loan usually must be repaid in five years, unless the proceeds are used as a down payment for your principal residence. Loans for down payments can typically be repaid over 10 to 30 years. Payments of principal and interest must be made on at least a quarterly basis. The loan cannot be renegotiated to extend the repayment term.

The interest rate on the loan must equal the prevailing rate charged by lending institutions for similar loans. Usually, that rate is a couple of percentage points over the prime rate.

For loans over $3,500, the administrator must inform your spouse of the loan and receive his/her written consent within 30 days.

If you terminate employment with your company before the loan is paid in full, you must repay the balance in full or the unpaid principal will be considered a 401(k) distribution, subject to income taxes and penalties.

While borrowing from your 401(k) plan is a convenient way to obtain money, it is important to consider a couple of factors before doing so. Although the interest rates charged on 401(k) plan loans are generally attractive, keep in mind that you are foregoing investment growth on the outstanding principal. The attractive interest rates may seem very expensive if you miss a major rally in your 401(k) investments.

Make sure that you can easily repay the loan. You don’t want to be forced to reduce or eliminate new 401(k) contributions because you are struggling to repay your loan balance.

If you have a equity in your home, consider a home-equity loan instead of a 401(k) loan. Interest rates on home-equity loans tend to be comparable to interest rates on 401(k) plan loans and the interest paid on the home-equity loan is usually deductible on your tax return if the loan balance is less than $100,000. Since interest paid on a 401(k) plan loan is not deductible on your tax return, a home-equity loan may have a lower after-tax cost than a 401(k) plan loan.

If you’d like to discuss whether you should obtain a loan from your 401(k) plan, please feel free to call at (800) 878-4036.

Before investing in tax-exempt bonds, you should compare the yield to the yield you could obtain on a taxable investment with a similar maturity and credit rating. In order to do that, you need to convert the tax-exempt rate to a "taxable equivalent." If you’re not investing in a municipal bond issued within your own state, which also exempts income from state and sometimes local taxes, the calculation is fairly straightforward: the taxable equivalent equals the tax exempt interest percentage divided by 1 minus your marginal tax bracket: Tax-exempt interest % = Taxable

(1-marginal tax bracket) equiv. %

For example, municipal bonds, as measured by the Bond Buyer Municipal Bond Index, currently yield 5.83% (Source: Barron’s, August 12, 1996). If you’re in a 28% tax bracket, you’d need a taxable investment with a yield greater than 8.10% to outperform the tax-exempt bond [5.83/(1-.28)=8.10]. (This example is included for illustrative purposes only and is not intended to project the future performance of any specific investment vehicle.)

The table below will give you a general idea of taxable equivalent percentages for various tax-exempt yields and tax brackets.

Marginal tax rate     15%              28%                     31%                         36%                      39.6%   

Married filing jointly         $0-40,100    $40,100-96,900    $96,900-147,700    $147,700-263,750    over$263,750

Head of household           0-32,150        32,150-83,050     83,050-134,500       134,500-263,750     over 263,750

Tax-exempt yields (%)                                              Taxable equivalent (%)         

3.50                                                                  4.12    4.86    5.07    5.47    5.79

4.00                                                                  4.71    5.56    5.80    6.25    6.62

4.50                                                                  5.29    6.25    6.52    7.03    7.45

5.00                                                                  5.88    6.94    7.25    7.81    8.28

5.50                                                                  6.47    7.64    7.97    8.59     9.11

6.00                                                                  7.06    8.33    8.70    9.38     9.93

6.50                                                                  7.65    9.03    9.42  10.16   10.76

7.00                                                                  8.24    9.72  10.14  10.94    11.59

A TRYING TIME FOR MUNICIPAL BONDS

Municipal bonds have been having a tough time lately. First, repercussions from the Orange County bankruptcy caused many investors to approach municipal bonds more cautiously. Then, a rocketing stock market caused many investors to concentrate on the stock market, ignoring municipal bonds. Finally, talk about a flat tax, which would reduce much of the appeal of municipal bonds, has made many nervous about purchasing municipal bonds.

The allure of municipal bonds is that in most cases their income is exempt from federal income taxes and, if the bonds are issued the state you reside in, also from state and local income taxes. Thus, the higher your marginal federal income tax rate, the more valuable this tax-exemption becomes. Someone in the 39.6% tax bracket will find a municipal bond more advantageous than someone in the 15% tax bracket. But if a flat tax of 17% is enacted, then this tax advantage becomes less important since everyone is paying the same tax rate.

Yet even though the flat tax is not even close to being enacted, the differences between returns on municipal bonds, 30-year treasury bonds, and corporate bonds have narrowed significantly. In fact, many feel that municipal bonds are being priced as if the new rate was already in effect. For example, municipal bonds were recently yielding 5.83% as measured by the Bond Buyer Municipal Bond Index, an unmanaged index of 40 actively traded tax-exempt bonds. For comparison purposes, 30-year treasuries yielded 6.94% and corporate bonds, as measured by the Dow Jones Bond Average, yielded 7.21% (Source: Barron’s, August 12, 1996). At a 16% tax rate, the yield on the municipal bond is equivalent to the yield on the 30-year treasuries. Anyone in a higher tax bracket would earn more on an after-tax basis with municipal bonds. At a 19% tax rate, the yield on a municipal bond is equivalent to the yield on corporate bonds.

Thus, if the flat tax is enacted, investors will still earn a return comparable to 30-year treasuries and corporate bonds. But, if the flat tax is not enacted, municipal bond investors will receive a return higher than that. In the 15% tax bracket, the 5.83% municipal bond yield is equivalent to a taxable yield of 6.86%; in the 28% tax bracket, 8.10%; in the 31% tax bracket, 8.45%; in the 36% tax bracket, 9.11%; and in the 39.6% tax bracket, 9.65%. (This example is included for illustrative purposes only and is not intended to project the performance of any specific investment alternative.)

Although municipal bonds aren’t an attractive investment for everyone, they also shouldn’t be shunned totally because of talk about the flat tax. If you’d like to discuss whether municipal bonds make sense for your situation, please call us at (800) 878-4036.

NEWS AND ANNOUNCEMENTS

KEEPING YOUR RECORDS IN ONE PLACE

Answer truthfully: if something happened to you today, would your heirs be able to readily locate all important financial information? If you’re like most people, your records are probably scattered in a number of places and you’re the only one who knows how to find all pertinent information. Not only will this make it difficult for your heirs to settle your financial matters, it will also make it difficult for them to be sure they’ve identified all your assets and liabilities.

Although organizing records is never a fun task, keeping all this information organized in one place will help your heirs identify your assets and liabilities and inform them of professionals that handle your affairs, such as lawyers, accountants, and financial advisers. It may also serve some immediate purposes, such as helping you assess your current financial situation, making you reevaluate your investments, causing you to think about your estate plan, or reviewing the adequacy of your insurance policies.

You’ll want to gather and record details about: wills; safe deposit boxes; life insurance policies; hospital, medical, and disability insurance; homeowner’s insurance; employee savings and stock plans, individual retirement accounts; credit cards; income tax records; real estate records; outstanding debts; children’s accounts and trusts; savings accounts; investments; and financial advisers. Many of these records you won’t want to keep at home, but you should indicate where the original documents are located. Be sure to indicate where birth, marriage, and military records are located since these documents are often needed to collect death benefits.

Once you complete this record, keep it in a safe place at home and make a copy for your safe-deposit box. Make sure your family knows where the record is located and be sure to update it on at least an annual basis. If you’d like help with this process, please call us at (800) 878-4036.

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