This 5.4% dividend is a 9% payout in disguise

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Municipal bonds are too often ignored by investors. That is a huge missed dividend opportunity.

Too bad, because billionaires have been using “munis” to anchor their wallets for years. And rightly so: as we will see later, munis can perform well when rates rise. They also pay a high “hidden” return that’s better than anything you’d get on a treasury — and most stocks.

“Munis” offer safe, high and tax-free returns

I’m saying that Munis proceeds are “hidden” because they… tax free. If you’re in a high tax bracket I probably don’t need to tell you how valuable a tax-free return is, but the numbers here are terribly compelling. Take the return of 5.4% on the Nuveen AMT-Free Municipal Credit Income Fund (NVG), a closed-end fund (CEF) that is one of the best ways for you to crack the muni market.

Thanks to its tax-free nature, that already healthy return of 5.4% can be worth 9% or more if you’re in the highest tax bracket. That’s the kind of return you should normally get for a high-risk investment like junk bonds.

But munis are the opposite of that – known for their stability and ready to hold up well, whatever happens to the economy from here.

If the recession forecasts are correct, municipalities are well equipped to deal with them, thanks to the reliable income they get from local taxpayers. In addition, many cities and states still have significant pandemic relief resources from the federal government.

History is on our side here, too: Despite high-profile bankruptcies in places like Detroit and Puerto Rico in recent years, Munis’ default rates are so low (less than 0.01%) that research firms have stopped talking about this as a realistic one. risk.

And if the recession call is wrong and inflation and rates rise further, history shows that munis are doing just fine, judging by the performance of the benchmark iShares National Municipal Bond ETF (MUB).

When the Fed started raising rates in late 2015, the muni market fell, but then rose again quickly as investors sought a safe haven from volatility. And munis continued to pay dividends throughout the period, providing investors with a much-needed income stream.

Think CEF, not ETF, when buying Munis

Finally, unlike an ETF, NVG is actively managed, and with munis it is having an experienced manager at the helm: critical. That’s because the muni market is much much smaller than the stock market, so a muni bond manager is better able to judge the quality of each bond. Here too, personal connections help, because the manager can be tipped if nice new bonds are issued.

Algorithm-driven ETFs, like MUB, just aren’t set up for those kinds of environments, as evidenced by a direct comparison of NVG and MUB since NVG’s inception.

Before I get into packing, let’s talk a little more about NVG and why I see it as a good buy now.

This rural muni-bond fund has assets across the country, making it geographically diversified, while the portfolio of over a thousand bonds protects it from one bond that doesn’t pay out thanks to its massive diversification.

In addition, about three quarters of the portfolio is investment grade credit, meaning we get the best quality and safest bonds out there. The fund is currently trading about 1% below its portfolio’s value (net asset value, or NAV), which isn’t a huge discount, but it has traded as much as 3% above NAV in the past year. I think it’s likely that these highs will be hit again as more investors see the high, tax-free returns and low volatility on offer here.

Michael Foster is the principal research analyst for: Contrary Outlook. For more great income ideas, click here for our latest report »Indestructible Income: 5 bargain funds with safe 8.4% dividends.

Disclosure: none

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