81°
Attention, bond investors. Some respected investment advisers take a dim view of owning Connecticut's tax-free municipal bonds. The state carries AA credit ratings, which sounds pretty safe. But that cuts no ice with super-cautious analysts. They see looming budget deficits, with no credible plan in place for paying the bills and replenishing the state's deeply underfunded pension plans.
Normally, investors flock to municipal bonds. Defaults are rare and the interest you earn is free of state and federal tax. But the risk of implosion in basket-case states, such as Illinois and California, has sharpened adviser's early warning systems.
"The question you have to ask yourself is whether you would buy a municipal bond, based on fundamentals, if it were not tax free. The answer in most cases is no," says Julie Jason, author of the "The AARP Retirement Survival Guide" and CEO of Jackson, Grant Investment Advisers in Stamford. "As states and municipalities borrow more than they can repay, including states like Connecticut, they're appearing to be less and less desirable for conservative investors."
Connecticut ought to be an exception. It's the country's wealthiest state. But instead of relying on taxes to cover expenses, it currently depends on borrowing. In fact, it has piled up more tax-backed debt than any other state in the union, according to Moody's, the credit rating firm.
Connecticut balanced its budget with nearly $950 million in borrowing over the past two years. It drew down its rainy day fund. Next year's budget projects a shortfall of $3.4 billion, which you'll be hearing plenty about during the political campaigns this fall.
Financially, the state's pension funds are hurting, too. The one covering state and local employees was only 52 percent funded as of June 30, 2008. The one for teachers was 70 percent funded. (The Office of the State Treasurer calculates this data every two years.) Connecticut is one of eight states that paid less than one-third of its annual obligation into the funds this year.
So what's a Connecticut muni bond investor to do?
Marilyn Cohen of Envision Capital Management in Los Angeles, Calif., and author of "Bonds Now!", is telling her clients to avoid the general obligation (GO) bonds of Connecticut and the seven other states that skimped on their pension obligations. (GO bonds are backed by the state's taxing power.)
In theory, you could buy revenue bonds backed by fees from reliable sources such as water and sewer districts. At the moment, however, Julie Jason isn't seeing any revenue bonds that interest her.
Both experts recommend that you diversify. That means adding out-of-state bonds to your portfolio or choosing a muni mutual fund that invests primarily in financially sounder states. You'll owe state income taxes on the interest but are buying peace of mind.
Jason chooses funds based on their credit quality, diversification, duration, cost and yield. Current possibilities: Marshall Intermediate Tax-Free (a no-load fund) and Invesco Tax-Free Intermediate (a load fund, bought through brokerage firms).
You might even consider buying taxable corporate funds instead of municipals. "I never thought I'd say this, but corporates are a safer place," Cohen says. There's tons of cash on their balance sheets, they've paid down high-interest debt, and improved their debts' maturity schedules. She's philosophical about the net yields. "In the end, you'll say to yourself, 'I paid extra taxes but at least I weathered the storm.' "
Click here to follow Daily Voice Norwalk and receive free news updates.
