Millionaires, who prize bonds for their tax advantages, security and income, are increasing their bond holdings in the current economic environment.
Stocks, bonds and real estate are the lead performers in most Millionaires’ investment portfolios, though the mix can vary with prevailing economic conditions. Current headwinds are driving Millionaires towards two embattled sectors, real estate and individual bonds. The Spectrem Millionaire Investor Confidence Index for August shows that Millionaires are shying away from investing in cash, and mutual funds made up of stocks and bonds. The wealthy nibbled at individual stocks, but showed a marked preference for individual bonds and real estate.
The real estate market remains in a five-year slump, yet prices show signs of stabilizing and interest rates remain at record lows. The buying opportunity has not been lost on Millionaires, whose preference for real estate jumped 7.3 points to 17.2 in the August index.
Bonds are a traditional mainstay for wealthy investors seeking to diversify their portfolios, reduce investment risk and shelter their income from taxes. Millionaires’ preference for bonds rose 6.7 points to 17.2, according to the August index. A subset of bonds, municipal bonds, offer desirable tax advantages because the income they yield is exempt from federal taxes. In some situations munis can be exempt of state and local taxes, too. The higher an investor’s net worth, the more attractive municipal bonds and their tax savings become. More than 80 percent of Millionaires with $15 million to $25 million own individual municipal bonds with an average balance of more than $787,000, according to a December survey by Millionaire Corner.
Like the real estate sector, the $3 trillion municipal bond market has seen troubled times. Dire, but yet unfulfilled predictions of billions of dollars in muni bond defaults in 2011, triggered panic selling throughout the winter, particularly of assets held in municipal bond mutual funds. A declining demand for muni bonds, coupled with a growing fiscal conservatism, created what The Bond Buyercalls “Summer Doldrums” for municipal bonds characterized by few new bond issues. Year-to-date issuance for muni bonds is 38 percent less than a year ago and the lowest level since 2000, the Bond Buyer reported yesterday. The low level of municipal borrowing indicates that fiscal conservatism and widespread deleveraging is trumping record low borrowing costs.
Muni bond defaults in the first half of 2011 were 67 percent below the $2.3 billion in muni defaults for 2010, according to the website Bank Investment Consultants, which notes “fears of defaults and worries over downgrades have kept many investors away from the tax-exempt sector.”
Millionaires seem to recognize potential in the highly diversified tax-exempt sector, made up of 50,000 separate municipalities issuing different types of bonds. The majority - about 75 percent - are revenue bonds typically supported by the proceeds of essential services, such as sewer and water projects. The financial advisory firm Charles Schwab advises investors to differentiate between bond issues. “Focus on quality, and use periods of volatility when yields rise and prices fall as a time to buy,” states an article co-written by Kathy A. Jones, a vice president and fixed-income strategist at the Schwab Center for Financial Research.