This Bond-Buying ‘Hack’ Converts A 5% Dividends To Massive 8.3% Payouts

Let’s escape of in the present day’s zero-rate wasteland and assist ourselves to very large, secure payouts yielding all the way in which as much as 8.3%. And these large payouts are tax-free too!
And, no, we received’t be hiring a workforce of CPAs to drag this off—nothing so costly and impractical. Instead, we’re going to set ourselves up with a closed-end fund (CEF) that holds municipal bonds, or “munis.” And because of their tax-free nature, if you happen to’re within the high tax bracket, a muni bond paying, say, a 4% dividend may very well be price 7% or extra to you.
I’ll offer you a selected CEF that’s price placing in your listing now in a second (its 5% acknowledged yield may very well be price an outsized 8.3% to you, if you happen to’re within the high tax bracket). First, although, let’s break down a pair misconceptions that maintain far too many traders from benefiting from the large, zero-tax dividends on provide right here.Debunking Muni-Bond MythsMunicipal bonds are simply what the identify says: bonds issued by basically any sort of governing physique, starting from single hospitals to state governments.
Through municipal bonds, these businesses borrow cash from the general public, promising an rate of interest in change for cash they’ll use to construct a brand new hospital, bridge or (in quite a lot of circumstances), pay out claims, pensions and different obligations.
Right now, there are an estimated $4 trillion of those bonds excellent, and so they’ve been producing regular returns, with little drama, making them a pleasant cornerstone in your earnings portfolio.Steady Returns From MunisMUB-Total-Returns ChartWith a 46.5% complete return over the past decade, the muni-bond market has been a technique to safe your wealth and get a dependable stream of passive earnings.
So why isn’t everybody in munis? One motive is an overblown concern of bankruptcies.
This is usually a media-generated fear, as a result of sometimes you’ll see headlines a couple of state or metropolis operating out of cash. With a wave of child boomers retiring, the necessity to pay out pensions to former state employees, and the drain on municipal accounts this causes, is a standard theme that rattles nerves. Who would need to purchase debt from states about to go bust?
There are two misconceptions right here. The first is that, regardless of what many of us suppose, the chances of your muni-bond issuer going bankrupt are so low, they’re basically at lightning-strike ranges.
Overall, investment-grade municipal bonds have a 0.09% default fee, and A-rated bonds’ odds of default are 0.07%. In different phrases, you would purchase a thousand of those bonds and chances are high none of them would default in any respect. And if one did? You’ve nonetheless bought 999 bonds which can be paying your earnings stream with no worries.
Here’s one other guardrail in your cash: even within the unlikely occasion of a chapter, municipal bonds undergo a course of the place judges work out how a lot cash bondholders ought to get. In most circumstances, they get 80% or extra of their preliminary funding again, and in some circumstances they get all of it.
The different factor that retains traders away from munis is that they have a look at the low yields on a benchmark muni-bond ETF, just like the iShares National Muni Bond ETF (NYSE:), and dismiss them out of hand.Low ETF Yield Doesn’t Tell the Whole StoryMUB-Yield-ChartEven although MUB’s 1.9% yield is tax-free, which means it’s the identical as simply 3.1% of taxable dividends for individuals within the highest earnings bracket. As I discussed off the highest, we demand extra—like 8% or extra taxable (which, after taxes, is similar as 5% from tax-free munis).
That’s why, as an alternative of settling for MUB’s crummy yield, we’re going to look to the Nuveen Municipal High IOF (NYSE:), which yields 5% now, giving top-bracket traders the identical earnings as an 8.3%-yielding inventory, and with a lot much less danger.NMZ Crushes the Main Muni-Bond ETFNMZ-MUB-Total-Returns ChartThat’s why NMZ has tripled MUB’s return over the long run and exhibits no indicators of stopping, all whereas paying us a monster earnings stream that comes with no tax invoice in any respect.
The fund generates that earnings stream by holding a portfolio of municipal bonds which can be rated BBB or decrease. This works for us as a result of that is the place administration can discover higher-yield bonds at higher bargains, as a result of bigger pension funds and different institutional traders are restricted to investment-grade points.
The fund’s managers are adept at working this area, which is how they’ve generated that 144% return—unparalleled for a “boring” funding like munis—over the previous decade. They additionally deftly unfold the portfolio out throughout 687 totally different munis, starting from points by the Chicago O’Hare Airport to the state-run Kentucky Wired high-speed Internet community. This diversification additional cuts NMZ’s danger.
Disclosure: Brett Owens and Michael Foster are contrarian earnings traders who search for undervalued shares/funds throughout the U.S. markets. Click right here to learn to revenue from their methods within the newest report, “7 Great Dividend Growth Stocks for a Secure Retirement.”

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