Keep More of What You Earn with Munis

They are an attractive investment. They offer a lot of value. But in the context of income, and I think that's important, investors really have to reset their expectations this year. The asset class isn't known for big total returns, yet we've seen that. If you think back where we were two years ago in 2010, we had a very big selloff in the market, but that created a lot of value. So, hence, in 2011-2012, very big returns, prices rose, yields fell, the income component was very strong. But now investors have to think about in a year where rates could rise, we're coming from a very low absolute level of rates, what their expectations will be, and they really need to just think about income, because this year's returns are probably mostly going to come from coupon. So, yes, we certainly do in that context think they represent good value.

And there's another story behind this and it's a good news/bad news story. The bad news is taxes are going up. People are already, as of January first, paying more taxes - that's a fact. The good news is there is a way to shelter that and keep more of what you earn, and that's through municipals. As tax rates go up, the value of that tax exemption goes even higher. There's also a complexity story here. So it's not only marginal tax rates going up for the income thresholds that were negotiated as part of the tax deal, that 400,000 and 450,000 for couples. It's also the payroll tax. It's the Affordable Care healthcare Tax of 3.8 percent, of which munis are exempt from that calculation. So that's another positive facet.

Then there's one more complicated one I don't think investors have necessarily been able to sift through just yet or understand, but I think they will as they go to their accountants and pay their taxes in April. I think they're going to begin to think about it, and that's the limitation on deductions that kicks in at 200,000 for single filers and 250,000 for couples. So all those deductions they've been able to take on their Schedule A, those itemized deductions, now are going to be limited to a great degree. Things like charitable contributions, home mortgage interest deductions, state and local property taxes - all things that people typically pay now is going to be limited. So that means their income is actually effectively the amount of taxes they pay go up, and that income they're going to get keep goes down. That's another popular facet of munis - they're unaffected by that. They'll get to keep more of what they earn by investing in munis.

What I do think they have to change this year is the approach. I talked about two good years of returns, resetting our expectations. So you really need to change your approach. We think we're going to see some volatilities, some volatility in the market. The chances of rates falling from here are pretty low. They're more likely to rise or maybe stay around this level. So we have to, I think you have to take advantage of the volatility that you see in the market. Any sell offs, use some cash to layer into the market.

In 2011- 2012, you were able to go all in. We saw investors pile into long duration funds, into high yield funds. I think be a lot more nimble, a lot more opportunistic and take advantage of the markets. The credit story has improved. I think we've actually reached bottom there. We've turned the corner both at the state and the local level, so municipal credit is stronger than it's been probably in the last four or five years. So, yes, we do think munis represent an attractive investment at this point in the cycle.