I’m guessing you heard about the plunge in Tesla
(The tweet—a poll of Twitter users—garnered a positive response, by the way; Musk says he’ll abide by it.)
I know—another bizarre Musk tweet doesn’t seem to mean much to us income investors. But this one is different, because as hard as it may be to believe, it’s telling us one thing: buy municipal bonds—an asset class many investors dismiss as “sleepy.” That’s not true: there’s a reason why “munis” are favored among billionaires, starting with their huge tax-free dividends.
And what Musk’s tweet is telling us (even if Musk himself doesn’t realize it) is that if we buy munis today, through closed-end funds (CEFs) like the one we’ll discuss below, we’ll get in just before a rush of new investors. And we’ll be pocketing yields that could be worth more than 8% to us, too!
Muni Bonds: Musk’s New BFFs?
Let’s start with why Musk posted this poll: he was responding to recent talk in DC about taxing the unrealized stock-market gains of billionaires. Specifically, the prospective tax aims to curb their regularly used strategy of keeping their shares unsold and borrowing against them to fund their lifestyles, thereby skirting the capital gains taxes they’d have to pay on any sales.
But if unrealized gains were taxed, billionaires would likely sell more shares and, more importantly, find tax-advantaged alternatives. That’s where munis come in.
The Muni Hack to Tax-Free Income
Many investors yawn when they hear about munis because the benchmark index fund for the asset class, the iShares National Muni Bond ETF (MUB), yields a paltry 1.9%. And a long-term return chart for MUB is pretty flat compared to the S&P 500.
But if you dig deeper, munis get a lot more interesting. Remember that MUB’s 1.9% income stream is 100% tax-free for qualifying investors (and most Americans qualify). That means, to get the equivalent of that 1.9% cash flow with dividend-paying stocks (or real estate investment trusts or junk bonds), you’d have to get a 3.2% yield if you’re in the highest tax bracket.
Of course, us CEF investors know that we can do a lot better than MUB by skipping the ETF option and going with a muni-bond CEF.
A Muni-Bond CEF Whose 4.9% Yield “Transforms” Into 8.1%
That brings me to the fund we’re spotlighting today, the PIMCO Municipal Income Fund II (PML), which yields 4.9% tax-free. That’s equal to an 8.1% taxable yield if you’re in the highest tax bracket.
What’s more, PML has easily beaten MUB in the last decade, with a solid 8.9% annualized total return. In other words, it’s done just what we CEF Insider members want it to: deliver strong and steady price gains while letting us enjoy our dividend in peace. (It’s worth noting, as well, that our default risk is low here: fewer than 0.001% of muni bonds default.)
Muni-Bond CEFs Give Us a “Heads You Win, Tails You Win” Setup
If an unrealized-gains tax is pushed through, or even if just a hike in billionaires’ taxes goes through, money will inevitably shift into the muni-bond market, moving prices higher.
And even if none of these tax plans materialize, anxiety about higher taxes on the rich won’t go away—a billionaire tax has been a talking point for over a decade now. And while that’s in the ether, investors will see value in top-performing muni-bond funds like PML, due to their lower volatility and tax-free income streams.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 7.3% Dividends.”