The case for municipal bond funds

Amey Stone

On Tuesday, I met with Bob Pariseau, who manages $3.7 billion in municipal bond portfolios for USAA Funds, including the USAA Tax Exempt Long-Term Fund (USTEX). I've never been a big fan of bond funds -- like most personal finance reporters, I've long thought it made more sense to buy and hold munis rather than have a portfolio manager trade them for you.

Pariseau happily disabused me of that notion and every other complaint that I could throw at him. Here's a condensed version of our give-and-take:

Amey: Isn't it better to buy individual bonds over funds?

Bob: No. With a fund you get diversification, liquidity and lower trading costs. Even better, you get a professional manager who knows when it's okay to buy slightly lower grade bonds so you get higher yields. Plus, you benefit from compound interest without the hassle of reinvesting small lots.

Amey: If interest rates rise, won't your funds take a major hit?

Bob: The price of the fund would fall temporarily, but you'd still get the income. In the long run, do you want more money or do you want the price not to change?

Amey: Don't tax-exempt bonds increase your chances of getting hit with the AMT (alternative minimum tax)?

Bob: Only certain kinds of municipal bonds are subject to the AMT and we don't own any of them.

Amey: What happens if there is major tax reform?

Bob: A flat tax? The numbers don't work. I just don't see it happening for a variety of reasons

Amey: With so many hurricanes, not to mention potential for terrorist attacks, aren't munis risky?

Bob: After 9/11 there were no defaults. There were three hurricanes in Florida and there were no defaults. The long-term default rate for traditional munis is just .02%.

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