Summary of conversation we have with clients a few times a week: Aren’t you worried about interest rates going up? The ten-year treasury is only paying 1.7%…rates are probably probably going to go up, and bond prices decline when interest rates go up. Why are you buying 10-year muni bonds?

Simple answer: Because the muni bond yields are high enough to provide us a fair rate of after-tax return, even if treasury bond rates go up by six percentage points! Just today, we bought muni bonds (of impeccable credit quality; virtually zero risk of default) paying yields of 4.5% to 5.6%. Since that yield is tax-free, it is the equivalent of earning 7% to 8.75% on a taxable bond — such as a US treasury. If treasury bond rates go from 1.7% up to 7-8%, we are still happy with our muni bonds.

But Rick, if rates go up, won’t the price of my muni bonds go down?

Yes, but only temporarily. Bonds are called fixed income for a reason. Any price increases or decreases are mathematically temporary. If your Schwab statement arrives some month-end and it shows that a bond you bought for $25,000 now has a “market value” of $24,000, that lower figure only applies to you if you are forced to sell the bond right now.

If you keep the bond until maturity, you get the full $25,000 back. Plus you get the tax-free coupon income. Which is vastly higher than any amount of after-tax treasury bond income you might get over the same period.

The negative “news cycle” surrounding California local government financial stress is creating great opportunities for us to lock in high after-tax returns, while avoiding the very real risk of the growing trend for municipalities to file bankruptcy. There are plenty of bonds out there without bankruptcy risk, and the spread of yields over taxable corporate and government bond alternatives has never been better.