Archive for the ‘Behavioral finance’ Category

Municipal Bonds and Abnormal Psychology

Thursday, January 27th, 2011

Have you heard there might be trouble with municipal bonds?  Can you fog a mirror?  If the answer to the first is no, and the second yes, then you should probably a) check out this blog more often, b) watch 60 Minutes, c) read the story that was on page 16 of the Wall Street Journal–3 years ago!–and which has now moved to page one of every newspaper.  Mitch Daniels is making it easier for municipalities–cities, is it?–to declare bankruptcy, and there has been talk in Congress of making it possible for states to default on their own debt–it’s presently unconstitutional.

No state in the union will default on its state-level debt obligations.  There.

We have heard of a number of folks who are concerned about the risk in municipal bonds.  So they want to reduce it.  Fine; makes sense.  That’s a prudent step.  Look at one’s holdings of bonds and bond funds to see if there are heightened risks with any of them.   Then sell them if–with individual bonds–the yield you receive based on the price you’ll be paid is worth it to you.  Shift to a safer municipal fund with all or a part of the bond fund proceeds.  Better yet, sell the riskiest individual bonds and invest the proceeds in a well-diversified municipal bond mutual–or exchange traded–fund.  The manager will have his eggs in many more baskets and will be trafficking in such quantities of bonds that it won’t be difficult to make moves based on that firm’s substantial research department’s calls.

But don’t try to reduce your risk by selling your municipal bonds and buying stocks with the proceeds!

You’ll reduce your default risk and heap on a–Indiana phrase coming–whole ‘nother bunch of risks, like event risk, political risk, amongst others–all the risks that are encapsulated in the chart below of the quintessential blue chip stock, Procter & Gamble.  Here’s the schpiel, 

“it’s a great company . . . been around for ever . . . nice dividend . . . you use their products, don’t you?  . . . you know, Tide, Crest, Kitty Litter . . . there management’s great . . . headquartered in the Midwest . . . “

You don’t know General Electric, Ford, Procter & Gamble–or any other stock–any better than you know those municipal bonds that have got you awake at night.