How to Pocket TAX-FREE Income With This Sub-$10 Investment
The financial media is obsessed with the next big thing. New tech startups and gimmicky services dominate the headlines. But unless you have incredible foresight or are incredibly lucky, the odds of you picking a Google in a sea of Pets.coms are quite slim.
Oftentimes, the best investments – the ones that will reliably make you money time and time again – are far less glamorous.
And a prime example is the humble municipal, or muni, bond (not to be confused with a Treasury bond). Munis are bonds issued by federal, state and local governments to pay for their projects. They’ve fallen out of favor over the last few years, as interest rates were pitifully low.
But these federal-tax-exempt assets are enjoying a renaissance as the Federal Reserve raises rates. Now, normally interest rate increases cause bond prices to tank, but muni bonds work a bit differently…
Contractually Obligated Profits
First, a brief crash course on bonds. Bonds are essentially contracts. Buying one means you are effectively buying the debt of the bond issuer, loaning them your money. The bond obligates the issuer to pay you back with interest, called a coupon.
You collect interest in the form of coupon payments for the life of the bond, and when the bond reaches maturity, you get the bond’s face value back. Face value is the amount of money you’re lending to the bond issuer, but the market value of the bond might be higher or lower.
Here’s how all this works…
Say you buy a $1,000 muni bond from your local government. It has a 5% coupon and matures in 10 years. That means you will receive $50 each year, usually in two $25 payments. When the bond matures, you’ll get the $1,000 back, having made $500 total for a return of 50%.
But sometimes the bond market will cause bonds to dip in price. If you buy that same 5% coupon bond for $900, then you will still get the $1,000 face value upon maturity. In that case, you will have made $600, or 60% total ($500 in interest and $100 at maturity from buying at a discount to face value).
The only problem is startup capital. Buying bonds gets expensive fast. One bond for $1,000 isn’t bad, but you’re making only a few hundred dollars that way depending on your coupon rate…
You need to buy a lot of them to make a big return. If you bought 10 of those 5% coupon bonds, you’d make $5,000 on the lot of them. But it would cost you $10,000 upfront, give or take.
But there is a cheaper way to profit from the tax-free potential of muni bonds. It’s called the Nuveen Municipal Income Fund (NMI), and it’s about to enjoy a windfall as interest rates rise.
The Swiss Army Stock
The Nuveen Municipal Income Fund is a tradable fund and a hidden market indicator all in one. It has the simple objective of generating a high level of current income that’s exempt from federal income tax. To achieve that, Nuveen invests 80% of its managed assets into investment-grade muni bonds. The other 20% goes into higher-risk bonds.
And it uses no leverage at all to purchase its assets, so overall it’s an incredibly low-risk fund.
The fund’s expense ratio is about 0.73%, which is in line with the average across mutual funds. It also costs less than $10 per share and pays a distribution that yields 3.97%. It’s a simple, straightforward fund that invests in stable assets that are sure to make money.
In addition, the fund is a hidden indicator that can potentially tell you what the market is about to do…
Bond prices have an inverse relationship with interest rates. When new bonds are issued, their coupon rates are based on the current federal funds rate. That means changes in interest rates by the Federal Reserve can cause values of existing bonds to increase or decrease.
Say you have a bond with a 4% coupon based on current rates. If interest rates rise and a new bond is issued with, say, a 6% coupon, the 4% bond will drop in value, as the 6% bond offers a better return.
However, if interest rates fall (as they always do because rates move in cycles), the 6% bonds will rocket up in value because new bonds will be issued at lower rates – around 4% or even lower. If interest rates drop even further, the 4% bonds will also go up in value. If you bought them when they were low, you could collect a nice premium.
Now, a fund like the Nuveen Municipal Income Fund can take advantage of all that. The fund will buy bonds as interest rates go up and will likely hang on to the older, lower-rate bonds. That means when interest rates cool off, the fund can sell the higher-rate bonds at a premium or just hang on to them and collect a high coupon. Either way, the bond fund profits and so do you.
What’s more, the Nuveen Municipal Income Fund benefits from the tax advantages of muni bonds and passes that on to its investors…
The interest earned off muni bonds is free from federal taxes and is often free from state taxes as well. State tax exemptions depend on what state the purchaser is from and what state issued the bond being purchased.
The Nuveen Municipal Income Fund seeks to deliver that tax-free income to investors. The fund yields 3.97% in tax-free income as of this writing. That’s the yield. You don’t need to pay any additional taxes on what is, essentially, a 4% yield.
That might not sound like much at first, but let’s look at an example.
The fund’s website has a handy calculator to work out the yield you would need to make to yield the same 3.97% after taxes.
So let’s say you’re a single person making $100,000 per year. Your federal tax rate is 24%, so in order to make the same yield that the Nuveen Municipal Income Fund offers, you need to find a fund offering a 5.22% yield before taxes.
That would likely be difficult to do, as your average dividend stock yields somewhere between 2% and 5% before taxes. Once Uncle Sam is done fleecing you, you’ll end up with a far lower yield than you thought. And it’ll almost always be lower than what you currently can get with the Nuveen Municipal Income Fund…
Because the Nuveen Municipal Income Fund’s distributions are paid out from the income it makes off its bonds, you don’t need to pay additional taxes on that income. So the 3.97% yield you see is the yield you get. And as an added bonus, the fund pays out income monthly.
But that’s not all… While you hold the Nuveen Municipal Income Fund, you can also use it as an indicator to guide your future investments…
All of the Nuveen Municipal Income Fund’s bonds are insured, as the fund is an insured muni closed-end fund. The bonds are going to pay out because even if the entity that issued them goes bankrupt, the insurance kicks in and pays out the rest of the bonds. That makes this fund about the safest investment one can make.
So when people start selling the Nuveen Municipal Income Fund, it means they’re panicking. It’s such a safe investment, you’d sell it only if you wanted out of the market entirely. When people sell the Nuveen Municipal Income Fund, they’ve hit the bottom and panic-selling has peaked.
When panic peaks, it creates an opportunity for you to buy stocks, as you can get in at a lower price before the market most likely recovers. It actually correlates with the VIX, or Volatility Index. If the Nuveen Municipal Income Fund dips to about $9 (just about what it trades for at the time of writing), that means it could be time to buy… not just the Nuveen Municipal Income Fund but other stocks you may have had your eye on too.
The Nuveen Municipal Income Fund does it all. It protects and grows your money… It lets you know when a buying opportunity is coming… It slices, it dices, it makes julienne fries. And you should add it to your portfolio as soon as you can.
Action to Take: Buy the Nuveen Municipal Income Fund (NYSE: NMI) as long as the yield is above 3.5%.
A Sure Bet in an Unsure Market
Muni bonds won’t win headlines like the latest gimmick sweeping Silicon Valley, but they will provide tax-free income regardless of what the broader market is doing.
And the Nuveen Municipal Income Fund is exempt from federal taxes, and it could even be tax-free in your state too depending on where you live. At the fund’s current price relative to its holdings, you can pick it up today for essentially $0.80 on the dollar.
With tax-free income at less than $10 a share, the Nuveen Municipal Income Fund is a no-brainer. Especially once interest rates cool and drop when the cycle changes direction.
If you buy in now, you’re positioning yourself for a major windfall in the near future.