A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

TAX-EXEMPT VS. TAXABLE BONDS ($10,000 FACE
VALUE)
Type of
Bond
Interest
Paid
Applicable Taxes
(36% Rate)
After-Tax
Income
4½% tax-
exempt
$450
$0
$450
6% taxable
600
216
384

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If you buy bonds directly (rather than indirectly through
mutual funds), I suggest that you buy new issues rather than
already outstanding securities. New-issue yields are usually a
bit sweeter than the yields of seasoned outstanding bonds,
and you avoid paying transactions charges on new issues. I
think you should keep your risk within reasonable bounds by
sticking with issues rated at least A by Moody’s and
Standard & Poor’s rating services. Also consider so-called
AMT bonds. These bonds are subject to the alternative
minimum (income) tax and, therefore, are not attractive to
individuals who have sheltered a significant part of their
income from tax. But if you are not subject to the alternative
minimum tax, you can get some extra yield from holding
AMT bonds.
There is one nasty “heads I win, tails you lose” feature of
bonds. If interest rates go up, the price of your bonds will go
down. But if interest rates go down, the issuer can often
“call” the bonds away from you (repay the debt early) and
then issue new bonds at lower rates. To protect yourself,
make sure that your long-term bonds have a ten-year call-
protection provision that prevents the issuer from refunding

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the bonds at lower rates.
For some good tax-exempt bond funds, consult the list in
the Address Book. If you have substantial funds to invest in
tax-exempts ($25,000 or more), however, I see little reason
for you to make your tax-exempt purchases through a fund
and pay the management fees involved. If you confine your
purchases to high-quality bonds, there is little need for you to
diversify, and you’ll earn more interest. If you have just a
few thousand dollars to invest, however, you will find it
costly to buy and sell small lots of bonds, and a fund will
provide convenient liquidity and diversification. There are
also funds that confine their purchases to the bonds of a
single state so that you can avoid both state and federal
income taxes.