Is Now the Time to Buy Long-Term Municipal Bonds?

Yields on long-term municipal bonds are significantly higher than short term munis and are at a historical high over Treasuries. Is now the time to go long?

In an article on this very subject, BusinessWeek stated the following:

"Yields on tax-exempt bonds maturing in less than 10 years fell to a six-year low during the week of Aug. 16. With 30-year municipal bonds offering yields near 5%—an astonishing four percentage points higher than two-year muni bonds—yield-hungry municipal bond investors are shifting money into riskier, longer-term municipal bonds, according to Municipal Market Advisors, which publishes a newsletter for municipal bond investors. "

In addition, the yields on munis are at an historic high vis-vis Treasury Bonds. The yield on a high quality long-term muni is 102% that of a 30 year Treasury while the historic norm is 80-90%. There is risk premium being built in muni bonds even though they default at very low rates.

Still if you are thinking of going long, there are some factors to consider.

1. Yields on short term Munis are depressed because of the Build America Bond program, which has sucked the life out of the short term muni market. Municipalities are using the non tax exempt BAB's instead of munis. This lack of supply means lower rates.

2. If inflation increases as many are predicting, long-term munis may be underwater. A muni that pays 5% over 30 years may not look that attractive with 10% inflation.

3. The yield curve flattens out after 15 years, so purchasing a bond for a longer period may not be necessary.

4. Long term muni investments require greater scrutiny. Who knows what will happen to a municipality in 30 years?

5. If you decide to invest in long-term munis, you'll have to decide between investing in individual bonds or a bond fund. While a bond fund does help to mitigate the default risk on any individual bond, it also lowers the return via fees and other expenses.

If you think now is the time to invest in some long-term munis, then perhaps you should consider a bond laddering strategy. Laddering your bond portoflio allows you to lock in some of today's rates while at the same time mitigating against interest rate risk.