Personal Business: SMART MONEY
AN EVEN SAFER WAY TO PLAY MUNIS
Falling interest rates have pushed yields on popular tax-free money market funds close to 4%, off 35% since January. But investors can make up some of the difference by using a little-known alternative: preferred stock of closed-end municipal bond funds, which cost $50,000 or $100,000 per share.
This stock doesn't trade on any exchange, but it's "preferred" in the sense that its owners have claim to the fund's assets before common shareholders. And unlike most preferred shares, the price doesn't fluctuate. "It's dollar-in, dollar-out. What you pay for the preferred is what you get when you sell," says Jeffrey Kratz, vice-president at John Nuveen, which offers 9 of the 21 available issues.
Terms are agreeable: no commissions, dividends are often paid weekly, and earnings are exempt from federal--and sometimes state--taxes. The yields of these stocks, also marketed by Kemper Financial Services, J. & W. Seligman, and Putnam, are set periodically.
In the 2 1/2 years since the bond funds have offered preferred stock, attractive returns have caused the market to hit $3.5 billion. Underwriters have priced the preferred shares competitively to draw big investors from tax-free money markets.
For example, the preferred shares of Nuveen Performance Plus now pay 4.62%--about average for the 12 national funds whose share yields are reset weekly. (There are also seven tax-free funds with preferred shares for New York and California.) Yields are even higher right now for funds whose rates are reset every 28 days, such as the 4.86% paid by Van Kampen Merritt Investment Grade Preferred.
In contrast, the average yield for tax-free money market funds, as tracked by IBC/Donoghue, was recently 4.14%. Hence, an investor in the 31% tax bracket could make $700 more a year on a tax-equivalent basis by putting $100,000 in the average seven-day muni preferred over the average seven-day tax-free money market fund.
DRAWBACKS. The closed-end funds must keep $2 in munis for every $1 of preferred shares. This protects preferred holders from losing their money and has earned the shares AAA ratings from Standard & Poor's and Moody's.
Despite its virtual money-back guarantee, the product has drawbacks. You have no chance to increase your principal; you earn only interest on the stock. And unlike money market funds, your cash is locked in for the 7- or 28-day periods, similar to a certificate of deposit.
But if you are in the market for extra tax-free income, these shares might be preferable short-term in-vestments.A SAMPLER OF
Kemper Municipal Series A 4.90%*
Van Kampen Merritt
Investment Grade 4.86*
Seligman Select Municipal 4.74*
Nuveen Performance Plus 4.62
money market average 4.14
*28-day rate DATA: MERRILL LYNCH
EDITED BY AMY DUNKIN Bruce Hager